— “Calling the Trend” Column, by George Leong, B.Comm.
The current market uncertainty requires prudence and strategy, not the act of simply chasing stocks. I will take this time to talk briefly about adopting a professional portfolio management approach.
Make no mistake about it: the stock market is a risky marketplace for all investors. Risk is the most important component of an equity security. If you are always mindful of the degree of risk associated with a stock, rather than the degree of potential return, you’ll do a much better job of protecting your wealth over the long term.
Investing in the stock market is just like undertaking any other business venture. Just like in the mainstream economy, for every one successful small business, 10 others go bankrupt. The stock market is similar in this regard. There are a lot of stocks in the market for you to consider, but only a select few will ever provide you with positive returns.
The first thing you need to have in order to help protect your wealth in the stock market is a business plan. This doesn’t have to be complicated, just an informal set of parameters that you can use as guidance while managing your positions.
As an example, some of these parameters might be as follows: “I will keep my money in a money market fund until I find a good opportunity in the market. I won’t rush into any positions. I will not invest more than 20% of my total portfolio in any one stock. I will not invest more than 30% of my portfolio in any one industry. I will diversify among large- and mid-cap stocks. I will only invest a maximum of 10% of my entire portfolio in small-cap or speculative stocks.”
It doesn’t matter if you are investing in the stock market, in real estate, or in antique cars. The best way to protect your wealth is not to put all your eggs into one basket.
One of the keys to successful investing is longevity. The longer you are in the business of investing in real estate or the stock market, the more experience you’ll gain and the more opportunities you’ll have crossing your path.
When you are buying a stock, you are investing in a business.
The phrase used to describe this spreading of investment risk is “portfolio management.” Portfolio management is a process that encompasses the creation, monitoring and adjustment of your investments. The process never stops, because you are continually buying and selling new stocks. Taking a “portfolio approach” to your stock market investments helps you stay in the game longer and improve your returns.
Taking a portfolio approach to your stock market holdings means diversifying the industries in which you invest. Not only do you need to spread your investment capital around a number of different stocks (say 10), but you also need to spread your holdings across different industries. Owning a basket of stocks in one market sector increases your investment risk substantially, so you have to spread your money around in different industries if you want to protect your wealth over the long term.