Your ticket to investing wisely

There was an article I read from the Straits Times dated 22 February 2009 and I've always wanted to share it. This was written by Ben Fok, who is the chief executive of a financial advisory firm and i thought that he wrote the article about investments in a very apt analogy which can be understood by all.

Now that I've scheduled some time to blog, let's get right down to it.

In difficult times like these, a plan-ride analogy may help you achieve your goals

Fasten your seat belt - To me the current financial crisis is the turbulence in our investment horizon. Investors can expect the market to be volatile. The markets will eventually recover, but we need to sit tight and rise out the market turbulence.

Over the last few months, I have counseled many investors who have lost money in their investments.

Over time, I realized that all they really wanted to know was : "What should I do now to get out of this mess? If the best time to invest is now, then tell me what should I invest in? do I have to follow every piece of advice given? How do I identify advice that is good for me?"

With this crisis hanging over out heads and no one knowing how long it will last, the best approach is to get back to basics.

I would like to use the analogy of taking a plane.

One of the things that air crews are trained to do is to adhere to a standard operating procedure.

Like air crews, an investor needs to have a proper investment procedure.

The first step is to know where you are going and how to get there. In other words, you need to know your destination and how much time you need to reach there.

To most investors, the objective of investing is to make as much money as possible. That is fine, but how much, and when do you need it? Without knowing your investment objectives, it is difficult to know what you should be investing in.

Most investors understand that investments span a range of risks. If you require a high return, you must be prepared to take a higher risk.

Using the plan-ride analogy again, once the plane is airborne, you as a passenger have already exposed yourself to greater risk.

Of course, the risk is mitigated by the fact that the pilot is well trained to fly the plane and to react to unexpected events.

Likewise when investing, you should consult a financial adviser who takes time to understand the risk level you can tolerate. Just as the pilot is trained to fly a plane, a financial adviser is trained to do the job of managing risk.

Your choice of investments must flow from your risk appetite. If you can take a 50 per cent drop in your investments, then high-risk investments like technology stocks/funds or aggressively managed funds like small-cal funds could suit you.

If you cannot tolerate too much volatility, opt for lower-risk investment like balanced funds where there is an allocation of 60 per cent in equities and the rest in bonds, for instance.

The idea is to make your risk appetite – not the investment opportunity – the reference point.

Most investment disasters happen when investors make the investment a reference point and then try to adjust their risk appetites accordingly.

Back to the analogy of the plane ride. When airborne, the plane may hit turbulence. For your safety, you are advised to return to your seat and put on your safety belt.

You will also notice that turbulence usually doesn’t last very long. Once the plane is out of the air pocket, it will be flying smoothly again.

Even pilots cannot tell the exact locations and severity of turbulence along their flight paths. All they can do is to build a good forecast by analyzing charts, flight monitors and weather conditions.

This is the reason they ask you to fasten your seat belt whenever you are seated, just in case the plan suddenly hits an air pocket.

To me, the current financial crisis is the turbulence in out investment horizon. Investors can expect the market to be volatile. The markets will eventually recover, but we just need to sit tight and ride out the market turbulence.

Finally, the place reaches your destination and you will be glad that the risks you have taken are over.

However, before landing, the crew will be busy checking landing procedures. This is akin to meeting your investment objectives.

The final phase of your investment horizon is extremely important. As you approach retirement, you should adjust your risk level and think about preserving your capital. Otherwise, you can have a hard landing like what many are experiencing today.

Once you step out of the airplane, you know that you have arrived safely.

Similarly, in investing, you will arrive at some point in the future and hopefully fulfill your financial objectives.

The entire process is the result of knowing your investment objectives, taking some risks and enjoying the fruits of your labour.