To suc­ceed in in­vest­ing, you must know how to han­dle

The Pak Banker - - Front Page - Clem Cham­bers

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.

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