Showing posts with label higher returns. Show all posts
Showing posts with label higher returns. Show all posts

Monday 1 July 2013

The relationship of risk and potential reward in stock investing is often misunderstood in shaping an investment strategy.

There is no investing in stocks without risk and there is no return without risk.

If you are adverse to the idea of taking any amount of risk, then stocks are not for you.

It will be more difficult (but not impossible) for you to reach your financial goals without investing in stocks.


Understanding Risk

Risk is the potential for your investment to lose money, for a variety of reasons - meaning your stock's price will fall below what you paid for it.

No one wants to lose money on an investment, but there's a good chance you will if you invest in stocks.

The rule of thumb is "the higher the risk, the higher the potential return, and the less likely it will achieve the higher return."

Buying a stock that is risky doesn't mean you will lose money and it doesn't mean it will achieve a 25% gain in one year. However, both outcomes are possible.

How do you know what the risk is and how do you determine what the potential reward (stock price gain) should be?


Measuring risk against reward

When you evaluate stocks as potential investment candidates, you should come up with an idea of what the risks are and how much of a potential price gain would make the risks acceptable.

Calculating risk and potential reward is as much an art as it is a science.

You need to understand the principle of risk and reward to make an educated investment as opposed to a guess.

The most common type of risk is the danger your investment will lose money.

You can make investments that guarantee you won't lose money, but you will give up most of the opportunity to earn a return in exchange.

When you calculate the effects of inflation and the taxes you pay on the earnings, your investment may return very little in real growth.


Will I achieve my financial goals?

If you can't accept much risk in your investments, then you will earn a lower return.

To compensate for the lower anticipated return, you must increase the amount invested and the length of time it is invested.

Many investors find that a modest amount of risk in their portfolio is an acceptable way to increase the potential of achieving their financial goals.

By diversifying their portfolio with investments of various degrees of risk, they hope to take advantage of a rising market and protect themselves from dramatic losses in a down market.

The elements that determine whether you can achieve your investment goals are the following:
1. Amount invested
2. Length of time invested.
3. Rate of return or growth
4. Fewer fees, taxes, and inflation.


Minimize risk - Maximize reward

The MOST SUCCESSFUL INVESTMENT is one that gives you the most return for the least amount of risk.

Every investor needs to find his or her comfort level with risk and construct an investment strategy around that level.

A portfolio that carries a significant degree of risk may have the potential for outstanding returns, but it also may fail dramatically.

Your comfort level with risk should pass the "good night's sleep" test, which means you should not worry about the amount of risk in your portfolio so much as to lose sleep over it.

There is no "right or wrong" amount of risk - it is a very personal decision for each investor.

However, young investors can afford higher risk than older investors can because young investors have more time to recover if disaster strikes.

If you are 5 years away from retirement, you don't want to be taking extraordinary risks with your nest-egg, because you will have little time left to recover from a significant loss.

Of course, a too-conservative approach may mean you don't achieve your financial goals.

Wednesday 20 June 2012

Returns are the reward you receive for taking investment risk.


investment
While most evident when markets are falling, threat is ever-present. However, it’s not something you want to avoid totally because without risk, you won’t be able to grow your wealth sufficiently over the long term to achieve your “financial goals”. And if returns are the reward you receive for taking investment risk, logic follows that the higher long-term returns usually come from investments with more risk (eg stocks).

Note: 
Over the long term, cash/term deposits are really risky.  The buying power of these decline due to inflation.
The dictum, you need to take higher risks to get higher returns is generally true.  However, the smarter investors also realise there are occasions when an investment is available at low risk with a potential of high return, especially when a good company is being sold at low prices not due to any fundamental reasons.

Friday 17 February 2012

Unlike return, risk is no more quantifiable at the end of an investment than it was at its beginning.



While security analysts attempt to determine with precision the risk and return of investments, events alone accomplish that.

Unlike return, however, risk is no more quantifiable at the end of an investment than it was at its beginning.

Risk simply cannot be described by a single number.  

Intuitively we understand that risk varies from investment to investment:  a government bond is not as risky as the stock of a high-technology company. But investments do not provide information about the risks the way food packages provide nutritional data.

Rather, risk is a perception in each investor's mind that results from analysis of the probability and amount of potential loss from an investment.

  • If exploratory oil well proves to be a dry hole, it is called risky.  If a bond defaults or a stock plunges in price, they are called risky.  
  • But if the well is a gusher, the bond matures on schedule, and the stock rallies strongly, can we say they weren't risky when the investment was made?  
Not at all.  The point is, in most cases no more is known about the risk of an investment after it is concluded than was known when it was made. 


There are only a few things investors can do to counteract risk:

  • diversify adequately, 
  • hedge when appropriate, and 
  • invest with a margin of safety.  

It is precisely because we do not and cannot know all the risks of an investment that we strive to invest at a discount.  The bargain element helps to provide a cushion for when things go wrong.

Sunday 20 March 2011

Buffett at University of Kansas (2005): You can still earn extraordinary returns on smaller amounts of capital.

University of Kansas : Warren Buffett Q&A
Notes by Professor Hirschey, University of Kansas ( May 6, 2005 )

Question: According to a business week report published in 1999, you were quoted as saying “it's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” First, would you say the same thing today? Second, since that statement infers that you would invest in smaller companies, other than investing in small-caps, what else would you do differently?

Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today's environment because information is easier to access.

You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map - way off the map. You may find local companies that have nothing wrong with them at all. 

A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.

Other examples: Genesee Valley Gas, public utility trading at a P/E of 2, GEICO, Union Street Railway of New Bedford selling at $30 when $100/share is sitting in cash, high yield position in 2002. No one will tell you about these ideas, you have to find them.

The answer is still yes today that you can still earn extraordinary returns on smaller amounts of capital. For example, I wouldn't have had to buy issue after issue of different high yield bonds. Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.

I know more about business and investing today, but my returns have continued to decline since the 50's. Money gets to be an anchor on performance. At Berkshire's size, there would be no more than 200 common stocks in the world that we could invest in if we were running a mutual fund or some other kind of investment business.


http://www.valueplays.net/wp-content/uploads/vinvesting-com.pdf

Friday 5 March 2010

How can the average investor improves his investment returns in stocks?


How can you improve your investment returns in stocks?

The adage, "Buy low and Sell high" and pocket the profit, is well known. I like to also remember it this way: "Never buy high and Never sell low".
The subsequent discussion applies to investing in high quality good stocks bought at a bargain only.

How can the average investor improves his investment returns in stocks? More specifically how can an average investor improves his return to 10% annually? Even better, to above 15% annually and consistently? Let us examine some factors affecting investment returns.


1. Stock selection
This is important. You wish to have a stock that gives you a good total sustainable return over many years. You will need to invest in those stocks with a high ROE of at least 15% or more. Also, these stocks should have good earnings growth (EPS growth) that is consistent and sustainable. Such companies run businesses with a huge competitive advantage over their competitors with a large moat.


2. Buy when the selected stock is selling at a low price.
This is the better way to get superior return - the potential return is higher with concomitant lower risk. Invest in "value stocks". A good portfolio should always have cash available to benefit from a bear market or a correction or panic sell in a bull market/or a specific stock.


3. Taking profit
Profit should be realised from sales of stocks in the following situations:
(I) when the stock is obviously overpriced, or
(II) when the sale of the stock frees the capital to be reinvested into another stock with potentially better return.

Not taking profit in the above situations can harm your portfolio and compromise its returns. In other circumstances, let the winners run.

Underperforming stocks should also be sold early. Hanging onto underperforming stocks is costly too. There is the opportunity cost that the capital can be better employed for higher return. Also, hanging onto these lack-lustre stocks reduces the overall return of your portfolio.


4. Reducing serious loss
When the fundamentals of a stock have deteriorated, sell to protect your portfolio. This decision should be make quickly based on the facts and situations, in order to keep your losses small.


5. Diversify, but not overdoing it
According to Buffett, adding the 7th stock to the portfolio reduces the return without reducing the overall non-systemic risk. of the portfolio. Select the best 6 stocks. If you need to add money to your portfolio, buy more of these preexisting stocks when they are offered at a good or bargain price. If you identify a better stock to invest, perhaps, this should replace one of the preexisting stocks in the portfolio.


6. Asset allocate according to your risk taking ability

It is perplexing to know of investors whose days are affected by the swings in the market. You should not bet your total networth into the stock market. Allocate the amount that you are willing to risk.

Many long-term investors are always riding on a significant amount of gains. This means that they will only lose their capital in very unlikely extreme situations.


7. So far so good. The hardest part: getting wired like Buffett!

To invest like what Buffett, you need to be knowledgeable and able to execute 'coldly' (or cooly) without being affected by emotions. These are among the harder skills to master. Have you wondered what drives this blogger to write on investing? Through writing, rather than lurking, you can focus on the facts and solidify your knowledge, philosophy and strategy.

Admittedly, there is no single philosophy or strategy; but you should have one to guide your investing. It prevents you from over-reacting to emotions and circumstances, that may harm your portfolio and investing returns. As this discussion assumes the portfolio contains only good quality stocks, it prevents you from "Buying high and Selling low" due to falling prices in the market. It may allow you to benefit hugely from the volatilities and follies of the market; making volality your friend.

Understanding and mastering this field of behavioural finance is yet another challenge to higher investment returns for the investors.

Sunday 29 November 2009

The Performance Illusion: Higher returns have long been associated with higher risks.

Which would you rather have, a portfolio with an average annual return of almost 34%, or one with an average annual return of just 5%?  Let's llok at a couple of examples that show why sometimes less is more.

Exhihit 1
The  Performance Illusion:  High Average Return

Year 1
Starting Value $100,000  Return 100%  Gain or (Loss) $100,000
Ending Value $200,000

Year 2
Starting Value $200,000  Return -99.00%  Gain or (Loss) ($198,000)
Ending Value $2,000

Year 3
Starting Value $2,000  Return 100%  Gain or (Loss) $2,000
Ending Value $4,000

Average Annual Return: 33.67%
Change in Value: ($96,000)
Percentage of Initial Investment Gained or (Lost) after 3 years: -96%



Exhihit 2
The  Performance Illusion:  Low Average Return

Year 1
Starting Value $100,000  Return 15%  Gain or (Loss) $15,000
Ending Value $115,000

Year 2
Starting Value $200,000  Return -15%  Gain or (Loss) ($17,250)Ending Value $97,750

Year 3
Starting Value $97,750  Return 15%  Gain or (Loss) $14,662.50
Ending Value $112,412.50

Average Annual Return: 5%
Change in Value: $12,412.50
Percentage of Initial Investment Gained or (Lost) after 3 years: 12.41%


Which return would you rather have? Of course, to illustrate the dangers of a high-volatility approach to investing, these two examples include an extreme case. Surely no one would ever face the kind of volatility shown in the 100 percent up and 99 percent down example ... but they might come close.



Exhihit 3
Nasdaq Composite Index

Year 1999
Starting Index Value 2192.69; Return 85.59%; Point Gain or(Loss) 1876.62
Ending Value 4069.31

Year 2000
Starting Index Value 4069.31; Return -39.29%; Point Gain or(Loss)(1598.79)
Ending Index Value 2470.52

Year 2001
Starting Index Value 2470.52; Return -21.05%; Point Gain or(Loss)(520.12)
Ending Index Value 1950.40

Year 2002
Starting Index Value 1950.40; Return -31.53%; Point Gain or(Loss)(614.89)
Ending Index Value 1335.51

Year 2003
Starting Index Value 1335.51; Return 50.01%; Point Gain or(Loss)667.86
Ending Index Value 2003.37

Average Annual Return: 8.74%
Change in Index: -189.32
Percentage of Initial Investment Gained or (Lost) after 5 years: -8.63%


Exhibit 3 shows the actual results of the Nasdaq Composite Index (Nasdaq) over five years beginning in 1999 and ending on December 31, 2003.

The truly remarkable 86% return posted by the Nasdaq in 1999 was followed by a truly gruesome bear market mauling over the three years. From the start of 2000 to the end of 2002, the Nasdaq shed an amazing 2,733 points - more than 67% of its value. The year 2003 brought welcome relief, but even after a 50% rise, the Nasdaq was still more than 8.6% below where it had stood five years earlier.

An investor unlucky enough to have missed out on the gains over this time span - either by coming late to the party or bailing out before the rebound - would have suffered a massive financial setback. As of the end of 2003, the Nasdaq remains more than 3,000 points, or 60%, below its all time closing high.


Exhibit 4
The Y2K Bear Market

Nasdaq
Index Closing High 5048.62
Date Hit 03/10/2000
Index (On 12/31/2003) 2003.37
Decline -60.32%
Points from High 3045.25
Gain Needed to Recover 152.01%

S&P 500
Index Closing High 1527.45
Date Hit 03/24/2000
Index (On 12/31/2003) 1111.92
Decline -27.20%
Points from High 415.53
Gain Needed to Recover 37.37%

DJIA
Index Closing High 11722.98
Date Hit 01/14/2000
Index (On 12/31/2003) 10453.92
Decline -10.83%
Points from High 1269.06
Gain Needed to Recover 12.14%


The Exhibit 4 shows the damage the Y2K bear market has visited on three major U.S. stock market indexes. The S&P 500 and DJIA did not soar nearly as high as the Nasdaq during the technology/telecom/Internet boom of the 1990s, and they suffered much less damage during the bust that followed.

The scenarios above are to illustrate, that there are consequences to taking risks. The easy success of the late 1990s bull market lulled many investgors, including many professional investors, into believing risk had lost its bite. Why not shoot for a 30 percent return? If you don't get it, you'll probably just have to settle for 20%. But that's not how it works in the real world - at least not in the long run. The experience of the Nasdaq versus the DJIA during the Y2K Bear Market wasn't a fluke. Higher returns have long been associated with higher risks.

Sunday 14 June 2009

Aiming for higher returns without losing your pants!

During the 2007-2209 severe bear market, there were many investors who cashed out of the market, at various stages of the unfolding bear. Many were happy that their capitals were not at risk during the turbulent bear evolving early stages. They were waiting to re-enter the market when it is 'safe' again. Just as they might not have cashed out at the 'right time', likewise, they might not have re-entered the market at the 'right time'.

What defines safety for these investors? They are probably referring to not losing their existing capital. Of course, the safest place was the money market or the fixed deposits. At which point in the bear market will they re-invest into stocks? During the slippery downturn, during the ups and downs, or when the market has turned up convincingly. I suspect many such investors having 'rescued themselves' or 'cashed out' of their stocks will not put their cash back to work until the market has turned up convincingly. This means they would have lost out on the fantastic return of the market during the last 2 months.

Therein is the difference between Warren Buffett and fellow value investors, and the general crowd. They bought at the time when everyone was fearful, probably committing more money into stocks too. The few value investors who spoke on Bloomberg or CNBC during the severe downturn sharing their views that they were net buyers appeared silly in the public eyes when the stocks prices sank further. But events have since proven these value investors to be more right than wrong.

Having a good knowledge of the risk/reward ratio offered by the market is helpful. The safest time to invest is when the market is at its low. This is also the time when the downside risk is small, though not completely eliminated, but the potential for upside gain is high.

Warren Buffett was right again. He asked to 'Buy America' in October 2008 when the US and world market 'fell off the cliff' following the Lehman collapse. For those who have bought following his call, subsequent events should have ensured good returns.

How can we aim for higher returns? Here is another lesson from Warren Buffett on this. What Ben Graham did was to inspire Warren Buffett with his investment strategy of buying bargain stocks that were selling below book value regardless of the nature of the company's long-term economics. This was something Warren Buffett was able to do with great success during the 1950s and early 1960s. But he stayed with this approach long after it wasn't viable anymore - the chains of habit were too light to be felt. When he finally woke up in the late 1970s to the fact that the Graham bargain ride was over, he shifted over to the strategy of buying exceptional businesses at reasonable prices and then holding them for long periods - thereby letting the business grow in value. With the old strategy he made millions, but with the new one he made billions.

As Buffett modified his strategy aiming for higher returns in the late 1970s, we should also regularly re-appraise our philosophy and strategy, through acquisition of appropriate investing knowledge, skills, and its better execution. There is definitely a 'holy grail' in value investing; to benefit from this hugely requires a deeper understanding of its core principles and better execution by the practitioners using proven safe strategies. So far, none is better than Warren Buffett, the accomplished sage. So much has been written on his strategy and method, and we only need to emulate these.

Aiming for safety of capital with a reasonable return was the initial goal. With increasing knowledge and skill, perhaps, aiming for safety of capital and higher returns are achievable. The returns of many investors are compromised by certain knowledge they possess and certain knowledge they do not have. Of course, you may not know what you don't know. Investing is a life-long passion for some. Having a good investment philosphy and strategy is the key. There is constant learning and re-learning. Some knowledge needs to be unlearned. As Warren Buffett said, "The chains of habit are too light to be felt until they are too heavy to be broken."

Also read:
You've Sold Your Stocks. Now What?