A Simple Concept

Add comment May 23rd, 2008

  Tracy S. Beard, CFP® 

One of the most powerful illustrations I have shared with my clients over the years involves a very simple math concept.  Imagine you started with a portfolio worth $100,000. If you lose 50%, how much return do you need to earn to get back to your original principal?  Often an investor will respond by answering 50%. However, a 50% return on $50,000 would only bring the portfolio value to $75,000.  The correct answer is 100%.  Yes, that is correct.  A 50% decline requires a 100% return to merely recover.  This is why controlling risk in a portfolio is so important. When investors ignore the benefits of diversification and become speculative, they are subjecting themselves to this type of speculative risk.  So what should an investor do?  Listed below are a few methods that may help protect your portfolio from speculative risk. 

• Avoid bad timing decisions and don’t let your emotions dictate your investment decisions – Too often investors misjudge risk.  They think risk is high when risk is really low.  For example, when the market corrects by 10%, most investors do not want to put money in the market.  However, they usually line up to make deposits when the market is on an extended run up.  What are implications of bad market timing?  If you bought into the market in March of 2000 (when it felt good), your portfolio of Large US stocks fell over 50% by 2002.  If you pulled your money out at the end of 2002 (when risk was actually low), you would have missed double digit stock returns for each of the next four years.
• Broadly diversify across a number of assets classes throughout the entire planet – While diversification seems boring, it works. You will not hit a home run in any given year since you will not have your entire portfolio in the hottest market.  Fortunately, you will not strike out either. 
• Stop watching the financial networks every day – When one watches the news everyday, they tend to believe markets are more volatile than they actually are.  This can play with your emotions and cause poor market timing decisions. 

For more on building a diversified portfolio, feel free to visit our website at www.savantcapital.com

Testosterone and Trading

Add comment May 23rd, 2008

 Tracy S. Beard, CFP® 

A recent study done in Britain attempted to link testosterone levels with trading performance.  The general conclusion indicated a higher testosterone level resulted in more aggressive trading. Aggressive trading led to better trades, and more profit for the investor.  However, it also referenced irrational risk taking when traders had elevated levels of testosterone.  Large declines and losses in a portfolio are often a direct result of irrational risk taking.  Normally, we do not get caught up in the speculative trading practices utilized by most of the investment world. After all, it is extremely difficult to beat the performance of a broadly diversified portfolio of low cost index funds.  But if you prefer to invest on the speculative side of the curve, this study maybe helpful.  Here are a few considerations. 

1. If you are using a female broker, you can probably ignore this whole blog.
2. Prior to placing trades with your broker, ask if he recently checked his testosterone levels. If the levels are high, have him call you tomorrow.
3. If you have a male managing the account, see if he is willing to get married.  Marriage has shown to lower testosterone levels. Better yet, see if they can have children as well.  Becoming a dad has been linked to lower testosterone levels.

Kidding aside, the investment world is always trying to find methods or explanations to make a quick buck. Many experts agree the most successful investments avoid aggressive and speculative trading.  Your time is probably better spent focusing on the following items: 

• Reducing your investment costs
• Broadly diversifying across US and international markets
• Remaining disciplined during volatile periods
• Rebalancing your portfolio when necessary