Why Your Best Investment Portfolio is all in the Mind

Investing

Why Your Best Investment Portfolio is all in the Mind

Personal finance isn’t just numbers; psychology plays the bigger role. If our emotions didn’t interfere with our money, we would have no compulsive gamblers, no overpriced financial services, and no one with credit card debt. And it would be easy to create your best investment portfolio.

Published on 14 June 2015

Personal finance isn’t just numbers; psychology plays the bigger role. If our emotions didn’t interfere with our money, we would have no compulsive gamblers, no overpriced financial services, and no one with credit card debt. And it would be easy to create your best investment portfolio.

Physiology of investing

But since that ideal is impossible, let’s look at coping with our less rational side:

01.

Think in terms of quantifiable goals

What is it you want to achieve with your investments?

The most common (wrong) answer is “to make more money”. This is not a functional goal, because it is too vague. There are plenty of ways to make more money, and very few of which would actually satisfy you.

If you made $20 selling some stocks this year, you would have made more money; but it would probably not be a meaningful contribution to your life.

For this reason, it is important to decide what you want, and then break it into financial goals involving (1) a specific quantity of money, and (2) a specific time frame.

For example, say it is your goal to retire with an apartment in Singapore. You could break the goal into quantifiable goals such as:

  • Get $3.5 million to purchase a nice apartment in Singapore, within the next five years
  • Having a monthly income of at least $5,000 a month once retired, until you are 80 years old
  • Build an emergency fund of $3 million, three months before retiring

This is quite simple compared to the in-depth planning a wealth manager can do for you. It is, however, still better than setting vague goals. Without clear numbers, you will find it difficult to allocate your assets or set priorities.

02.

Pick a strategy and stick with it

Long term investing can be compared to baking a cake:

Once you have ensured the ingredients are all mixed in, all that’s left is to leave it in the oven. And it’s vital not to open the oven and poke around while it’s baking, or you’re guaranteed to ruin it.

Some investors, however, can’t stop themselves from repeatedly opening the metaphorical oven. They sabotage their own plans through knee jerk reactions and anxiety. An example would be ditching your blue chip stock because a big company is facing low sales this year, or selling part of your portfolio to buy property because the news says everyone is doing it.

Remember that, over a long investment period of 10 – 15 years, these momentary fluctuations are not significant. This is precisely where investing differs from trading; you’re not trying to make a quick buck from shorting stocks or flipping houses. You’re looking at long term prospects, and the longer you give your assets time to perform, the more likely they are to perform as expected. Only with that benefit of a long term approach can you really work at achieving your best investment portfolio.

03.

If  you don’t understand it, don’t invest in it

How do you define risk?

The most common answers are volatility, standard deviation, and trading history (or the lack thereof). Successful investors may not actually understand all of those, but they understand the single most important form of risk: lack of information.

For example, say you decide to invest in a commodity such as a coal. Despite knowing nothing about the energy industry, you agree to purchase physical coal that a mining company will then sell for you.

The mining company is able to show they have a client, who has already signed a contract to buy from them. By all appearances, the risk is low.

But what happens if an accident occurs at the loading dock, and a large part of your coal ends up at the bottom of a river instead of the barge?

Or what of the government passes a new policy, which requires the mine to shut down for environmental reasons?

That’s probably when you’ll realise your whole investment is sunk. There is no one obliged to make up the losses to you.

The same is true for almost any asset you invest in. The less you know about it, the more difficult it becomes to see the true degree of risk. Of course, it’s difficult to know everything about the companies you invest in, which is why you need the aid of a good wealth manager.

You can speak to one right now, and clarify the details of your various investment options.

Why Your Best Investment Portfolio is all in the Mind WEALTH

04.

Pick lowly correlated cssets for diversification

Diversification is the process of mixing different types of assets in your portfolio. This ensures that, when a particular asset performs badly, its poor returns are offset by another, better performing asset.

Diversification also prevents your portfolio from being wiped out. For example, if all your stocks are in a single company, the closure of that company would destroy your whole portfolio.

A key part of diversification is choosing lowly correlated assets. That is, assets that have as little to do with one another as possible.

If you were to buy shares in a gold mining company, units in a gold fund, and then physical jewellery, you may think your portfolio is diversified. After all, these are not the same kinds of assets.

But if the price of gold were to plummet, all of those assets would be affected at once. This is because they’re all tied to by gold prices, and hence have a high degree of correlation.

If you wanted to be diversified, you could instead have assets in a transport company, a property developer, a food supplier, and an electronics manufacturer. There is a low correlation between these industries, so it’s unlikely that they’ll all sink or rise at the same time.

Of course, picking such a diverse range of assets can be difficult. This is why it’s a good idea to speak to a wealth manager – you want to diversify, but not to the point of buying random junk!

05.

Be thick skinned

If your portfolio isn’t meeting your financial goals (see point 1), change your wealth manager or financial advisor.

We all hate that awkward conversation when you have to fire someone, but remember it’s not just money at stake – You can’t afford to wreck your children’s inheritance, or your peace of mind, just to seem agreeable.

Being thick skinned also applies to loss. There will be times when, due to circumstances beyond your control, you will lose money. It can feel unfair, especially if you followed all the rules of financial prudence. An example of this would be the power outage at the Singapore Exchange (SGX) in 2014, in which some investors lost money.

In such a situation, do remember: while you’re busy mourning your loss, everyone else is already off chasing their next dollar. You’re better off joining them than wallowing in regrets.

We think your best investment portfolio is in reach. What do you think stops you from reaching it? Contact us and let us know.

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