Wednesday, 13 December 2017

5 Steps to Manage Risk in Shares Investing (Especially beginners!)

In share investing we always talk about managing risk, which may sound rather abstract.

The objective of managing investment risk is to minimise the possibility of your portfolio running into huge, irreversible loss. If one's overall portfolio is down by 50% on paper, his funds would be stuck for an extended period and not able to invest somewhere else profitably. The opportunity cost is immense.

Worst case would be an investor who can't stand the drop and sell out, his previous good returns earned during market rise (like now) would have been emptied. Besides financial loss, it would deal a big blow to his confidence and some may just bow out and leave the market for good.

So how can one properly manage investment risks at a portfolio level?

Define Percentage of Available Funds to Invest
In essence this is about taking a good hard look at your overall financial position. Each individual's situation is different. The key is to put in a percentage significant enough to compel one to learn the basics of investing, but small enough to not make one lose sleep over paper losses.

For young people with stable jobs, regular income, with long investment runway ahead and intend to pump in capital regularly, this could go really high (eg. 80%) excluding emergency funds.

Determine Maximum Amount in 1 Counter
Let's say you have $100k, and would like to invest into 8 shares. The maximum funds per share will be $12.5k. This is what we call position sizing - the size of your position in a particular counter relative to entire portfolio.

In the worst case scenario that company goes belly up, you already set a cap on your maximum loss. Your portfolio is still intact, and can live to fight another day. This is why you see some investors not affected by huge loss in a particular counter which may only make up just 10% of its portfolio.

Decide a Stop Loss Point
No matter how good a stock picker one is, you are bound to have a few rogue counters in your PF. This happens to even the experts. Do not let losses in these counters snowball into catastrophic scale. If losses ever get to that scale, one would be paralysed, not knowing what to do, and lose the will to clean up the mess. And you would probably run into my Noble situation.

So decide a stop loss, and stick to it. The price drop is already an evidence that something is wrong with the company. Rid the losers, keep the winners.

Establish Minimum Cash Level
Never 'all-in' your portfolio into shares. We never know when will market turn, and should the share price drop, having no cash on hand means we can't scoop more on the cheap.

It also requires experience to operate a portfolio that is all shares. If some counter drops, one may need to decide which share, and how much to sell/buy. That is 4 decisions in total and it requires some experience to implement.

Having cash on hand gives us peace of mind to buy more when market drop. Personally, I will keep minimum 10% of portfolio in cash.

Always Have Additional Capital
Should your portfolio has really suffered large irreversible loss, having additional capital that comes from regular salary can be useful. Having done your research, deploying new capital into strong companies would ensure one has a chance of making a comeback.

And if you buy at the depth of a financial meltdown, probably also the time when your original capital is almost gone, the ensuing rise from a recovering market would bring you multi-fold returns.

Then at the very least, you can get your capital back.

The 5 steps are good starting point to manage one's investment risk. As one gets more experienced, you may refine these rules flexibly to suit your investment style. But the fundamental principles should remain.


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