In my Investment Risk Management Strategies – Part 1 post last week I shared with you some risk management strategies that I’ve learned… the hard way. I was too busy with my work to take care of my retirement portfolio. After working for many years for major financial corporations, I accumulated a substantial amount of money that needed to be managed. When I was offered by a representative from the brokerage company to meet with their affiliated advisers, I was ready to delegate the responsibility of managing my retirement portfolio to professionals!
I interviewed a couple of advisers who showed me how great they performed in the past, their projected (based on historic returns) return on investment and their fee (1-1.5 % of the value of my portfolio). I was so eager to outsource the responsibility of managing my money to professional investment managers that I jumped in with both feet and hired a pro to help me!
NO, I didn’t ask them:
- How the performance of my portfolio will be linked to their compensation?
- What will happen if my portfolio will not perform as projected?
- What asset allocation are they going to use to achieve the desired ROI (return-on-investment)?
- What criteria are they going to use for choosing companies they invest in?
- Do they use the dividend reinvestment strategy (to take advantage of compounded interest)?
- What is their risk management strategy and how will they hedge the market risk in my portfolio?
- What is the maximum allowed loss per position in my portfolio?
- What is their view on seasonal, economic and political cycles that affect the stock market and how they align their strategy accordingly?
- Why do they suggest using mutual funds vs ETF (exchange traded funds that are less expensive)?
- How often will we have an opportunity to review my portfolio’s performance?
Well, it was a costly “learning experience” for me. I lost a lot of money and had to pay the portfolio manager for this poor performance! After waiting and giving them a chance to show the promised performance for a couple of years, I decided to educate myself enough to manage my retirement portfolio myself.
I am not alone – I know many people who have worked hard, made a lot of money but haven’t taken the time to educate themselves about investment and risk management. Just like I, they outsourced their portfolio without thoughtful screening their investment advisers and got very disappointed. This is true for not only the stock market investments but real estate, precious metals, fine art and other investments.
Become an Educated Investor
Invest in areas that you have some level of expertise in or be willing to educate yourself. You can subscribe to investment newsletters, read books on investing or attend investment seminars.
If you choose to delegate growing your wealth to a financial planner or an investment adviser, research their suggestions and their track record before signing up to do business with them. Make sure that advisers are not compensated based on the amount of money you invest with them (not commission-based.)
ALWAYS REMEMBER THIS: Nobody cares about YOUR MONEY more than you do, therefore, exercise extreme caution if you outsource managing your money to others.
Don’t Let a Small Loss Become a Huge One
You must exercise utmost discipline with your investments on the stock market because it is extremely difficult to recover your portfolio from a big loss. Here is a market portfolio loss/recovery forecast:
- If you lose 10 percent, you need an 11 percent gain to get back to ‘square one’
- If you lose 50 percent, you need a 100 percent gain just to get you back to where you started
You may think it’s very unlikely to lose so much on the stock market…and I say it is highly probable and, in fact, happens all the time. Unfortunately, inexperienced investors get frozen when they experience high losses of value and do nothing with the hope to at least recover their losses. Most of the time, this waiting strategy leads to an even more desperate situation. You don’t want this to happen to you!
Experienced investors know that both, the buy and sell decisions are equally important. However, most individual investors are consumed only by decisions about what and when to buy and almost never think about when to sell. Lack of an exit strategy leaves a big gap in successful investing and often leads to losing money on even initially good investments.
You can set a mental sell stop for your investment and execute it when your position hits this price or enter it explicitly on your brokerage account as a stop limit or a trailing stop. The latter allows your investment to rise but activates a sell order if the position falls by a pre-set amount or percentage. This discipline is yet another form of risk management.
As John Maynard Keynes famously noted: “The market can stay irrational longer than you can stay solvent.” I suggest that you use limit stops or, better yet, 15 to 25 percent trailing stops on ALL your portfolio positions and apply these stops as soon as you execute your buy order. This will limit your losses and preserve your capital, which is the most important thing in investment.
Cool Attitude Factor
It is quite common for novice investors to get emotionally attached to a particular investment and get completely frozen and desperate when a promising investment starts melting away. That is why a cool attitude factor—your temperament—is so essential for successful investing. A high level of stress associated with investments is a sign of an amateur or a greedy attitude.
A poor investor has a “how much can I make on this and how fast?” attitude. A good investor contemplates what needs to be done to minimize losses to pre-set minimums in case the promise of a particular investment doesn’t actualize/materialize. Having a disciplined and rational approach instead of a greedy and emotional one with all your investments is absolutely essential to achieving success in investing.
Many times it is smarter to do nothing. Often, just a few wise decisions over time add up to great wealth. Of course, you have to know when to act and with how much.
To your Health, Wealth and Freedom!
With Love and Gratitude,