For example, buying garments on wholesale and then selling them retail at a good mark-up in your local neighborhood bazaar has its risks.  You may not be able to sell everything, and at the price you hoped to get.   But maybe the possible profits that you could make are worth the risks that you’re taking. That’s entrepreneurship for you.  Or you could be buying insurance from a reputable firm, then suddenly discover one day that that insurance firm itself is going bankrupt.

No investment is perfectly predictable.  Therefore, even good investments have a certain amount of risk involved.  If no one ever took any risks, then there would be no economic progress at all.  The key is to anticipate the risks, and manage the investment so that the risks are reasonable compared to the return that you expect to make. 

It’s all a matter of risk-return tradeoffs.  The higher the risk involved, the higher should you demand the returns/profits to be; otherwise you will not make the investment.

Some suggestions

Usually, when making an investment, you are attracted by the possible returns that you could make from that investment.  Most likely, you would compute potential profits, given realistic, but favorable conditions.  You could also compute potential profits should your luck really be good (assuming the return is not fixed).  Don’t get blinded by these computations, though, but seek another person’s opinion (someone whom you consider wise and unbiased), to make sure that your assumptions make sense.  Many people have been fooled by scams and swindlers who present seemingly realistic, easy-money promises, and who take advantage of an investor’s ignorance and greed.

But you shouldn’t stop there.  Before making any investment, it would be wise to anticipate and predict a “worse case” scenario to see how much you would lose, or how low your profits would go, in case something negative happens that you didn’t expect.  With a little calculation, you can determine your break-even points, and compute your remaining profits (or losses), given those worse-case situations.   Again, it helps to seek the counsel of a third-party, someone who has no stake in the investment, and certainly not the person who’s selling you the investment, to help you assess the various downside scenarios, and give you a reality check.

Then you should weigh the pros and cons of these various situations, and the likelihood of occurrence of each of these.  If the upside is likely, but the profits are not so fantastic, compared to the losses that you might incur if the downside occurs, then you would probably decide that “it’s not worth the risk.”  On the other hand, if the upside, though not so likely, is very attractive compared to the danger of losing in a downturn, then you will decide that “it’s a good investment.”

In a future blog, we will continue this discussion on risks to see lessons from the past.

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So how do you differentiate yourself from a fund manager? – Basically you come up with answers to the same three questions (what . . . , when . . . ., and how much . . .) using different means.

What to Buy or Sell

In answering the question “what to buy or sell”, most fund managers use fundamental factors, technical indicators and mathematical tools.  As an investor all you need to do to answer this question is to set your goals (retirement, college funding, capital for business, etc.) and to know your risk appetite (aggressive, moderate, conservative). 

When to Buy or Sell

To answer the question “when”, a fund manager again uses many tools (mathematical, cyclical, trend followers, etc.).  To accomplish the same feat as an investor, what you need to do is to determine how much time you have to invest (this is almost automatically determined once the goals are set) and what resources you have available for investing (how much of your monthly salary can you set aside for investing?).  For an investor like you there is only on answer to this question – NOW.  Your success as an investor will not be a matter of timing but of how much time you have to invest.  So start early!

How Much to Risk

Finally in order to manage risk effectively as an investor, you don’t need all those ratios, alphas, betas, audits and what have you that fund managers use to evaluate risk. All you need to do is to choose the right fund and the right fund manager.  Nowadays with all the scams going around choosing the right fund manager is almost as important as choosing the right fund.  Once you have accomplished the first two steps you will realize that choosing the type of fund is best for you will be easy enough because you already know what type of returns (professional financial planners can help you determine this)  to look for in order to meet a specific goal. 

So, to develop that winning investor’s mindset just remember these four simple phrases:

1. You are not a FUND MANAGER! Think Like an INVESTOR
2. Know your GOALS (put them on paper) and RISK APPETITE.
3. Determine how much TIME you have to invest for each goal (the longer the better so start early).
4. Choose the RIGHT FUND, and the RIGHT FUND MANAGER.

Here is a typical telephone conversation between an investment solicitor/banker (Jill not her real name) and a prospective investor (aka Mr. Belle not his real name either). 

Phone rings…

Jill:  Hello, May speak to Mr. Belle please?

Mr. Belle:  This is he.  Who is this please?

Jill:  Good morning Mr. Belle.  This is Jill from JMC-Duart Investments, and I’m calling to ask if it is possible to see you in person regarding an investment proposition.

Mr. Belle:  What kind of investment are you carrying?

 Jill:  JMC-Duart is principal distributor for an assortment of mutual funds that have varying degrees of risk and potential returns.

Mr. Belle:    I already have mutual funds.  What is the average return on your stock fund?

Jill:  In the last three years our equity fund has averaged over 16% net for shareholders.

Mr. Belle:  Hmmm, that’s quite impressive but the market is really bad right now so I don’t think this is the best time to get into equities.  In fact, just recently, I decided to redeem my equity mutual fund shares to limit my losses.  The fundamentals are bad and the technical indicators are not very promising either.  I don’t want fixed-income investments either because interest rates are currently too low.  Call in a couple of months.  If the timing is right, I might consider meeting with you to find out more about your funds.

What went on during the conversation?  Well, in a nutshell, Jill tried to sell Mr. Belle mutual fund shares but Mr. Belle felt that the timing is not right.  Furthermore, Mr. Belle is an aggressive investor and considers only high yielding investment. He is also the type of investor who prefers to manage his own investment portfolio.

And what does Mr. Belle do for a living?  He sounds like a banker, an investment officer, perhaps a stock broker or maybe he is a fund manager.  Actually, Mr. Belle is a BALLET INSTRUCTOR.  He knows a lot of the investment jargons because he is genuinely interested in investments so he reads a lot.  But does that make him a professional fund manager?  Not quite.

A fund manager is a different kind of animal (no pun intended).  Upon waking up in the morning a fund manager would look for the morning paper before his sleepers so he can catch up on anything that might have happened while he was asleep.  He or she will have breakfast while reading the business section, somehow be able to take a shower while still reading, and drive to work still reading the paper (Don’t Try This at Home).  The only time he lets go of the morning paper is when gets to the office and he comes face-to-face with his best friend in whole wide world – his Bloomberg terminal. He then spends the whole day in front of the monitor to watch the markets go up and down, up and down, . . . . .  up and down all day long.  After work, he goes home, has dinner, maybe a couple of drinks and goes to sleep.  While asleep he will dream of the markets going up and down, up and down, . . . .up and down all night long.

 I am of course exaggerating.  My point is this.  A fund manager eats, sleeps, breaths, and lives in the markets.  He is capable of doing things with the markets that ordinary people can not do – like shoot an order to buy or sell a security at the snap of a finger (or at a click of a button if he or she does not have an assistant) and more importantly, stay emotionally unattached to the markets.

So if you are NOT a fund manager by profession then don’t fall into the trap of trying to think like one.  The best thing for you to do is to THINK LIKE AN INVESTOR and let your fund manager do his job.      

To be continued . . .