Creating an investment strategy is the first step to reaching an objective. But the more you get to know yourself and adapt your strategy to match, the better your chances of success will be.
Driving a Porsche 911 GT3 with a PDK (Porsche double-clutch transmission) gearbox is quite an experience. In PDK Sport mode, the gearbox adapts to your driving style and to your speed, providing either a high-performance or a comfortable ride and giving you the sense that you’re in total control.
Being passionate about Porsche, I’m thrilled that the metaphor above is perfect for explaining how investment risk profiling works. By the end of this article, you’re going to understand the many different factors that can impact how you invest.
When you have a PDK Sport gearbox, your driving style (and many other factors) are taken into account by the intelligence of the gearbox software, which finds a good mix and balance on the road.
Translating this into an investment language, we get: A tailored investment strategy actually takes into account your investor profile (and many other factors) and helps you find a good balance through market cycles.
The investment strategy is about you, about your objectives, your risk tolerance, and much more… It is your personal guidelines for your investing road trip.
Feeling anxious with an investment strategy could lead to irrational moves, including one of the biggest mistakes beginner investors tend to make: changing strategy without material reason. The classic example is selling an asset low and buying high because emotions led you to act too quickly. (You might sell low, buy high because you might have exited too early for instance).
Feeling anxious while driving could make you do piloting errors along the road, or adopt an inadequate speed.
This is why an adapted investment strategy is the first step of the investment process.
Now, you may ask … what is an investment strategy and what is it based on? Well, this is an investment plan to follow so that you invest with logic, based on a rationale and on specific rules, in order to give yourself the best possible odds to reach your objectives.
The investment strategy is about you, about your objectives, your risk tolerance, and much more… It is your personal guidelines for your investing road trip.
This article is all about the importance of this investment strategy, but also which factors tend to influence it.
People investing via their banks are usually asked to fill a risk profile questionnaire but are rarely explained how the questionnaire works, or what some questions are there for.
If by now you are already lost, we highly recommend you read our Masterclass series in order to get a bit more familiar with the terms that we are using. Otherwise, bear with us, we will keep going into the details.
When it comes to investing and risk tolerance, the problem lays in the fact that we do not know our personal tolerance for risk until we’ve first experienced the pressure and observed our reactions. It can nevertheless be estimated thanks to specific situational exercises.
In order to simulate the market shifts and see how security would react to them, investment professionals usually have a closer look at historical returns (which are actually the past returns and performances of investment security).
By simulating gains and losses, they learn whether or not the maximum loss (which for instance, might be 40% during a market crash) is too much for you to bear… In that case, they will conclude that the strategy was not correctly adapted for you.
Building an investment strategy is always based on several variables, that each impact at least one of the following parameters:
- The asset allocation (% of equities, % of fixed income, and % of alternative investments for instance) defines your risk/return characteristics.
- The securities that you select (they are not all appropriate for all kinds of investors).
Knowing which factors influence an investment strategy will thus help you act with more wisdom, logic, and make more informed decisions while defining yours.
So, what are the variables that we consider as the main influencers of the strategy?
Here is how each variable influences each section of the strategy:
Answering the above questions will avoid you being left with a non-adapted investment strategy.
Markets are of uncertain nature (although economists have been fighting for centuries over the existence of repetitive economic cycles). But despite their randomness, investing with random strategies have low chances of success. They commonly end up with these three results:
An overly conservative strategy, which will leave you frustrated that you’re missing out on upward market trends
An overly aggressive strategy, which will leave you in a panic as market downturns lead your portfolio to drop more than you’re emotionally comfortable with
An adapted strategy, by chance, that enables you to experience market cycles in an acceptable way
The best way to face market shifts is to have an adapted strategy.
The best way to face market shifts is to have an adapted strategy.
During a car rally, although all drivers compete on the same road stage, they all have a different car setup to suit their driving style.
Depending on their driving style and ability to bear the risk (and their co-drivers), they will go faster or slower in each stage.
Defining an investment strategy works in the exact same manner and it’s all about finding the right balance that works for you. You can think of the markets as the road. There are left and right turns, and you have an objective.
If you want to reach your objective in your anticipated timeframe, you need to adjust your speed so that when the next turn comes, you are prepared and ready to handle it. And one thing is for sure… turns will come. Markets are much less like a highway, and more like a winding mountain road.
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