Sunday, 4 November 2012

Protect your serenity, protect your assets. How to be rational and find peace of mind. The role of regular saving and investing in personal development

"Does the future look as black as they paint it?" This is a question that you should ask yourself when you read troublesome economic predictions. On most days, the prevalent opinion in newspapers is a mixture of distrust and hesitation. Is there a way to make solid decisions about where to place your savings and minimize financial risk?

Looking for the right methodology

In investments, like in most things in life, it all boils down to using the right methodology. How can we determine what is true? What facts are relevant? Which predictions make sense? Can we figure out the future by applying principles extracted from experience?

"If you intend to climb a high mountain, always choose the smoothest path," wrote Chinese philosopher Lao-Tzu in the year 520 BC. In times of economic adversity, investing becomes the equivalent of climbing the Swiss Alps bare-handed in the middle of the winter.

Making some mistakes is inevitable in any human endeavour

After suffering the negative results of wrong financial decisions, many individuals are reluctant to place any money in the stock market. Are those fears justified? Making some mistakes is inevitable in any human endeavour. A wise man must be willing to accept occasional errors and use them as stepping-stones for building a better future for himself. We should view the stock market in the same way.

The main lesson to be drawn from past financial mistakes is that, when it comes to investing, methodology is everything. Deeper research can help us make better decisions in the future and more self-discipline can help us reduce risk and minimize losses.

Five principles of risk reduction

The following principles of risk reduction have endured the worst of times. Use them to your advantage to build a prosperous financial future. From time to time, your decisions will not be correct, but if you maintain a prudent strategy, you will keep losses under control and let your profits grow.

[1] Choose solid companies: Preferably those that pay regular dividends. Unless you are a professional investor, it is advisable to avoid speculative stocks of small enterprises whose future is dependent on one single product or customer. During periods of economic adversity, well-established companies whose products fulfil fundamental needs will fare better than small risky undertakings.

[2] Diversity amongst at least 20 different investments: Never place more than 5% of your savings on a single investment. Even if your investment decision was correct today, circumstances may change. The easiest way to minimize risk is to spread your savings into different assets. The rule of 5% implies that you should aim at having at least 20 different investments.

Risk reduction is worth the effort of researching 20 different investments. Some of them will generate outstanding returns and others will deliver negative results. Since you cannot know for sure in advance, you will be better off by spreading your money.

[3] Diversify amongst sectors and countries
: You have no control over what problems will affect specific industries or countries in the future. Those negative events are, to a great extent, unpredictable.

Follow the example of professional investors and spread your savings amongst different types of assets. Diversify also internationally and place a good part of your savings in stable countries around the world, so that your financial future will be less affected by problems in any particular territory.

[4] Trust facts more than opinions: Understand that nobody can tell with certainty when markets have hit bottom or are about to crash. Never act blindly on someone else's advice, no matter how brilliant their track record is. Everybody makes mistakes and, as a general rule, it is better to trust facts than opinions. Listen to knowledgeable individuals, but always check things for yourself.

[5] Invest regularly, monthly if possible: This will ensure that you invest also during periods of deep pessimism. Psychologically, it is easier to place your money in the stock market when prices are rising than when the world seems to be falling apart. Nevertheless, periods of economic pessimism are precisely the best to purchase shares at a low price.

This principle is the most difficult to apply, since it requires enormous self-discipline. When we overreact to painful experiences, we inevitably overlook great opportunities. When the stock market goes through a difficult period, its low prices offer excellent possibilities. If you adopt the habit of investing regularly, you will be able to make profitable purchases when few people are willing to take any risk.

Times of economic adversity are often the best to build (or rebuild) an investment portfolio. As Lao-Tzu observed twenty-six centuries ago: "Truth is often paradoxical. Don't make the mistake of believing that you know what you don't know." Make risk reduction a part of your financial plan and preserve your peace of mind.

Some stocks that I am currently considering

In my relentless search for diversification, these are some stocks that I researching right now for my own investment portfolio:

eBay (EBAY)

While the profits of Visa (V) and other credit-card companies are growing, the growth trend in electronic payments is mightily confirmed in the case of PayPal, the internet payment company owned by EBAY. The financials of EBAY are themselves quite convincing, with the shares at the current price of $48.69.

EBAY has a great balance sheet with little debt (a ratio of 0.4 of equity), and has an operating net margin of 26% which is twice as high as the net margin of Visa. The price-earnings ratio is currently at 21 and the company does not pay a dividend. If you are an income investor, this means that you would be buying EBAY shares with the plan of selling them in the future to generate income.

Gold Fields (GFI)

This is a South African company that is listed in the New Stock Exchange by means of an American Depositary Receipt. At the current price of $12.40 per ADR, this gold miner fetches a modest price-earnings ratio of 9.7 and pays a small dividend. If inflation pushes the gold price higher, the profits of this company should grow, with the added benefit for investors of being able to collect a dividend.

The balance sheet carries a moderate amount of debt (a ratio of 0.4 to equity) and the sales of the company have been growing steadily during the last years. The total revenue of Gold Fields is currently around $6 billion per year, and it generates a healthy net operating margin of 15%. This company might be appealing to income investors who wish to protect their portfolio against any upcoming inflation.

iShares MSCI Singapore Index Fund (EWS)

This Exchange Traded Fund includes shares of the MSCI Singapore index, which is composed by financial companies for about 30% and industrials for about 20%, the rest being real estate holdings, telecommunications companies, and about 10% of consumer companies. The financials include names such as the United Overseas Bank and the Oversea Chinese Bank.

At its current price of $13.20 per unit, this ETF generates a yield of 3%, which may appeal to income investors. The price-earnings ratio average of the shares in this ETF is 15, which is not overly high considering that the Singapore economy is expected to grow at about 2.5% in 2012 and above 3% in 2013.

For more information about rational living and personal development, I refer you to my book about how to be rational  "The 10 Principles of Rational Living"


[Image by corrieb under Creative Commons Attribution License. See the license terms under]

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