Five virtues of a successful investor

IN THE current market, the old adage 'what goes up must come down' could probably be updated. These days, what goes up not only comes down, but goes back up and then down again. It's called volatility and for better or worse, it's an integral part of stock market investing.

In volatile market conditions, investors get jumpy and try and predict where the market is going, selling off equities or becoming too nervous to invest at all.

Investing doesn't have to be like this. Despite what market 'experts' say, investing is not a game or a contest, it is a continuous process that lasts a lifetime. Whether you are winning or losing at any given moment is beside the point. As such, volatility is not the long-term investor's concern. The only thing that matters is whether you prevail in the end. And the factors that determine long-term victory are probably the exact opposite of the ones that create short-term success.

In the short run, the investors who can't let go - who track every market move - can occasionally come out on top. But the longer they keep at it, the more likely it is that these same people will lose. That's because obsessing over the market leads you to think you can foretell the financial future. You then make increasingly aggressive bets. Sooner or later you'll experience either heartburn or heartache. Fortunately, you can break this destructive pattern with a secret weapon based on self-control. At Russell, we call it 'virtuous investing'.

When it comes to investing many of us apply principles such as risk and reward and fall prey to greed although we may not admit it. When we check how the markets are doing, we don't think about the admirable qualities we need to be investors. We just want to know how much we have made or lost. But the qualities we need in our daily lives also apply to investing.

'Virtue does not come from wealth, but wealth, and every other good thing which men have, comes from virtue.' - Socrates

Have courage: Investing in shares is risky but it is a calculated risk. Think about recent market gyrations as the outcome of a dice, but one with more than six sides. And the good thing about this 'super die' is that it has more positive sides than negative ones. Each time market forces roll this dice, you take a chance on the outcome. In the 12 months to June 2007, there was an amazing run of the die: The Singapore stock market (STI) saw positive returns in the past four quarters. Risks appeared to have disappeared. But don't forget the die does have negative sides - we just haven't seen them in a while. So July and August brought us negative results. As the die is rolled in the next month, quarter or year, we take the risk that it could again land with a negative side facing up. But our chances of seeing a positive number next time are greater than the chance of a negative. The stock market's positive numbers have outweighed the negative numbers over long periods of time. There is no reason to believe that they will not continue to do so in the future.

Be honest: Be honest with yourself about how much you really know. Be honest about - and constantly test - what you don't know. Decades of research by the world's leading psychologists have shown that over-confidence - thinking you know more than you do or that you are more skilful than you actually are - is one of the most fundamental aspects of human nature.

Back in 1999, when you could dump all your money into just about any tech stock and watch it triple in two days, it was easy for an investor to feel like a genius. In fact, anyone who made money trading shares without first studying the underlying companies had a lot of dumb luck but not an ounce of genius!

Successful investors accept not just the possibility - but the certainty - that they will be wrong a lot of the time. You need to protect yourself against being wrong in two dimensions: space (picking the wrong investments) and time (buying when you should sell or vice versa). Over-confident investors are convinced they're right in both dimensions - just when they are most likely to be wrong. Fortunately, powerful protection tools are available and putting all these protective tools to work at once will provide you with the closest thing to real peace of mind as an investor. These are the ways to get 'power protection':

Diversify in space by investing some of your money in local investments and some internationally, in shares, bonds and cash. Draw up an asset allocation plan by deciding what percentage you want in various asset classes - for example, 60 per cent in shares, 10 per cent in property, 20 per cent in bonds and 10 per cent in cash. Knowing that the gain or loss in any one individual investment is just a small piece of your investment pie should help you keep your cool.

Bet only on the side. If you're sure a security, fund or industry sector is a good bet, put only a small piece of your total assets there, say, 5-10 per cent at most. And never add more, no matter what.

Dollar cost average. Diversify the risk of time by investing the same amount every month through a dollar cost averaging programme. That way, you'll never put all your money in the market right before a crash or have nothing invested right before the market soars.

Re-balance. Finally, once or twice a year, adjust your assets so that they match the target percentages you picked earlier. That will force you to sell a bit of whatever has gone up and buy a bit of whatever has gone down. This reverses the tragic buy-high, sell-low pattern that plagues most investors.

Be detached. Armed with a balanced portfolio, you will never be afraid to read the headlines. There is a tendency for the mass media to excite its audience about short-term fluctuations in the market and get investors hot and bothered about the fortunes of individual securities, countries and sectors.

You don't have to look far to find examples of financial shock therapy in the daily news. The stock market plummets and the headlines warn of economic Armageddon. Oil prices soar and another investment 'expert' touts the need to buy shares in energy companies. Investors are far better served by being detached from the constant noise coming from the media.

In the long-term ride to wealth accumulation or preservation, an honest confrontation with risk and reward - implemented via a carefully selected asset allocation plan - is the only way to prepare for unpredictable volatility. Accept that the value of your investments will rise and fall in the short term based on market behaviour. And remember that what matters most is the size of your account on retirement day.

Be disciplined. Don't let emotions rule your investment strategy. It's easy to let short-term market movements affect and even dictate your investment decisions. Which is why it's important to understand the role that investor sentiment and emotion plays in the cyclical nature of equity markets. How often have you seen an investor who, during a strong market upswing, rushes to buy so as 'not to be left out of the gains'. Conversely, during a strong downturn investors will feel compelled to sell so as 'not to be left bearing the losses'.

Be committed. Keep your eye on the prize and ignore short-term market events. History shows that moving in and out of the market may reduce returns, so don't bail out. Consider a 'holder', a hypothetical investor who invested $100,000 in a diversified portfolio** comprising 20 per cent Singapore shares, 30 per cent international shares, 5 per cent Singapore bonds, 15 per cent international bonds, 30 per cent property in January 1996 and stuck with it through to December 2006. His average annual return would have been 10.65 per cent and his investment would have been worth $304,332 at the end of that period.

Now consider a 'bailer' or 'chaser' - a hypothetical investor also starting with $100,000 in 1996 - who chases the top performing asset sector each year and switches on Jan 1 every year. During the same period, this investor would have changed his asset allocation 11 times. By the end of 2006, his average return would have been 8.74 per cent and his investment worth $251,463. Our 'holder' fared much better.

Hopefully, you've chosen your investment strategy based on your risk tolerance, age, how long you plan to work, financial circumstances, retirement goals, and attitude to investing. Stay committed to your strategy and don't alter it unless your life changes.

The point? These simple virtues may not make you wealthy but they will help you handle your investments with the same grace we strive for in other aspects of life. So keep these five virtues in mind the next time the market dives or you're tempted to act on a 'hot tip' from a friend.

As Socrates said: 'Virtue does not come from wealth, but wealth, and every other good thing which men have, comes from virtue.'

**Hypothetical performance calculated by using the following index returns. Singapore Shares: STI, Singapore Bonds: UOB Govt Bond Index (SIBID prior to January 1999), International Shares: MSCI AC World, International Bonds: LB Global Agg, Property: FTNAR EQ Reit.

Lim Meng Tat is director, Russell Investment Group

Source: Business Times Online