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June 16, 2006
Manage risk
Remember the old commercial - "Speed kills?" In this day and age - when the one thing we all have in common is that we must save, invest and fund 30 years of retirement - risk kills.
Charley Ellis, former president of the Institute of Chartered Financial Analysts and founder of Greenwich and Associates said, "Investing is a 'loser's game in which the winner is often the investor who makes the fewest errors." Benjamin Graham taught his mentee Warren Buffett well when he told him, "The essence of investment management is the management of risk, not the management of returns."
One of the most prevalent misconceptions about risk is taking more risk guarantees you a higher return. Mathematically, the only thing taking more risk guarantees you is higher losses. Losses are bad.
Losses are bad because losses are so much more powerful than gains. Let's take recent market numbers. The S&P hit a high of 1326 on May 8th. One month later, we are just about back where we started the year. Since January, we have gone up 6% and then back down 6%.
Not it is time for a quiz: If I went up 6% and then down 6%, I should have the same amount of money I started the year with - true or false?
False! If I invested $100K at the beginning of the year and it went up 6%, it is now $106,000. Then when it loses 6%, 6% of $106,000 is $6,360 so now I have $99,640 - less than I started with!
The wider the swings, the more pronounced the effect in real numbers. Let's do it the other way. Let's assume I start with $100K and the market loses 35%. My $100K is now 65K. If the market gains 35%, I still only have $87,750. It would take a gain of 53% to get me back to break-even after a 35% loss. It takes a gain of 100% to get me back to break-even after a 50% loss.
Most investors focus on performance. Worse, they focus on short term performance. This is bass-ackwards. The focus has to be on avoiding losses because of the relative power of losses compared to gains.
And please don't tell me you are going to avoid losses by timing the market or picking the best stocks. Surely you aren't so naïve that you still believe that load of crap, right? Never mind, that is a topic for another day - soon. Until then, try this on for size:
To be a successful investor, you must understand risk, be able to measure it and only then can you manage it to achieve the desired risk-adjusted returns.
As always, your thoughts and comments are not only welcome, but appreciated. You can leave them below.
Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.
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Kim Snider is an author, speaker and host of Financial Success Coaching, Saturdays at noon, on KRLD Newsradio 1080, Dallas - Fort Worth. This blog is primarily devoted to empowering individual investors with information to help them be good stewards of their money. Above all, it is about achieving true financial success. Kim's book, How To Be the Family CFO: Four Simple Steps to Put Your Financial House in Order is in bookstores now. Order yours from Amazon or other fine booksellers today.
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