Ideas on how to become rich - Financial Management - what the rich do in a down market, part 4

SALLY KLAUS AND HER FINANCE IDEAS:

FINANCIAL MANAGEMENT: WHAT THE RICH DO IN A DOWN MARKET
Part 4

Here we continue the financial management series with more ideas on how to become rich.

Mix and don’t match

In investment and asset allocation, plaids do go with stripes. What goes up must come down and vice versa. What do these strange aphorisms mean? Applied to investments, the concept of mean reversion states that, after a period of several investment cycles, most financial asset returns will tend to generate their long term average investment returns. This is best illustrated with a concrete example for understanding. For example, Japanese equities’ returns in the mid to late 1980s were far greater than their long term average and at some point it became increasingly likely that they would revert to their mean returns by producing returns that were near to their long term average.

All we have to do is to watch the numbers because numbers don’t lie. The whole point of asset allocation and investing is to protect your capital and earn a satisfactory return. Your investment return may come from dividends or interests or appreciation of investment assets in real estate or stocks. Some returns from some financial asset classes are fixed in amount while others are less predictable and more market dependent.

Our minds - our selves – do not be your own enemy

One of our investment pitfalls is that we suffer from varying degrees of overconfidence. We think we are better at something than we actually are. Stereotyping ourselves sometimes limits our views to possibilities and opportunities. Many people, when they have made some money from the stock market, think they are investment geniuses and forget that they may only be lucky for once. There is a need to know that we must not confuse investment luck with investment skills.

It is okay to get lucky, but don’t assume a lucky financial gain can be repeated because you are “so smart”. Sometimes being smart was not the cause of the lucky financial gain. The market is in fact not controlled by one person or a group of people. Mistakes can be made by being inflexible, and stubbornness can sometimes really make you pay. We need to be aware of what the behavioral finance types call framing. Framing is simply how we look at our investments. When we get a phone call about our investment idea involving some new wonderful boom-bang investment, do we get caught up in the excitement without considering how it affects our overall investment plan?

Do we know what exactly is happening financially and how well we know the financial developments?

We need to be realistic in our approach to investing. Be methodical and careful in your investment approach. Do your homework. Keep the short term business news in perspective and focus on the big picture. Know your investment weaknesses as well as your investment strengths. When you hear about a new idea that sounds interesting or exciting, ask how it fits in with your plan. Remember all the earlier materials that we covered in the other sections of this financial series? Your plan may not be the same as your neighbour’s or your family member’s plans. By focusing on your goals, avoiding highs and lows of your emotions you can structure and manage your asset allocation plan to take advantage of others’ emotions and mental mistakes instead of getting them richer because of your mistakes!

End of fourth part of this “financial ideas” series


Special thanks to Sally Klaus and her valuable contributions to my finance, investment and money blog. More to come from Sally Klaus in future posts; stay tuned!

Ideas on how to become rich!