By Tony Samson
INVESTMENT OPTIONS vary depending on the risk one is willing to assume. Investment advisers want to know their client’s investment philosophy to evaluate risk appetite. If the goal is just to conserve capital and perhaps get a modest return for income enhancement, the portfolio recommendation will favor fixed-income bonds, defensive dividend-paying stocks, or even time deposit.
Investments can be likened to a culinary adventure. Are you the type to order the same dish because of its familiarity, even when traveling abroad? Do you play it safe with the familiar? Or do you take chances with the native cuisine and sample deep-fried grasshoppers (listed in the menu as “land shrimps”)? Your preference is all about your appetite for adventure… and risk.
If the risk appetite is hearty (there are carnivores as well as vegans) the mix may go for small-cap stocks that have both high upside potential as well as downside risks. Here are some things to consider with risks.
Cash is not entirely risk free. There is a mistaken belief that cash is the safest form of investment. This conviction disregards inflation and the effect of currency depreciation. Cash is seldom kept under the pillow, as this will make it too lumpy to allow sleep. Still, interest from even a special deposit account may not cover the twin effects of inflation and foreign exchange risk. So, “parked cash” can also be dented by careless valet attendants.
Opportunity cost needs to be considered. Keeping investments in one form necessarily means giving up yields of alternatives. Especially if the present cash hoard is the result of liquidating a position in equities by taking profits or limiting losses, waiting in the sidelines entails an opportunity cost. It may mean giving up potential gains from a stock price rally. This opportunity cost consists of foregone profits.
Risk and reward go together. Even the most conservative investor does not keep all her assets in cash. Part is invested in real property, as in the house or condo she lives in. It’s possible to spread the risk, and perhaps allocate a portion to riskier equities. To cushion the risk impact, it is possible to acquire only dividend-paying stocks. A dividend track record makes a stock more attractive, especially if it is also tagged along in a rally.
Stock picking can be delegated. It is always helpful to track personal portfolio picking, especially the crucial matter of timing when to buy or sell, against professionally run funds with research teams tracking corporate performance or even algorithms that buy and sell according to certain parameters.
Even after a balanced mix of risks, there is the option of using borrowed funds for investing. The use of margins or loans to buy stocks can exacerbate steep declines in value. It is possible to lose more than the investable funds. Margin calls and redemptions of panicky mutual fund investors can accelerate the selling pressure on the market and accelerate corrections.
Dips in the composite index price are often considered temporary and perceived as a window of buying opportunities.
Is it time to raise the bet and go “all in” in a correction, or should one simply fold his cards and wait for a better hand? Is the drop in prices a time to jump in; or a fire alarm to head for the exits? Is buying cheap now a way of averaging down or simply a case of catching a falling knife?
Funds for investment should not include those intended for such things as rent or amortization, groceries, or tuition fees for the kids. What about the savings for a Mediterranean cruise or the purchase of a third car — can these be considered investable funds? This compartmentalization of cash is called “mental accounting” by behavioral economists such as Richard Thaler. This approach is useful in understanding savings and investments.
Not all risk assessments have to do with economic events. Political risk can come unexpectedly, out of the blue. Suddenly someone rants about certain private companies making too much money and making people suffer. The affected stocks swoon, as the banks get jittery about long-term loan repayment prospects.
Rhetoric, especially from a certain political source, plays a role in changing the investment climate. When a specific name is mentioned in a speech and not in a positive way, say the designation as national artist or most outstanding investor in the economy, the ripples can rock small boats.
The risk of being mentioned negatively in a speech, no matter how obscure the venue, can make anyone lose his appetite… even for food.
Tony Samson is Chairman and CEO, TOUCH xda.
