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Saturday, 12 March 2011

Define your Investment Strategy

For years, if not decades, we've lived under complacent financial allocations. Most of us consider debt to be risk-free. Till a few years ago, most of us considered equities to be risk-free over the long-run. We systematically look at price targets on our investments without considering the downside risk we're taking on. The number of equities investors, who get paranoid when their portfolios are down 20% tells you everything you need to know about the lack of appreciation of risk that permeates societies across the world today. Mass-marketing of financial securities has led to a widespread under-appreciation of risk. These false convictions were both the foundations of and the consequence of one of the most pronounced financial bubbles in human history. 

If there's one thing I'd like you to take from this blog, it's this: think through the impact of your financial decisions. Appreciate the risks involved. Pursue returns consistent with your risk-taking capacity. Also understand that the monetary system we live in penalizes idle money. Money loses value over time. A dollar today will be worth less in 2015. So, most of you probably don't want to leave your money idle. However, none of you want to be invested in a stock or commodity based purely on hope. There needs to be a compelling reason that draws your funds into a long-term investment.
There needs to be a degree of conviction to a short-term trade. People have got rich based on good fortune in the past, and they will continue to do so - but, a competitive market punishes gamblers and rewards investors who enjoy a genuine edge in the market place. There is time tested wisdom to George Soros' assessment that "Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes". 

Booking your losses is often an important ingredient in seeking long-term returns. Liberate yourself from any emotional ties to your investment decisions. Investing, trading and making money in markets is about buying low and selling high. Compelling ideas are worth more than mediocre ones - but all investments have a price beyond which they are irrational. Don't get caught up in irrational exuberance.

In the days, weeks and months that follow - I will often draw upon a compelling idea. I might tell you how much of my allocation I consider it worthy of. However, please always make an independent financial decision if you ever choose to follow a recommendation. Risk-assessment is something I will constantly re-visit on this blog. But, don't ever lose sight of the downside risk of any financial security. There are no "sure things" in financial markets - merely high probability events. Good bets and bad bets.

Personally, I don't build hard and fast allocations. I've had zero percent in my equity portfolio on occasion. I've had exclusively long positions. Exclusively short positions. I've had a mix. I've moved significant portions of my portfolio to gold, and I've held no commodity at all. However, this is a consequence of dedicating myself to markets. For most of you, you will need to make allocations. While doing so, you need to consider your time horizon, your appetite for risk and the entry point of your investments. Always stress test your allocations. Consider a scenario where the risk you take on leads to significant downsides. Ponder what you would do in that situation.

Don't expose yourself to risk levels that you can't handle emotionally. Markets tend to oscillate between greed and fear. If you learn to disassociate yourself from both emotions - you will increase your chances of making financially sound, rational decisions.

Happy Investing

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