Do You Have An Investment Process?

Why do you invest and how do you go about investing?

This is a complex question but many people (including both retail investors and high net worth individuals) whom I have posed this question to, gave the simple answer “make money; buy stocks”.

 

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I think everyone should do the following 3 things in his/her investment process:

1) Define your investment objectives (see fact sheet on “What every investor should know” from the CFA Institute)

Is it capital preservation, cash flow generation or capital growth? Or a combination of goals?

This is not a simple exercise as you need to consider many factors, such as returns expectation, amount available for investment, liquidity needs, family commitment and time horizon.

2) Understand your risk profile (ability and tolerance)

Are you concerned about the day-to-day (minute-by-minute) price movement of your stock?

How much loss can you tolerate before you lose sleep?

If your answers are “Yes” to the first 2 questions, you probably have a low risk profile and your portfolio should not only consist of stocks.risk

 

3) Implement asset allocation and diversification

By that, I mean putting money across asset classes (such as cash, equities, fixed income and commodities) in order to balance risk and returns as various assets perform differently in different market conditions.

Splitting your portfolio into 1/3 REITs, 1/3 blue chips and 1/3 penny stocks is not asset allocation as all 3 groups are under the equity class – this is just diversification within an asset class.

I believe most people will agree (as least intuitively) with the benefits of implementing asset allocation. However, as discussed in several previous posts, retail investors in Singapore have limited options and face limitations especially in accessing fixed income products.

So, when I mooted the idea of P2P lending being an alternative investment tool with my friends, it was not surprising that common objections include “the upside is capped but the downside is 100% if the borrower defaults” and “I’d rather buy penny stocks than lend to small companies”.

I would think that many framed their analyses with reference to their experiences in trading stocks, but the reasoning behind such comparisons (equity vs fixed income) is flawed. First and foremost, it ignores the features and risk-reward characteristics between the 2 asset classes. (More in a future post.) Next, individual preferences also need to be considered, such as one’s investment objectives and risk profile, before finally employing appropriate asset allocation.

If you are a punter aiming to make phenomenal returns by timing the market based on tips and instincts, P2P lending will be boring and ineffective.

But if you are looking for an investment that generates a stable and regular cash inflow to cover your mortgage or hire purchase, something like P2P loans might make sense.