Thursday, October 20, 2011

Personal Investors As Risk Averse

Investing, Not Gambling
It may seem odd  that I would see the best investors as being risk averse.  After all, no risk, no reward, right?  But this isn't gambling, this is investing.  The odds are stacked against the gambler - eventually the house always wins.  I invest only when I believe the odds are in my favour.  I see people putting their money into penny stocks, or wanting in on the next hot thing, or Initial Public Offering  (IPO).  I ask myself, why? Now, I'm not saying there is no money to be made in these areas, I'm just saying for most Personal Investors the odds are against it.  Very few people have the necessary skills.  These are also areas that manipulators work to their advantage.  People get fooled, believing their loss would be small while their return could be almost infinite.

Loss vs. Gain
Personally, I am less interested in how much I can make as I am in how much I can lose.  The bottom line is, any loss is significant.  I believe the best Personal Investors have a low pain tolerance for loss.  That is one of the reasons I now believe it makes no sense to buy anything with only the hope that, one day, it will be worth more than what I paid for it.  Such is the thinking behind Buy and Hold - buy now, hold until it is worth more than what we paid, even if it means suffering major losses.

Lesson Learned
But, what if the markets go down before going up?  It happened to me - once. Leaving the company I had worked at for many years, I took the proceeds of what was to be my pension and invested that money in the stock market.  In the following six months, or so, the market dropped by more than 25 percent.  I sought advice, which went from, no need to worry, to, too late to sell!  In my case, I was lucky.  It only took a little more than a year for the market to get back to even.  Knowing what I do today, I would have made more than a seven percent rate of return during that same period of time.

Capital Gains or Capital Losses?
When the Tax Free Savings Accounts (TFSA) were first introduced, some advisors were saying not to hold equities in such accounts since we can never claim the losses as a tax deduction.  My reaction to that was, if we are losing money in our TFSA, then we are doing it wrong!  I would rather avoid the taxes on my capital gains than on my losses, as long as I keep my losses small. 

First Rule Of Investing
Warren Buffett has said the first rule of investing is to not lose money.  After the experience of mine with my pension proceeds, I looked for methods of limiting my losses.  I could buy and hold and just wait it out and hope I lived long enough, or I could develop an exit strategy which would leave me with most of my money to buy at a better price.  People will point to the cost of commissions and fees and taxes and say it isn't worth it.  But, why wouldn't I pay a couple of commissions to end up with several percent more in my account?  Seems like a reasonable trade off to me!

Win or Lose?
The successful personal investors, I know, aren't easily fooled by the promise of huge returns.  They know their success lies in the ability to limit their losses by minimizing risks.  Doing so let's even the smaller gains accumulate and compound while others are praying for a chance to get back to even.

How is your risk tolerance? 

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