In college, I learned that there are two kinds of investors: risk averse and risk lover. A risk averse investor is one who, when faced with two investments with a similar expected return, will prefer the one with the lower risk. A risk lover is an investor who wouldn’t mind additional risk for a relatively low expected return.
The Philippine stock exchange (“PSE”) (unfortunately our country only has one stock exchange, so there’s not much room to play) back then was pushing towards the then unprecedented 6,000-value mark. There was some optimism for high returns. Interest rates (for bank deposits) on the other hand, were minimal.
I recognized that if I chose to be a risk averse investor, I would miss out on the high PSE returns by putting too much of my money on fixed-income instruments (like bonds, money market instruments or certificates of deposit). However, I also did not savor putting too much faith on the PSE, given its highly volatile nature.
While doing research for my undergraduate Economics thesis in the library, I stumbled upon this book that gave a good rule of thumb in balancing between risk aversion and risk taking. This book (unfortunately I cannot recall the title or author) recommends the following formula:
legend: x= percentage of assets to be invested in stocks
y= current age
x = 100-y
Thus, at my age back then (19), this is how the formula should be applied :
x=81% of assets should be held in stocks
As an uninitiated investor and a teenager, this rule of thumb was useful and easy to implement. In keeping with the foregoing formula, I kept most of my assets back then in stocks. I got huge returns to as high as 100% net profit on a single stock sale within the span of 3 months from the purchase of said stock. My portfolio back then was marked by large profits in a short period of time. I reinvested most of the profits, including the dividends back into my stock account.
Another perk of keeping a such huge portion of my assets in stocks was that my money is mostly kept away from me. It’s such a hassle to withdraw, thereby decreasing any tendency for frivolous spending. As I left my teen years behind and my priorities changed, I learned to tweak this rule to suit my current needs.
The foregoing formula should therefore vary (in that you can increase or decrease your stockholdings) according to the following factors, among others: (a) whether one is a long or short term investor ; (b) current macro economic factors such as gross domestic product, net exports and policy interest rates; (c) your personal financial goals i.e. are you saving for any immediate purchases within the next 1 to 3 years like a house; and most importantly (d) your personal projection of where the local and global economy (and consequently the PSE) would be within the next couple of years.
If you have a positive projection for the future, then by all means stay invested for a whole lot of money. If not, there’s not much harm in being risk averse.
As with any financial advice there is no one-size fits all rule. The foregoing rule of thumb may be useful to start you on you financial adventure, as it helped me get a start on mine.
20 something lawyer