As the old adage goes, the best offense is a good defence. This is true where the development of your investment portfolio is concerned. There are times when a defensive strategy can be more effective in protecting or even increasing the value of your investments simply because you do not take undue risks and are prepared to react when the market takes a sudden dip.
We often look at countless ways to get ahead of the markets but fail to see ourselves as an important component in the equation to achieving success. Our psychological behaviour and intellectual abilities will generally determine how we invest, and because everyone is unique, the way we interpret the information may differ considerably. With a better understanding of yourself, you will know how to enhance your strategies. The following are a few key characteristics that tend to affect our financial decisions:
Everyone who trades expects to make money; losing is not an option. It is great to be determined or have a positive attitude but this will not guarantee success, especially when you are faced with difficult decisions and are under pressure to make the right call. How you react and manage yourself in the face of a crisis or challenging decision will define what you are made of. Don’t presume that the phrase ‘no risk, no gain’ is applicable here. Bank traders can possibly adopt this attitude since they are not using their own money and still receive their salary even if they lose money, but can you afford it?
This is when you need to be true to yourself. Several factors that generally affect your risk tolerance levels are personality, personal financial commitments, understanding of the investment or trading product and availability of funds. This is why financial regulators in many countries require financial institutions or advisers to conduct a risk assessment on the clients before they can offer the various categories of investment products. Investors with low risk tolerance who are advised to buy high-risk products often end up losing more than they can afford when the investment sours. This is because they either do not have the expertise to make the appropriate decision and/or the understanding of the product’s complexities.
Get to know your inner self and your true strengths and weaknesses. It is human nature to think highly of oneself, but it serves no purpose if you make investments beyond your capabilities. When we invest beyond our risk tolerance level, most of us tend to make more mistakes or even react irrationally.
Have you noticed how bank traders generally tend to have similar personality traits, such as being outspoken, highly competitive, overly confident and quick tempered? This is primarily because banks have already established a ‘typical’ trader profile and interview candidates who fit this profile tend to clinch the job.
It does not mean that you need to fit the typical trader profile to be successful, but the more you understand yourself the better you can develop your trading style. Ask yourself if you will go ballistic if you lose 1% of your portfolio in a day or if you are the cowboy who shoots from the hip, hoping to hit the target until the last bullet. Always establish risk tolerance parameters that you are comfortable with and stay within the boundaries. For novice investors, it’s best to be conservative until you learn about your personality as an investor.
I always recommend that novice traders only trade with spare cash as many of us have some form of financial commitment, such as home mortgage, education and car financing. It all adds up and leads to stressful situations, especially when you are faced with a loss trading position. When we subject ourselves to financial risks, things can easily spiral out of control. Our decisions will often be compromised and our actions tend to get increasingly desperate when the losses pile up.
Experienced investors and traders will always tell you not to jump into the deep end without knowing the basics. The concept of investing and trading is simple, but you will notice that banks don’t allow novice traders to trade until it becomes second nature to them. All traders undergo comprehensive training in order to thoroughly understand the product. This means that they study and collate all factors affecting the product before trading to minimise the risks and maximise their chances of success. These include making sense of economic data, geopolitical events, technical analysis and trends, and market conditions. Until you are confident about the mechanics and fundamental issues affecting the product, take baby steps.
It’s never the same when trading with someone’s money as compared to your personal savings. Regardless of whether you are a millionaire or a working-class individual, you will feel the pinch when you incur a loss from your personal savings. The degree of ‘pain’ will differ depending on the individual’s availability of savings or need for funds.
Bank dealers, on the other hand, trade on behalf of the bank and funds are seemingly inexhaustible. With these two key factors in play, the risks are greatly reduced. So try to play the same game—trade with spare cash and always be willing to lose it all. When the fear of losing is eliminated or minimised, you can trade with a clearer frame of mind.
All professional investors and traders abide by trading limits, be they self imposed or set by an independent unit or regulators. Although professional traders seem to trade without limits and restraint, it is important for you to learn to identify, navigate and limit the risks so that you don’t crash and burn.
Much like the speedometer and safety devices in a car, limits are the safety mechanism that warn and protect the trader. Knowing your limits helps you to drive safely and to stay in control of your investments.
When faced with a loss, our instinct is often to try and recoup the loss by doubling the bet or even praying for divine intervention. The best traders know when to cut their losses and not to look back. Although it is possible to hold a losing position, the situation becomes worse when you play on the margins as there is often a need to pump in more cash as the loss grows bigger. Always be ready to cut your losses as soon as the situation takes a turn for the worse. It is always better to be able to regroup to trade another day than to be left with nothing.
Being on a winning streak is a great feeling. But we tend to let our greed get the best of us and want to milk every cent we can. Remember that any gain made when you trade is a paper gain and is not worth anything until it is cashed in. The gain you see on paper may turn into a loss in a matter of hours or less, depending on the volatility of the market. Banker traders know that their bonuses depend on realised profits so they will lock them in even when the profits may seem trivial.
The chances of catching the most profitable or best rate are never easy and the longer the wait, the more risks set in. So set a comfortable level and take your profits with no regrets even if you could generate more. When your profits are locked in, you create more opportunities to seek other profitable trades, so don’t lose sight of the big picture. Small amounts of profits do add up to a larger sum so it is always good to stay on the positive side of the equation.
All too often, we let our stubbornness or fear call the shots even though we are sinking deeper into financial trouble as we try to stay the course. As the financial markets are always dynamic and volatile, you need to adapt and change your strategy to suit the situation. A minor change may make a significant impact in protecting or salvaging your investment portfolio, so give yourself the option of looking into alternatives.
As the risks grow and your portfolio is underperforming, take the opportunity to rebalance your assets. This could mean changing the percentage of the class of assets (for example, switching out of shares and buying more fixed income assets) or changing the risk profile within the portfolio (such as selling off speculative shares and replacing it with blue chip shares). When experts say to hold your investment for the long term, it does not mean to make a purchase and expect it to provide the expected returns without constant and regular rebalancing.
Never leave your investments unattended as you should learn to adapt or align it according to market conditions. For example, although investing in properties is considered a long-term investment and the initial purchase may be in a prime district, the property may lose its value over time as it is considered old or the area no longer commands the prime value it once did. So it may be better to sell and invest in another property that has a potential to generate a higher return.
Investing is about knowing when to buy and when to sell, and not holding on to a bleeding investment and hoping for an eventual turnaround. All professionals will agree that it is sometimes better to cash out underperforming investments and sit on a pile of cash until a good opportunity presents itself and not to jump into alternative investments in hope of recovering earlier losses.
Be careful when seeking expert advice as the more you seek the more confused you will be if you do not know how to filter out the noise. When in doubt, always pause to sort out your next move. This may take anywhere between a few weeks and perhaps even months; never rush into a hasty decision that you will regret later. By holding cash, you are able to reposition your investment portfolio that minimises risks to wait out the crisis.
There is a difference between building your nest eggs early on in life and starting much later. We often overlook the fact that we need to adopt the appropriate investment strategy in accordance with where we are in our careers and the numbers of years we have to retirement. Particularly with a defensive play, it is critical to acknowledge that your chances for future earnings will be limited if you are close to retirement as opposed to when you are starting your career. Your risk appetite should therefore be controlled. When you overstep your financial limits, you start to gamble, which can result in unpleasant consequences.
If you have just started to build a portfolio in your fifties, chances are that you are cash rich but time may not be on your side when it comes to recovering from a significant loss. Which means that you will consider getting out of underperforming assets faster or even limiting your asset classes to less volatile markets. It may be true that your earning potential will increase with age but your personal financial commitments—such as starting a family and putting your children through college—will also increase. Not everyone will start investing at a designated time in their life, so be realistic and selectively apply strategies that are ‘age appropriate’ to your current stage in your career or future earning potential.