IntroductionMany investors find themselves with an investment portfolio that is too complicated to understand, hard to manage and difficult to change. The fact that an investment strategy involves complicated processes does not guarantee commensurate returns on investment. Investors should therefore strive for simplicity in portfolio construction to ensure the achievement of maximum returns with minimum means. Failure to keep an investment strategy simple can expose an investor to costly mistakes.
In this edition of Investment One education series, we will highlight investing principles that will simplify the maze that new investors often go through in their quest to make intelligent investment decisions.
Many factors can influence an investor to own a complicated investment portfolio, these include a tendency to buy into investment vehicles without regard to the impact on the overall portfolio investment strategy; lack of basic understanding of diversification, buying complex investment products and buying investments without a disciplined investment strategy.
Factors that can contribute to a portfolio’s complexity are further enumerated below:
• Investing in complicated investment products
Funds that invest in single or two asset classes are simple enough to understand compared to funds that invest across several market classes thereby raising the level of complexity so high that an average investor becomes lost as the embedded options create difficulty for investors seeking to understand and manage the risk associated with many of these complicated products.
•Investing in too many securities
As the number of securities increase, so does the amount of attention it demands and this invariably requires more commitment of funds. An investor’s goal should be to attain proper diversification with minimum number of securities.
•Investing in too many accounts
Some investors, due to the exigencies of meeting various commitments i.e. family upkeep, children’s education, owning property, retirement, among others, often keep a myriad of accounts between several different institutions. The challenges of keeping these accounts with different institutions with perhaps diverse reporting standards add to the complexity of monitoring and determining what investment are put into each account as this adds to the administrative burden of the investor.
•Investing in an overheated market
Although there are no absolute division between a safe and risky place to invest, investors who stay in markets where people are getting greedy and excessively risk-seeking, and are taking too many daring chances are likely to get caught up when the market goes under.
•Having too many advisors
Some investors have more than two investment advisers as well as having a go at trying to manage a part of their portfolio holdings. Having many investment advisors does not guarantee success rather it can complicate the portfolio without adding to performance or risk reduction.
•Attempting to time the market
This remains one classic blunder that affects investors all over the world. Investors often believe they can tell with certainty when a market has gone down to its lowest level (in actual fact, no one can). Similarly, believing that particular stocks will always make a comeback or that conservative stocks do not fluctuate can mislead investors into pushing the panic button when stocks performance suddenly decline thereby exacerbating the complexities of investing.
Failure to balance portfolio holding between stocks, bond holdings and other appropriate investment vehicles can skew an investors risk profile toward the high-risk quotient as market forces trend continuously experience spasms. A portfolio that does not consider an investor’s specific goals, financial circumstances, such as age, income, years to retirement and risk tolerance to various investment platforms enhances the prevalence of complications.
• Investing without defined time frame
Thinking like a long-term investor and acting like a day trader is one sure source of engendering complications in investing. Also chasing capital gains without following investment blueprint also leads to reliance on speculation or gambling, which also pushes up portfolio maintenance cost.
Tips for simplifying investment decisions include:
•Defined investment strategy
The starting point of every investment decision must begin with a documented blueprint that addresses the investment objective, time horizon, and risk profile, vehicles among others. A strategy document safeguards against the emotional vagaries that arises with fluctuations in market dynamics and serves as source of foundational signpost for review and measurement of investment objectives.
•Invest for long term
Staying invested in the market over the long term has historically paid off, however the market performs, the fact remains that long term investing is fundamental to dividend and earnings growth.
Long-term investing further simplifies investing as it moderates the relationship between volatility and time, as assets with higher short-term volatility risk (such as stocks) tend to have higher returns over the long term than less volatile assets (such as money markets.)