Financial Planning: What kind of investor are you?

 

What kind of investor are you?

55 year-old Daba Lawson is five years from retirement, and is still smarting from her experience in the Nigerian stock market since 2008. Daba like so many of us got caught up in the euphoria of the bull-run. One of her young friends had taken a margin facility to leverage her stock portfolio and had enjoyed huge successes. Her friend urged Daba to borrow from her bank to buy shares, and for two years she realised huge “paper” profits in her portfolio.

Then the market changed, and at the time of the downturn, Daba had almost all of her money in stocks. Daba’s friend advised her to “hang in there” and things would soon rebound. The stockmarket decline continued unabated and in Daba panicked and sold all her stocks to pay off her margin loan; she lost about 65% of her money.

Daba tried to try to recoup at least some of the huge losses she sustained during the stockmarket crash and decided to put what was left in a fixed deposit and earned 14% per annum for about a year. She vowed never to touch the stock market again. Now Daba has a new problem; all her money is still in the money market and she is earning only 3.75% per annum. Daba moved from an all-stock portfolio to an all-cash portfolio both extreme and extremely risky, neither of which will help her achieve her financial goals and objectives.

Like Daba, many investors overreacted to the volatile market conditions and completely abandoned the stockmarket during the steep decline. Whilst this may have brought them some temporary peace-of-mind, unless they consider a more diversified portfolio that includes assets that have some prospect of growth, the long-term effect may be just as damaging.
 It is important that investors balance fear and risk against the likelihood of achieving their financial goals. This involves a process of gradually moving to a more balanced asset allocation.

Don’t put all your eggs in one basket

Daba has sought advice from her financial advisor who has pointed out that as most of her retirement savings are in the money market, it is unlikely that her retirement fund will keep apace with inflation. Unless she diversifies her portfolio and considers going back into the stockmarket but with careful thought and a tested strategy this time, she has little prospect of achieving the retirement she envisaged for herself. As Daba is still very risk averse, and really doesn’t have the time nor the expertise to select stocks herself, it is recommended that she should re-enter the market through an equity mutual fund. This provides her with a diversified portfolio, which is managed by professionals.

Consider a cost averaging strategy

This time, however, Daba will avoid making any single big move into stocks, but will do so gradually using a cost averaging strategy. This involves investing a certain sum regularly into a carefully selected equity fund that focuses on investing in blue chip growth stocks. By drip-feeding her funds into the stock market she feels more comfortable; she is also putting away each month only what she can comfortably afford from her monthly income. Fortunately she is earning enough to be able to afford to invest N50,000 a month by direct debit from her salary account so she is not tempted to spend it. She has also promised herself that this is her retirement nest egg and she wont be touching it for several years. A long-term perspective is what is required for the stock market, which has historically out-performed other investments over the long-term. She is under no illusion that she must cut back on her spending and might even have to delay retirement and she is prepared to so this so that she does.

What is your money personality?

It is important to know your money personality. Are you risk-averse and feel over anxious or even panic when you learn that the value of your investments has gone down? Or are you able to stay fairly relaxed as the value of your investment fluctuates with the ongoing market volatility? You might on the other hand be one of those people that can sit back calmly during the market swings and stick with your long-term strategy even if you face short-term losses. These are all questions to answer as you develop your strategy. Do you have a strategy at all? Risk is a natural part of investing; it is thus important to understand what the risks are.

Investor confidence has suffered a great deal in Nigeria and indeed all over the world. Fearful of the stock market, many retirees or those close to retirement have shunned traditional investment vehicles like stocks and mutual funds. It is true that anyone invested in the stock market is bound to lose money from time to time, yet those who retained some exposure to equities amid the peak of the global financial crisis are likely to have ended up better off on average, than those who reduced their equity exposure to zero. Understanding your personal risk tolerance will help you create a sound financial plan that you can stick with through both good times and bad. 

  source:moneymatterswithnimi.com