A fool and his money are soon parted

August 4, 2008
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, NAIROBI, September 3 – Famous American baseball coach Earl Weaver once said: “It’s what you learn after you know it all that counts.”

These words could be adopted in the sphere of personal finance: We all have some form of income that we derive from our daily toil; the key difference amongst all of us is what one does with the rewards from our toils.

Personal finance is not rocket science! It boils down to the basic understanding of balancing one’s income to meet expenses while retaining a portion for future use. It is not a competitive sport either; It is – instead – an important individual effort to achieve some predetermined financial goal balancing one’s risk-tolerance level with the desire to enhance capital wealth.

Good investment management practices are complex, time consuming and require discipline, patience, and consistency of application. Too many investors fail to follow some simple, time-tested tenets that improve the odds of achieving success and, at the same time, reduce anxiety naturally associated with an uncertain undertaking.

If in doubt try to apply the following cycle in planning your investment depending on the stage of life you are in.

There are three phases classified using age groups:

Accumulation Phase (age 20-30s).

This is a critical phase for accumulating assets to satisfy immediate or future financial needs. It is important to know that starting early pays off due to the power of compounding.
The optimal investment strategy should be a high-risk-high-return type of investment.

Consolidation Phase (age 40-50s).

People in this age group are past the mid-point of their careers. By this time, they should have accumulated some assets to cover important needs such as housing and living expenses.
They are now looking for opportunities to generate wealth but are likely to take a less risky approach.

The optimal investment strategy for this group would be balanced; moderately high-risk with capital preservation.

De-accumulation Phase (age 60-70s).

The investor is no longer working actively and is living on income and capital accumulated in the first two phases. The optimal strategy here would be income and capital preservation, which means they would opt for less risky options.

Here are a few tips on improving your investment knowledge;

A fool and his money are soon parted.

Investment capital becomes a perishable commodity if not handled properly. Be alert and serious; pay attention to all your financial affairs by taking an active, intensive interest. If you don’t, why should anyone else? Remember, risk and return are interrelated and so you must set reasonable objectives using history as a guide. Most investors underestimate the stress of a high-risk portfolio on its way down.
 
Don’t put all your eggs in one basket.

Diversify. Diversify. Diversify!

Asset allocation determines the rate of return: Stocks beat bonds, fixed deposits and Treasury Bills over time.
Remember, leveraging too works both ways and so never over reach for yield.

“More money has been lost searching for yield than at the point of a gun,” so said renowned Wall Street economist Ray DeVoe.

Spend interest never the Principal.

If possible, always take out less than comes in. Then, a portfolio grows in value and lasts for eternity. You cannot eat relative performance.

Learn to measure results on a total return portfolio basis against your own objectives, not someone else’s. Avoid the ‘herd mentality’; just because someone else made a windfall does not justify one to make rush decisions. Always remember, it is your money!

Don’t be afraid to take a loss.

Mistakes are part of the game. The cost price of security is a matter of historical insignificance, of interest only to the tax man.

Averaging down, which is different from shilling-cost averaging, means the first decision was a mistake. It is a technique used to avoid admitting a mistake or to recover a loss against the odds such as buying stocks when the market is bearish and thereafter buying in small quantities over a period of time pegged on one’s investment objective.

When in doubt, get out. The first loss is not only the best but is also usually the smallest.

Watch out for fads.

‘Kenyan uniform’ exhibition stalls and mega returns from IPO’s were all fads that didn’t last. There are no permanent shortages (or oversupply). Every trend creates its own countervailing force. Expect the unexpected and be prepared to act.
Be ready to make decisions as no amount of information can remove all uncertainty. Have confidence in your moves.  It’s better to be approximately right than precisely wrong.

Take the long term view to investments.

Don’t panic under short-term transitory developments as was the case when the stock market was self-correcting.  Always stick to your plan. Prevent emotion from overtaking reason but most importantly understand that market timing generally doesn’t work. Recognise the rhythm of events. For instance, the change from analogue systems to digital in relation to the stock price of a telecommunication company.

And remember, whatever goes down must come up albeit having in mind the particular circumstances.

Lastly, note that history is a guide – not necessarily a template – and hence past performance is not always a guide to future performance.  Try not to be too rigid in your investment approach.

Happy investing!

Waiyaki Hinga is a Financial Adviser, British American Asset Managers Ltd.  [email protected]

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