Daily Gains Letter

The Basic Principle Smart Investors Shouldn’t Forget

By for Daily Gains Letter |

050913_DL_zulfiqarOver the Labor Day weekend, I met up with my old friend, Mr. Speculator. As always, we had a debate about portfolio management. We had a long conversation about what really is the right way to manage your investments—and, for that matter, if there is any. Should investors invest 40% of their portfolio in bonds and 60% in stocks? Should it be the opposite? Or is there another possible combination?

He said, “Moe, I am a firm believer in going for the fences every time for now, but do you really think I will continue to have the same approach in the long run?” (Turns out, there’s actually a rational investor in Mr. Speculator.)

“The answer is very simple: no,” he added. “When it comes to portfolio management, investors really need to realize there isn’t really a one-size-fits-all approach. I take risks now because I can afford to, but for those who are close to retirement, this is certainly not the way.”

I disagree with Mr. Speculator on many aspects of portfolio management, but on this, I can’t help but agree. Portfolio management differs from one person to another, and the amount of risk an investor should take also operates the same way.

A person who is 50 years old and has accumulated a significant amount of funds in their retirement account should not be taking the same risk as a person who is in their late twenties.

A person who has saved money for their retirement and are closing in on their golden years should be conservative with their investments. They should have more of a focus on assets with low volatility and employ investment strategies that are focused towards reducing risk and losses.

One way they can continue to generate income on investments they already own in their portfolio is through an option strategy called the “covered call.” You can read more about it here.

On the other hand, an individual who is young and has time on their hands can afford to take a little higher risk, and can even afford to take a loss. The reason behind this is that they can recover their losses with time, or just simply add more money to their portfolio. For example, when Mr. Speculator says he can afford to take risks, it is because he’s working full-time, and no matter if he’s up or down, he takes 10%–15% of his monthly income and adds it to his portfolio.

This may all sound too simple, but sometimes, investors forget these very basic principles of portfolio management. In order to attain the higher return, they simply start taking more risks, without realizing what it can do to their portfolio—it can destroy it if the trade or investment doesn’t work in their favor. It might pay off in the short term, but in the long run, it simply doesn’t work.

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  • Bruce Willis

    This is a great topic you have covered here. I can really use some of your tips to help myself in the future investment opportunities. Keep Writing. Cheers!