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Now your destination and course is set. How fast do you want to get there? Drive
at break neck speed and risk getting a ticket just so you can get there in less than
an hour. Or, drive carefully and take two hours but drive safely. We live in a world
of uncertainties with financial markets swinging up and down affecting the values
of investments.
Risks can never be avoided and failure to assume risks when planning or investing
may decrease your chances of achieving your goal. On the bright side, risks fall
over time. This explains why stocks which are volatile in nature tend to grow your
money over the long-term.
Naturally, market downfalls cause concern no matter how aggressive and conservative
investors are. There are many types of investment risks and understanding them will
help you to cope with volatility. Assessment of risks involves knowing the types
of risks for particular investments and the investorsí tolerance to taking these
risks.
You determine how much risk you can take. If you are conservative, you may take longer
to reach your objectives but you know you won't suffer heart attacks along the way
or risk losing your entire capital. Likewise, if you are aggressive, you may have
a few accidents along the way and may or may not survive but if you do the rewards
can be substantial.
Your risk tolerance will basically determine the appropriate investments for you.
For example, a conservative investor will favor fixed income instruments such as
fixed deposits and bonds over stocks.
Balanced investors will likely go for managed investments such as unit trusts or
mutual funds or a combination of stocks and bonds while the aggressive ones will
opt for the more volatile stocks and commodities.
So, what is your risk limit? Never choose an investment that will give you sleepless
nights. Ask yourself the following simple questions. Were you be able to tolerate
the wild swings in the stockmarket last year? Will you be able to sleep well when
the stock that you bought just minutes ago plunged 10%? Would you rush in to buy
"cheap" stocks when the market has fallen sharply in a turbulent period
or would you rather stay out fearing further downside?
It is always easy to act during a rising bulls but not in a sliding markets where
the tendency is to act irrationally.
The length of time an investment will be held is a critical factor and it will affect
your investment strategies. Normally, investors with longer time horizon are more
aggressive in their investment approaches.
You are more likely to take a higher degree of risks if your retirement is still
20 years away. This is because risks are lowered with longer time horizon. Over the
longer term volatile investments such as stocks grow to help realize your goal. You
will not likely favor low risk investments such as the typical time deposits and
bonds.
In the opposite, investors who need money within a short time frame usually cannot
afford to deal with risky investments - they have lower risk tolerance. Unfortunately,
very often we find local investors with short-term needs who punt in the stockmarket
hoping to reap fast rewards. In short, investors cannot design and build an investment
plan for themselves without understanding their time frames.
Your next step would be to allocate different types of investments - a process called
asset allocation. It is important to diversify accordingly in order to reduce risks
particularly during periods of turmoil. To support this, had you invested solely
in stocks last year, your capital would have been severely eroded. But wise investors
who diversify are always able to meet their goals over the long-term.
Most importantly, design an asset allocation that you are comfortable with. Investors
normally allocate a certain percentage to stocks, bonds, cash, property, or other
assets. Conservative investors tend to put a large portion to cash and fixed deposits
while some aggressive investors allocate 70% of the total money in stocks.
Early in 1997, many investors overweighted Malaysian stocks on expectations of a
positive economic outlook. As we are well aware, things did not turn out as hoped
with most regional stocks plagued by currency devaluations, the local stocks fell
sharply from the year's high, hurting those with investments concentrated on stocks.
Investors who have reviewed their asset allocation by shifting their money away from
stocks in the middle of the year would have minimized their losses. Do not lose sight
of your original asset allocation as the risks could multiply threatening the capital
value of your investments.
During periods of turbulence and uncertainty, it is always wise to adopt a cautious
approach by allocating a larger portion of your assets to cash/fixed deposits. However,
investors should not shun stocks totally.
Why bother about short-term volatility when you are investing for your children's
education 20 years away. History is on your side - stocks tend to appreciate in value
over the long time. For those who invest long-term, go counter cyclical - buy in
times of gloom. Next week, we will look into different investment opportunities and
their respective prospects for 1998.
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