Showing posts with label Facing My Financial Fears: Investment Risk. Show all posts
Showing posts with label Facing My Financial Fears: Investment Risk. Show all posts

Tuesday 25 September 2012

Even Lousy Investing Beats Not Investing

By Chuck Saletta September 18, 2012

It wasn't that long ago that we suffered through a period of time in the stockmarket that has come to be known as "The Lost Decade." The 10-year period between the start of January 2000 and the end of December 2009 was one of the worst for stock market performance, ever.
Yet even during those dark times, one very straightforward strategy would have allowed you to just about break even -- or perhaps even make a few bucks along the way. All you would have had to do is dollar-cost average into the low-cost market-tracking SPDR S&P 500 (NYSE: SPY  ) ETF and reinvest the dividends you received. That's one of the simplest ways to invest, and that strategy -- or one essentially equivalent to it -- is very often available in 401(k)s and other retirement accounts.
Although those returns were lousy, both in absolute terms and when compared to the market's long-run average, there's one strategy that it certainly beat: not investing at all.
The act that matters most
When all is said and done, doing what it takes to invest in the first place matters at least as much as the actual returns you get on your invested cash. There are several reasons for this. Perhaps the most obvious is that if you never put any money away at all, no rate of compounding will get that goose egg to ever be anything but a goose egg.
But on another, more subtle level, the act of investing itself matters because making the commitment to do it well requires the rest of your financial house to be in order. You need to be in control of your debts and have enough cash coming in not only to pay your bills, but also to put some away for your future. In essence, investing takes discipline -- the exact same type of discipline that will help you manage whatever sized nest egg you do manage to amass over your investing career.
Your potential $1 million payout from "lousy" investing
A typical working career may last in the neighborhood of 45 years. Having and keeping a consistent investing plan throughout that journey may seem like a daunting task, especially if we suffer through many more of those "Lost Decades." Still, as the table below shows, the reward at the end of the 45-year process may well be over $1 million, even while earning consistently lousy 2% annualized returns:
Monthly Investment
-1% Annual Returns
0% Annual Returns
1% Annual Returns
2% Annual Returns
$0$0$0$0$0
$100$43,499$54,000$68,162$87,466
$200$86,998$108,000$136,324$174,931
$300$130,497$162,000$204,487$262,397
$400$173,996$216,000$272,649$349,863
$500$217,495$270,000$340,811$437,328
$750$326,242$405,000$511,216$655,993
$1,000$434,990$540,000$681,622$874,657
$1,250$543,737$675,000$852,027$1,093,321
$1,416$615,945$764,640$965,177$1,238,514
Source: Author's calculations.
Granted, to reach the bottom line of that table, you'd have to contribute the maximum allowable $17,000 to your 401(k) throughout your career. Still, the $1 million nest egg at the end is an incredibly impressive result for only managing 2% annualized returns. No matter how challenging it may seem to sock away more than $1,400 a month, note what happens on that top line. If you don't invest at all, when it comes time to retire, you won't have anynest egg to tide you through your not-so-golden years.
The joys of lousy investing
Once you realize how important making the commitment to invest is, getting past the fear of investing poorly is much easier. You can much more objectively look at every investment you have made as either a place to earn or a place to learn. For instance, I view my investment in industrial and financial titan General Electric (NYSE: GE  ) as one of the best investments I've ever made. It was a good investment because of what I've learned from it, in spite of the lousy returns I've received along the way.
Indeed, the principles I learned from that GE investment -- looking for a strong balance sheet and a well-covered and rising dividend -- have yielded far more successful investments than failures over the years. When coupled with the third key lesson from that investment -- prudent diversification -- the experience formed the foundation of an investing strategy that looks capable of withstanding the test of time. Not bad for an investment with objectively lousy returns.
Often, investing does work out
Of course, not all investments turn out poorly, and in fact some wind up doing quite well. Over the course of an entire career, the combination of lousy and great investments in the context of an overall solid strategy could very likely exceed that 2% annual return level. But if you're planning for lousy returns and wind up with better ones, you'll end at a much better place. Yet no matter what your ultimate returns, it's having the foundation and the dedication to invest that matters most.


Thursday 16 August 2012

Risk is Manageable: Risk-Avoidance Strategies

Master Investors use one of the four-risk avoidance strategies:
1.  Don't invest.
2.  Reduce risk (the key to Warren Buffett's approach).
3.  Actively manage risk (the strategy George Soros uses so astonishingly well).
4.  Manage risk actuarially.

There is a fifth risk-avoidance that is highly recommended by the majority of investment advisors:  diversification.  But to Master Investors, diversification is for the birds.

No successful investor restricts himself to just one of these four risk-avoidance strategies.  Some - like Soros - use them all.

Wednesday 18 January 2012

Conquer Your Fear of Investing


Updated: 8/11/2011 

Many of the most worthwhile things in life are scary at first. Consider, for example, going to school for the first time, falling in love, learning to drive, starting a family, figuring out your new Tivo…
Investing is no exception. The thought of possibly losing money is a terrifying prospect. And the fact that today’s economy has seen better days probably isn’t helping those fears. Investing in the stock market has its risks. But if you give in to fear, you’ll pass up some incredible opportunities—ones that come with big dollar signs attached.
Now is actually a good time for young adults to bite the bullet and get started investing. Think of a market downturn as a clearance sale: It’s a good idea to go shopping before prices climb again.
Bottom line: Surrendering to fear only holds you back. If you want to get ahead financially, you’ve got to invest in your future. Below are five common excuses and the strategies you’ll need to overcome them.

FEAR: I don't want to lose all my money.

CONQUER IT: Diversify.

If your investments are too heavily-weighted in one stock or even one particular kind of stock, you can deep-six your savings goal. (Remember the tech bubble or, more recently, the financial services crisis?) Mutual funds are a good way to achieve instant diversification because they allow you to invest in dozens of stocks within a single fund.
One of the quickest ways to diversify, if you’re new to investing, is with a fund of funds that invests in other mutual stock funds. Or if you’d like something a little more conservative in this uncertain market, go for a so-called “balanced” fund that owns stocks as well as bonds. But bear in mind that for long-term goals, stocks should earn you the highest return.

FEAR: How will I know the best time to invest?

CONQUER IT: Dollar-cost average.

There’s no crystal ball that tells you exactly when the market will rise and fall. The trick is to invest regularly no matter what the market is doing. A simple strategy called dollar-cost averaging eliminates the guesswork. By investing a fixed dollar amount at regular intervals, such as every month or every quarter, you smooth out the ups and downs of the market. This trick takes out all the emotion—it’s scary to invest when the market’s falling, for example—and investing becomes much less daunting.
Mutual funds are, again, a great investment for dollar-cost averaging because you aren’t charged a commission each time you buy (like you are for individual stocks).

FEAR: I'm too queasy for the ups and downs of investing.

CONQUER IT: Ignore your investments.

When you obsess over how your investment is doing from day to day or week to week, you could be more tempted to tinker with it instead of sticking to your long-term diversified plan. Not to mention, you’ll probably lose sleep.That’s not to say you shouldn’t ever reevaluate your investment choices. Just don’t fixate on them.

FEAR: I don't have the time or knowledge to manage a portfolio well.

CONQUER IT: All-in-one funds or index funds.

Think simple. When you start investing and aren’t sure what you’re doing, don’t pretend you do. Truth is, most actively managed mutual funds don’t beat their market benchmarks. If those fund managers have the time, the education and the motivating paycheck, and they can’t pull it off, don’t worry if you’re afraid you can’t either.
Go with funds of funds to achieve instant diversification. Or assemble a simple index fund portfolio. Index funds don’t try to beat the market benchmarks, they match them. Put 75 percent of your money into a fund that tracks the overall U.S. stock market, 25 percent into one that tracks international stocks. Then let ’em ride. As your investments rise and fall, all you’ll have to do is realign your money every year or so to maintain the proper weighting in each fund.
One more way to set it and forget it: Sign up with your broker or fund company to have your regular contributions automatically withdrawn from your bank account.

FEAR: What if I need the money?

CONQUER IT: Set clear goals and choose your investments accordingly.

Before you start investing, write down what you’re investing for and when you think you’ll need the money.
If you’ll need the money within the next three to five years, preservation is your number-one aim. Put that money somewhere safe and accessible, such as a money market mutual fund or a high-yield online savings account. You could also opt for a bank certificate of deposit. But bear in mind your money is locked in for the term of the CD, and you’ll pay a hefty penalty if you need to cash out early.
If you’re investing for the long term, growth is your goal. Invest that money in a broad-based mutual fund that holds mostly stocks. If disaster strikes and you really need the money, you can cash out at any time – but you’ll have to pay taxes on the money you made.

http://www.kiplinger.com/magazine/archives/2009/01/fred_frailey.html

Monday 22 August 2011

The psychology of investment: caution or risk?


What makes some investors revel in danger and others flee at the first sign of market volatility?

'Mind-reading machine' can convert thoughts into speech
The psychology of investment: caution or risk? Photo: GETTY IMAGES
Evolution has programmed us to flee from danger. But the same instinct that protected early human from the sabre-toothed tiger makes for an unsuccessful investor. As global markets have fluctuated wildly, investors have been indiscriminately cashing in their investments, panic selling as times get tough.
A tenth of the fund supermarket Fidelity FundsNetwork's customers have switched their investments into less risky assets as a result of the eurozone worries, with low-risk bond funds the preferred option over equity or equity-income funds.
But if those investors kept their composure and did nothing, they would have made money as banking stocks pushed the FTSE 100 up to close last Friday on 5,320, compared to 5,247 the previous week.
But what makes some people flee to cash deposits as markets crash and others gleefully seek out opportunities among the ruin? While many of us would prefer to consider ourselves spontaneous risk-takers, when it comes to the crunch, most investors value capital preservation over high-risk, high-income investments.
"Everyone wants minimum risk and maximum return, but it is rarely possible to do both," said Neil Pedley of Vestra Wealth.
Wealth managers have the complicated task of gauging a client's risk appetite to allocate their cash correctly. Rather than take the client's word for it, wealth managers at Barclays Wealth employ personality profiling to gauge investment attitudes.
"It can be difficult for investors to be honest with themselves," said Greg Davies, who is head of behavioural finance at Barclays Wealth. "Some people like to think of themselves as composed risk-takers, but if you try to invest in a way that does not respect your natural 'type', you make decisions you are not comfortable with and you will lose money."
There are two parts of our brain that govern decision making.
1.  The first is rational, logical and more suited to decision making based on long-term goals. 
2.  The second controls emotional decision making – the fight-or-flight reflex.
In times of stress or perceived danger, humans default to the emotional brain and seek instant gratification, rather than considering long-term success. Though this "action bias" may have been a successful tactic when early human was faced with a predator, it does not help investors make money.
"When we pull our money out of markets during a crash, we get instant emotional gratification. We are happy because we have removed ourselves from the perceived danger – the risk of losing more money. However, this short-term thinking is bad for long-term goals," said Mr Davies.
As well as asking clients about their investment goals, Barclays constructs client portfolios based on the results from the personality profiling, which assesses composure in the face of risk.
The idea is that two clients could have the same amount of money to invest and the same long-term investment goals, but if one has a high level of composure and the other a low level of composure, their investments should be different. The client with the low composure is more likely to act rashly when he sees his investments fluctuate in value, so his portfolio is hedged with slower growth but low-volatility assets.
By constructing a portfolio in this way, Barclays lessens the chances of clients falling for pack mentality – buying at the highest price and selling at the lowest.
Wealth manager HFM Columbus also uses psychometric profiling to help determine clients' attitudes to investment risk, as well as the ways to best service clients, for example, are they likely to read fund literature, or would they prefer a short summary?
The test assesses five major personality traits: openness, conscientiousness, extroversion, agreeableness and emotional stability. "We are focusing principally on the 'conscientiousness' variant to ascertain how much or how little the client wishes to engage in the advice process and to ensure that we deliver the correct amount and type of information in order for them to make a decision," said director Marcus Carlton.
"We anticipate that the client's degree of conscientiousness will inform us if they are rash decision makers or if they make more studied decisions, and the profiler will also look at emotional stability in order to analyse likely reaction to unexpected outcomes – for example severe market volatility – so that we can protect clients and manage their expectations better."
You do not need a psychometric test to take advantage of this psychology. Mr Davies said investors should exercise self-knowledge and put in place a set of rules for investing.
"Most of us can help break our emotional investing habits by setting a framework in place in times of calm to be prepared for times of turbulence. You can bet those investors who are taking advantage of value stocks now will have planned their response to these situations. They will be informed and have engaged with markets for a while," said Mr Davies.

Wednesday 2 March 2011

How to overcome your financial fears in investing?


These are the usual three basic fears one has to face in investing, namely:

Fear of loss
Fear of failure
Fear of unknown

Here are some suggested ways to overcome these:

Fear of loss:  Understand the probabilities and consequences of any potential loss(es) in your investing.  Always remember, in the face of uncertainties, your investing actions should be based on the consequences rather than the probabilities of these loss(es) occurring.

Fear of failure:  Nothing venture, nothing gain.  Without trying, you have already failed.  Seize the opportunity.  Be prepared for possible failures too, but take these as valuable lessons preparing you for a better future.

Fear of the unknown:  Research the topic well to become knowledgeable.


Also read:
I Will Tell You How to Become Rich: "Be fearful when others are greedy, and greedy when others are fearful."
http://myinvestingnotes.blogspot.com/2010/12/i-will-tell-you-how-to-become-rich-be.html


Wednesday 1 July 2009

Facing My Financial Fears: Investment Risk

Facing My Financial Fears: Investment Risk
November 23, 2006 @ 12:01 pm - Written by Trent


This week, The Simple Dollar is doing a five part series on financial topics that scare me just a bit. Researching and then writing about them will (hopefully) alleviate some of that fear
Other fears include buying a car, estate planning, and Roth IRAs.

My fear of financial risk goes back to the stock market crash of 1929 and the subsequent bank collapses of the early 1930s. My grandfather was a young entrepreneur in the late 1920s who held almost all of his assets in either stocks or in a local bank; between 1929 and 1931, he lost everything he had. After that, he did all of his savings in large glass jars.

This rubbed off on me as a child. I would watch him keep money in jars all over the place on his property and when I would ask him why he didn’t put it in a bank, I would get a very angry old man railing about how banks stole all of his hard-earned money and that they’re all crooked.

I eventually started a savings account at a local bank, but before I did I insisted on a copy of the FDIC guarantee on the account and, for almost my entire life, I’ve either held my money in my hands or kept it in that bank.

This fear is really my grandfather’s fear, I guess; I worry that I will simply lose everything I have if I entrust it to others. Whenever I make a decision to move my money, I still do it with extreme care, checking the history of the bank and the insurance on the accounts. I now have savings at three different banks, though it took me a while to reach that point.

The next step was taking the risk of investing in a retirement plan. Even with 100% matching from my employer, I felt on some level that I was “giving away” money. I spent an entire day asking all sorts of questions to a financial planner (who apparently later indicated to others that perhaps I was a bit paranoid) before finally investing in a 403(b).

We’re not even talking about the risks of investing in the stock market, though once I was able to push through that first barrier, I began to slowly look at other types of investment as well.

I spent most of the last year carefully examining the possibilities of a mutual fund, thinking about it, weighing the multiple levels of risk (in my mind), and finally, I pushed past that fear. I opened a mutual fund account and made my first investment within the past week.

It was a major psychological hurdle for me to cross, but it is exhilirating to know that my money is now actually working for me instead of merely sitting somewhere, just reinforcing my fears.

http://www.thesimpledollar.com/2006/11/23/facing-my-financial-fears-investment-risk/