Friday, 12 February 2010

Individual investor should focus on absolute returns from their investment.

The fund manager tends to benchmark the return of the fund to an index. However, for the individual investor, it is better to focus on absolute return on their investment. Their first priority, of course, is not to lose money.

It is not difficult for the average investor to get a modest absolute return from the stock market consistently over a long period. Through careful selection of only a few stocks, this is easily achievable.

However, the investors, with better knowledge, skills and the willingness to spend time doing the homework, can hope to better this modest absolute rate of return consistently over a long period.

The returns are volatile over the short term. However, over the long term, the returns will reflect the fundamentals of the invested companies. Adopting the simple strategy of investing in good quality companies bought at bargain or reasonable price, the absolute returns over the long term should predictably and hopefully be positive.

Those with the ability to sense or value the overall market can employ tactical dynamic rebalancing in their portfolio management. They can allocate a bigger percentage to equity when the reward/risk ratio is more favourable during the depth of the bear market and by investing less into equity when the reward/risk ratio is less favourable during the height of the bull market. This strategy reduces the risk of big losses during a bear market. Implementing this strategy will be challenging and can only benefit those with good rational understanding of the valuation of the overall market.

Why do people lose money in the stock market?

Graham defined investment thus: "An INVESTMENT OPERATION is one which, upon THOROUGH ANALYSIS, promises SAFETY OF PRINCIPAL and a SATISFACTORY RETURN. Operations NOT meeting these requirements are speculative."

Maybe these people are gambling or speculating rather than investing. Perhaps, they thought they are investing when in fact, by Graham's definition, they are gambling or speculating.

(Absolute return, Relative return, Short term, Long term)

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