To succeed in investing, you must know how to handle
PEOPLE invest when they believe they are going to make a profit. The bigger the profit they think they are going to make, the more they want to invest. This seems the most natural thing in the world to do. You wouldn't invest in something if you thought you were going to lose, would you?
Well, what you must remember is the world doesn't oblige the investor like that. In fact, the "prop- er" way to invest is not very natural.
You can never be very sure that an investment is going to pay out. Meanwhile, the likely profit is linked to the risk of loss. So, the higher the likelihood of an investment failing, the higher the profit you will, on average, make from that investment. The key words to remember are "on average."
So amongst your portfolio of 30 stocks, if you own, say ten, risky investments, many will go sour, meanwhile a few will pay-out a jackpot. This jackpot counteracts the bad investments. You could end up with a better overall profit than investing in a selection of lower risk opportunities.
Of course, we all wish we could pick only the winners, and some of us may believe we actually can, yet it's always prudent to keep the belief in mind that one's skills are not beyond the norm. Sadly, most investors think the opposite. This is another bad way of thinking and a big "no no" when you invest.
So apart from reminding ourselves that we are likely average investors when it comes to skills, that it's a fact of life we will pick dud investments as well as winners and that it is important to spread the risks of investments over a menu of investing opportunities - rather than put all ones investment eggs in one basket - how does risk direct our investment?
Here is a good way off thinking about risk. Imagine you were going to buy nine stocks. You could go out and buy the best and biggest companies on the stock market. There would be nothing wrong with this, although perhaps you could save yourself the effort and simply buy an index tracking Exchange Traded Fund. However that might be too boring. In the end, most people prefer a little more engagement with their money.
So instead… an investor can think to himself, 'I will buy three low- risk stocks, three mid-risk stocks and three high-risk stocks. Also, I will spread myself over small, medium and large sized companies.'
The result will be a selection of one of each of all the permutations of risk and company size. You will buy for example, a low-risk small company, a medium -risk small company and a high- risk small company. You will also buy a lowrisk medium sized company, a medium -risk medium sized company and a high- risk medium sized company. To finish of the portfolio you will buy a risky big cap, a medium -risk big cap and a lowrisk big cap.
Now all you need to do is select your favourite candidates fitting the bill. Of course, it needn't be size that was the second criteria, it might be your three favourite sectors, or international markets or some other factor. However, it should be the risk, or perceived risk that drives your selection process.
People think risk is bad. In actual fact, it is the investor's life blood and (unpredictable and sometimes dangerous) friend. However, like any wild beast, it needs to be handle with care and respect.