What lessons learned from Katrina can also be applicable in stock investing. The stock market is volatile. For every 5 years of investing, do expect to encounter 1 year of bear market. Therefore, the prudent investor is prepared to meet the bear and hope to profit from it too.
The safest period to invest is actually during a bear market. The most 'dangerous period' to invest is actually at the height of a bull market. Yet, human beings are not wired to take advantage of this simple fact. We are wired to react with fear to threats and to react with greed to wanton rewards. A falling market is perceived as a threat by many investors. Yes, their portfolio prices have been decimated. Those who are focussed purely on prices of their stocks, with little or no reference to their underlying intrinsic values, would tend to feel threatened and make an inappropriate irrational decision(s) harming their portfolio.
The best time to prepare for a bear is actually 'to be prepared at all times'. How can this risk be minimized or managed?
- Well, for a start, invest only in very good, high quality stocks. This have been written about on many occasions. Good companies are companies with growing revenues, growing earnings, little debts, increasing dividends and successful track record over many years (5 to 10 years).
- Also, ensure that the management is of the highest quality and integrity. These are managers who have the interest of the business owners (shareholders) at heart. They are managing the companies efficiently, increasing the revenues and containing their costs. The profit margins of these companies are steady or increasing.
- Another way to contain risk is to buy when the price is offered to you at a bargain or at a fair price. This concept of buying with a margin of safety is very easy, provided one has the patience. The market always comes around and there will be times when the market (Mr. Market) is offering good quality companies at very good bargain prices. Ensure that you always have a list of companies in your surveillance and when this offer arises (often it is a small window of opportunity to buy at this price), be confident in your analysis and buy BIG. Buy very big indeed. This buying would have locked in your gains at the time of purchase, as you will be purchasing with a margin of safety and with a discount to the intrinsic value. This action will also ensures that your return will be above the normal of that returned by the whole market.
- Avoiding silly mistakes is another way to minimize risk and loss. Avoid buying overpriced stocks - this also means that you will need to know valuation and to know to control your emotions. Some investors are carried away during the bull market due to overconfidence. They abandoned their caution and may not spend the time to carefully analyse the quality, management and value of the stocks they are buying. They are so involved in the market observing the prices and trading the prices without realizing that their risk management might not be appropriate when the bear market appears.
- How much you allocate to equity in your asset allocation at various phases of the stock market is also important. Periodic rebalancing of your portfolio between cash, bonds and equities also minimizes your risk.
Therefore the strategies to minimize risks and irreversible losses should be in placed at all times during your investing career. When these are in place, the investors can be expected to be rationale and not react irrationally to the fear or greed generated by a bear or bull market respectively. Also, be aware of similar emotional responses to severe drop in prices or bubble in individual stock too. Those who are prepared rarely need to employ stop loss strategies, though, the stop loss should and can be usefully employed by those investors to minimize potential irreversible losses.
There is no substitute to experiencing the ups and downs of the market acquired over many years and to managing your stock picking, your risk and your portfolio to minimize the risks and to maximise the returns at these various times. For those wishing to invest and benefit from the stock market, there is also no substitute but to acquire the necessary education. Warren Buffett alluded that this need not be too complicating. You basically require knowledge in how to value a business or stock and to understand the working of the stock market so that you can take advantage of its price volatilities.
Investing is not without risks but these risks can be minimized and managed. Among the various strategies, value investing is the safest from my assessment. Of course, many have also employed other strategies and benefited from these too.