Risk avoidance is the single most important element of an investment program

Another common belief is that risk avoidance is incompatible with investment success. This view holds that high return is attainable only by incurring high risk and that long-term investment success is attainable only by seeking out and bearing, rather than avoiding, risk. Why do I believe, conversely, that risk avoidance is the single most important element of an investment program? 

If you had $1,000, would you be willing to wager it, double or nothing, on a fair coin toss? Probably not.  Would you risk your entire net worth on such a gamble? Of course not. Would you risk the loss of, say, 30 percent of your net worth for an equivalent gain? Not many people would because the loss of a substantial amount of money could impair their standard of living while a comparable gain might not improve it commensurately. If you are one of the vast majority of investors who are risk averse, then loss avoidance must be the cornerstone of your investment philosophy.

Greedy, short-term-oriented investors may lose sight of a sound mathematical reason for avoiding loss: the effects of compounding even moderate returns over many years are compelling, if not downright mind boggling.

Perseverance at even relatively modest rates of return is of the utmost importance in compounding
your net worth. A corollary to the importance of compounding is that it is very difficult to recover from even one large loss, which could literally destroy all at once the beneficial effects of many years of investment success. In other words, an investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principal An investor who earns 16 percent annual returns over a decade, for example, will, perhaps surprisingly, end up with more money than an investor who earns 20 percent a year for nine years and then loses 15 percent the tenth year.

How do investors "chase the market"? It this a bad thing?

	How do investors "chase the market"? It this a bad thing?
Generally, an investor "chases the market" when he or she enters into a highly priced position after the stock price has increased rapidly or become overpriced. An investor who exits a position after the security has lost considerable value also is said to be chasing the market. Both positions suggest that the investor chased the market by following trends unwisely. Many investors unknowingly chase the market and endure large losses as a result. During the dotcom bubble, for example, many investors sought to profit from buying shares of internet and technology companies that were doing well. The popularity of dotcom companies eventually dropped and the investors who had chased the market were left with big losses. Investors who chase the market typically make investment choices based on emotion rather than careful consideration of market trends using statistics and financial data. For this reason, this strategy has been widely criticized and most financial advisors warn against it For more on this topic, read When Fear and Greed Take Over and The Madness of Crowds. This question was answered by Bob Schneider.

Read more: http://www.investopedia.com/ask/answers/09/chase-the-market.asp?partner=basics122311#ixzz1hPJzapcB

Lessons from the '87 Crash

SPECIAL REPORT October 11, 2007

Lessons from the '87 Crash

Enjoying the Dow's record run? Don't get too comfy. The market's Black Monday breakdown is a reminder of how quickly investor sentiment can turn

by Ben Steverman

As major stock indexes hit all-time highs, it's worth looking back 20 years to a far gloomier time, when investors were cruelly and suddenly reminded that the value of their investments can depend on something as unpredictable as a mood swing.

Every once in a while, fear, snowballing into panic, sweeps financial markets—the stock market crash of October, 1987, now celebrating its 20th birthday, is a prime example.

In the five trading sessions from Oct. 13 to Oct. 19, 1987, the Dow Jones industrial average lost a third of its value and about $1 trillion of U.S. stock market value was wiped out. The losses culminated in a panic-stricken 22.6% decline in the Dow on Black Monday, Oct. 19. The traumatic drop raised recession fears and had some preparing for another Great Depression.

Stock market crashes were nothing new in 1987, but previous financial crises—in 1929, for example—often reflected fundamental problems in the U.S. economy.

MYSTERIOUS MELTDOWN
The market's nervous breakdown in 1987 is much harder to explain. Especially in light of what came next: After a couple months of gyrations, the markets started bouncing back. The broad Standard & Poor's 500-stock index ended 1987 with a modest 2.59% gain. And in less than two years, stocks had returned to their pre-crash, summer of 1987 heights.

More importantly for most Americans, the U.S. economy kept humming along. Corporate profits barely flinched.

To this day, no one really knows for sure why the markets chose Oct. 19 to crash. Finance Professor Paolo Pasquariello of the University of Michigan's Ross School of Business says the mystery behind 1987 prompted scholars to come up with new ways of studying financial crises. Instead of just focusing on economic fundamentals, they put more attention on the "market microstructure," the ways people trade and the process by which the market forms asset prices.

True, in hindsight there are plenty of adequate reasons for the '87 crash. Stocks had soared through much of 1987, hitting perhaps unsustainable levels: In historical terms, stock prices were way ahead of corporate profits. New trading technology and unproven investing strategies put strain on the market. There were worries about the economic impact of tensions in the Persian Gulf and bills being considered in Congress.

OUT OF SORTS
But for whatever reason, the mood on Wall Street shifted suddenly, and everyone tried to sell stocks at once. "Something just clicked," says Chris Lamoureux, finance professor at the University of Arizona. "It would be like a whole crowded theater trying to get out of one exit door."

It's a fairly common phenomenon on financial markets. Every stock transaction needs a buyer or a seller. When news or a mood shift causes a shortage of either buyers or sellers in the market, stock prices can surge or plunge quickly. Most of the time, balance is quickly restored. Lower prices draw in new buyers looking for a bargain, for example.

Sometimes, as in 1987 and many other true crises, things get out of hand. What happens at these moments is a mystery that may be best explained by dynamics deep within human nature.

Usually, explains behavioral finance expert Hersh Shefrin, a professor at Santa Clara University, investors believe they understand the world. In a crisis, "something dramatically different happens and we lose our confidence," Shefrin says. "Panic is basically a loss of self-control. Fear takes over."

BUYERS AND SELLERS
Why don't smart investors, seeing others panic and sell stocks, step in to buy them up at a bargain?

First, it's very hard, in the midst of a crisis, to tell whether markets are acting rationally or irrationally. Buyers refused to enter credit markets this summer on fears about risky mortgage debt. It will take months, maybe years, to add up the full impact of losses on subprime loans.

It's also tough to think rationally yourself. "It's hard to keep your emotions in check when your money is on the line," Shefrin says.

And, even if you're confident the panicked market is giving you a buying opportunity, you're likely to want to wait until it hits bottom. If a market is in free fall, buying stocks on the way down is likely to give you instant losses.

Not only will buyers hold back. A falling market will bring many more sellers out of the woodwork. Leverage is one reason: Many investors buy stocks on borrowed money, so they can't afford to lose as much without facing bankruptcy.

This is one explanation for the temporary, sharp drops in many financial markets in the summer of 2007. Losses on leveraged mortgage debt prompted many hedge funds to dump all sorts of assets to raise cash.

THERAPY FOR A PANICKED MARKET
The solution to a panicked market, many say, is slowing down the herd of frightened investors all running in the same direction. New stock market rules instituted since 1987 pause trading after big losses. For example, U.S. securities markets institute trading halts when stock losses reach 10% in any trading session. "If you give people enough time, maybe they will figure out nothing fundamental is going on," University of Michigan's Pasquariello says.

There's another form of therapy for overly emotional markets: information. In 1929 and during other early financial crises, there were no computer systems, economic data were scarce, and corporate financial reporting was suspect. "The only thing people knew in the 1920s was there was a panic and everybody was selling," says Reena Aggarwal, finance professor at Georgetown University. "There was far less information available." In 1987, and even more today, investors had places to get more solid data on the market and the economy, giving them more courage not to follow the herd. That's one reason markets found it so easy to shrug off the effects of 1987, Aggarwal adds.

You can slow markets down, reform trading rules, and tap into extra information, but financial panics may never go away. It seems to be part of our collective human nature to occasionally reassess a situation, panic, and then all act at once.

Many see the markets as a precarious balance between fear and greed. Or, alternatively, irrational exuberance and unwarranted pessimism. "All you need is a shift in mass that's just big enough to push you toward the tipping point," Shefrin says.

IN FOR THE LONG HAUL
What should an individual investor do in the event of a financial crisis? If you're really sure that something fundamental has changed and the economy is heading toward recession or even another depression, it's probably in your interest to sell. But most experts advise waiting and doing nothing. "In volatile times, it is very likely that you [will be] the goat that other people are taking advantage of," University of Arizona's Lamoureux says. "It's often a very dangerous time to be trading."

Shefrin adds: "The chances of you doing the right thing are low." Don't think short-term, he says, and remind yourself of the long-term averages. For example, in any given year, stock markets have a two in three chance of moving higher. Other than that, it's nearly impossible to predict the future.

So, another financial panic may be inevitable. But relax: There's probably nothing you can do about it anyway. Anything you do might make your situation worse. So the best advice may be to send flowers to your stressed-out stockbroker, stick with your long-term investment strategy, and sit back and watch the market's roller-coaster ride.

Steverman is a reporter for BusinessWeek's Investing channel .

http://www.businessweek.com/investing/content/oct2007/pi20071011_494930.htm

Equity investors: Don't panic!

This week has heralded another sharp sell off in the stock market – but whatever private investors do they must not panic.

When there is a mass sell-off of assets everything falls. Photo: AP

By Garry White

5:02PM GMT 21 Nov 2011

Of course, the situation in Europe is serious – with debt concerns moving from Greece to Italy to Spain and now France. the US deficit is also of serious concern. However, events currently unfolding are not the end of the world. Equity markets are likely to recover from this crisis over the next few years as the global economy improves, but there will be plenty of pain on the way.

When there is a mass sell-off of assets everything falls – the good assets and the bad. Investing is a long term affair and panic selling could means good investments are sold when they are cheap. This defeats the main investment principles of buying low and selling high.

Of course, the value of an asset is only what someone else is prepared to pay for it – so although shares look cheap at the moment they could get cheaper in the short term. However, returns from the stock market over time – particularly when dividends are reinvested – are still likely to mean it is worth staying in the market.

There’s also the fact that panic selling can crystallise tax liabilities to consider.

The truth is, now is actually a great time to buy quality companies at what could be a bargain prices, as long as you have a sensible investment horizon. And are brave enough.  

Invest at the point of maximum pessimism." This is a famous quote from legendary investor John Templeton, who was one of the last century's most successful contrarian investors - hoovering up shares during the Great Depression. He was the founder of fund management group Templeton.

Conversely, the theory goes, you should sell at the point of maximum optimism.

It is important to remember that you will never time a market bottom or market top accurately. That's why Questor thinks the best investment strategy is to continue to drip-feed funds into the market – and this is especially the case when markets are falling.

This strategy is called pound-cost averaging and it makes good sense for investors with an appropriate time frame.

Although the sharp falls seen recently in equities is a concern – it is not a reason to panic. Sell in haste today and you may regret your decision in two year’s time.

http://www.telegraph.co.uk/finance/markets/questor/8904859/Equity-investors-Dont-panic.html

Don’t Let Your Losers Become Big Losers

Don’t Let Your Losers Become Big Losers

So with my Trailing Stop Strategy, when would I have gotten out of the failing muscle-shirt business? You already know the answer.

Remember, the shares started at $10 and fell immediately. Instead of waiting around until they fell to $6 as the business faltered, using my 25% Trailing Stop, I would have sold out at $7.50. And think of it this way – if the shares fall to $8, you’re only asking for a 25% gain to get back to where they started. But if the shares fell to $5, you’re asking for a dog of a stock to rise 100%. This only happens once in a blue moon – not good odds!

Take a look at how hard it is to get back to break even after a big loss...

You’ll Never Recover
Percent fall in share price	Percent gain required to get you back to even
10%	11%
20%	25%
25%	33%
50%	100%
75%	300%
90%	900%

So what’s so magical about the 25% number? Nothing in particular – it’s the discipline that matters. Many professional traders actually use much tighter stops.

Ultimately, the point is that you never want to be in the position where a stock has fallen by 50% or more. This means that stock has to rise by 100% or more just to get you back to where it was when you bought it. By using this Trailing Stop Strategy, chances are you’ll never be in this position again.

http://www.dailywealth.com/1041/Don-t-Lose-Money-The-Most-Important-Law-of-Lasting-Wealth

"But I thought Greed was Good"

Greed leads to losses

Be fearful when others are greedy and Greedy when others are fearful.

Wealth and happiness from the power of 10

Wealth and happiness from the power of 10

Marcus Padley
June 19, 2010 - 3:00AM

You don't have to be a genius to work out that if only we could avoid the losses, we would all be winners. The first rule of making it is not losing it. So here are my top 10 tips on not losing money.

1 Inside information. A colleague has professionally traded all his life. It's what he does. He says: ''If I had never been given any inside information … I would be a million pounds better off than I am today.''

2 IPOs. The golden rule of IPOs is that if it's any good, it won't be offered to you. If you get offered it … then you don't want it.

3 Pretending to be Warren Buffett. The concept that Buffett can be emulated has cost investors more than it has ever made them. No one has ever managed to replicate his performance. The idea that you can is the biggest drawcard the equity market has and it is a lie. We all keep buying the dream.

4 Gurus. Go to any rainforest, discover any tribe and you will find them huddling under some concept of god and creed. It is a human need to be able to answer the unanswerable questions and we do it by deifying someone or something. In our search for answers to the stockmarket's unanswerable questions, we credit our commentators with vastly more powers than they could possibly deserve or possess. And dangerously, he who guesses the boldest guesses the longest.

5 Greed. The biggest killer of them all. Approaching the stockmarket with greed is like running onto a battlefield in bright orange. We'll get you.

6 Leverage. The mechanism of greed. Leverage is marketed one way, but it works both ways. You lose much faster as well. That means it only works for some of the time and not all of the time.

It only works when you are right. And with average equity returns after interest, transaction costs, inflation and tax of less than zero, man, you had better be right, and right at the right time. You cannot habitually use leverage to ''invest''. Only trade and trade at the right time, not all the time. That's a big ask for someone with a day job.

7 Confidence. What's the core skill of the finance industry?

I'll tell you: it's marketing. And oh, do we have some material to work with. The finance industry is never short of a success story to free your wallet from your pocket. But we cannot all be successful, and of course we aren't. But the concept of success from mere participation in the financial markets is sold and endures because of one convenient fact of life. Crappy cars and small houses don't attract attention. The winners stay, and we raise them up. The losers, conveniently, go away. Thank goodness for that. Imagine how much product we'd sell if we raised them up.

8 Expectations. The root of all happiness. The root of all unhappiness. Expect the unexpectable and expect the inevitable. Best you expect the expectable.

9 Laziness. The nucleus of many of the stockmarket's very large and public losses. There has been more money lost through laziness than through effort - in particular, from putting your future in the hands of financial products you haven't taken the time to understand (Opes Prime, Storm Financial), from ''investing'' without investigating (otherwise known as gambling), from relying on someone else's grand declaration rather than taking responsibility yourself. Let's get this straight. There is no easy route to riches in the stockmarket and there is no free lunch, so participation without effort is not enough.

10 Life. My mum used to say there are three foundations for spiritual and financial happiness and success: your relationship, your job and where you live. Get one of those wrong, and all three will go wrong. Note there's no mention of the stockmarket in there. The stockmarket is not life. It is a side issue. The biggest financial decisions you will make in your life have nothing to do with the stockmarket - such as getting married, getting divorced, having kids, investing in your home, committing to your career or your business. These are the biggest financial decisions you'll ever make. Focus on them. The stockmarket is not a priority.

Marcus Padley is a stockbroker with Patersons Securities and the author of the daily stockmarket newsletter Marcus Today.



This story was found at: http://www.smh.com.au/business/wealth-and-happiness-from-the-power-of-10-20100618-ymsd.html

"Make Hay While the Sun Shines": When Greed leads to Heavy Losses

An illustrative story.

Rick found out the hard way that greed leads to heavy losses, not gains.

At age 40, Rick had been in an unfortunate accident that would prevent him from ever working agin.  To compensate for his loss of future earnings, he was awarded a lump sum of approximately $4 million.  In 1996, Rick's attorney recommended that he seek out a financial planner to manage his money.  Rick's goals were to set up an investment portfolio that would provide him with current income of $8,000 per month, and an income that would keep pace with inflation over the balance of his lifetime.  Because he depended on income from his assets for his sole support, he wanted to be very careful with his money.

Lump sum: $4 million
Current income:  $8,000 per month

As the stock market advanced unabated, Rick started to listen to the siren's song of the easy money to be made.  He told his planners that he wanted to get more aggressive with his accounts.  The high returns and easy money that the markets were offering were just too good to pass up.  He acknowledged that he had told his planners that he needed to be conservative before, but now he felt that he should "make hay while the sun shines!"  In other words, he perceived that there was little risk involved in getting more aggressive.

Rick did not need to chase high returns because his asset base was sufficient to allow him to pursue a lower risk and return strategy.  Most important, he would always be okay so long as he kept his capital base intact to produce the income he required.  His planners counseled Rick to stick with his conservative income and growth plan because he could not earn back the money he might lose.  But by 1999, the siren song proved too much for him.  He abandoned his investment strategies and moved his entire portfolio into high-flying tech stocks just before the speculative bubble burst.

The ensuing "Tech Wreck" shattered Rick's financial security along with that of millions of other investors.  Greed had won again.  Rick's more aggressive investment strategy that had looked like a sure path to untold wealth became the wrecking ball that destroyed his financial security.  With losses that averaged in excess of 70 percent, Rick's capital base was decimated, and with it, the engine of his income production.

To add insult to injury, the income strategies Rick abandoned actually increased in value.  With the huge stock market declines, investors fled to the relative safety that income-producing investments provided.  Bond prices increased as did the prices of many high-yielding dividend-paying stocks.