We appreciate that investors can find it hard to make the right decisions in the best interests of their entire portfolio when capricious markets are accompanied by “noise”. We have three forensic questions that will get to the heart of the actions investors need to take. However, they require honest and unbiased answers to be useful.
1. Do you have the right proportion of your total net wealth allocated to the sharemarket?
This is a useful question as it allows you to think holistically without the interference of individual stock performance. Consider your risk tolerance and the role your equities investment plays in the overall mix.
For example, if your investment strategy states that shares should make up 5-10 per cent of your portfolio (a conservative allocation), then investing in big caps only (such as the banks) could mean you “double-dip” on your risk aversion. In fact, you may have needed that percentage to be a growth component, supporting your other more conservative investments. If you are out of balance, make the appropriate trades and get back into alignment.
2. Does an investment in a particular share represent the best opportunity to maximise your returns?
Opportunity cost is the cost of missing out on a new position because you have your funds committed elsewhere.
Therefore, when investors say, “I might as well leave my money in XYZ stock”, they are in effect saying that right now, the stock is the best place for them to maximise their future returns. While investors who have done their research and had conviction in the business may feel comfortable with this response, those that don’t need to decide.
3. If I had to invest in the business today, how much would I invest, if at all?
Existing investors often forget that they have a choice of where to place their investment dollars.
Consider yourself in the mindset of a new investor, without the past performance baggage. This can be a useful tool when determining what actions to take next.
It can be an effective way to decide on taking profits if the price has gone beyond your desired initial investment amount. It is also an excellent way to seize the opportunity to top up if you believe in the business, yet the price has fallen due to sentiment. But if you would not invest in the company today, then why would you continue to hold it in your portfolio?
If you have the right asset allocation, every stock you hold represents the best opportunity to maximise your returns and meet your objective.
And if you would be comfortable buying all the stocks in your portfolio if investing for the first time today, then have confidence that you have managed it to the best of your ability. Markets will hopefully look after the rest over the long term.
For any Nest Egg readers who’d like to experience a total DIY investment solution, we’re offering a FREE Stock Doctor 14-day trial. Stock Doctor empowers you to invest successfully with confidence, control and peace of mind.
The trial comes complete with one-on-one coaching, strategies and investing education.
Lincoln Indicators is a fund manager and creator of Stock Doctor. Elio D‘Amato is the Executive Director at Lincoln Indicators. www.lincolnindicators.com.au