02 August 2013

Risk & Return

In modern portfolio theory, it mentions that majority of the investors are risk adverse, they are only willing to take on the risk for investing only if the return is higher to them. The Pre condition is the investors are behave rational and have all sort of information in the market. 

The safest asset class is fixed deposit. Next is government bond. Next is Private Bond. Next is REITs. Next is Blue Chip Stocks. Next is Small-Medium Cap Stocks. Next is leveraging products. 

So if you look at the graph chart, you can notice that higher risk asset class would have bigger volatility and more steep towards uptrend in long run. 

The second modern portfolio theory is diversification. As you do not really know what will happen next day to your investment product, it is advised to hold more counters / asset classes in your wealth portfolio. This can diversify risk of experiencing particular risk in the market. 

Both are quite true, especially if you have little knowledge in investing. So invented products such as ETFs and Mutual Funds are created to help passive investors. 

However to active investor who like to manage their own cash flow management, it is wise for them to find out more from the product itself. For example, if you are investing in Malaysia Equity Fund, you have to find out what counters contribute most in the fund, and the fund manager behavior in managing the fund such as to follow composite index or have active management by switching counters in regular basis etc. You also have to be aware of currency risk, political risk, economic risk etc before just go ahead to invest. 

Some investors may rely on price trend to decide their buy/hold/sell strategy, and may incur more transaction costs. To me, I prefer to have a longer term portfolio with growth stocks combined with undervalued stocks. You have to be aware of the reasons why the stock prices are dropping/rising. 

For most of the time, the market is rational, with little time that we may fall into the panic sell trap / purchase a counter without consider the Risk. Just ask yourself a question - Will you buy more if price is going down as fundamental does not change? Will you sell instead of buy more if price is up and fundamental does not change?

I always believe in long term investment, provided the counters that we purchase are in low price, and what we need to do is to hold for longer term for share price to turn up to its Long term intrinsic value. 

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