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The Most Important Thing in Investing

Ser Jing - One Important Thing To Remember in Falling Markets (pic)I was having a conversation with a few friends over dinner the other night and for some reason or another, we kept coming back to the topic of investing. I guess we couldn’t really help it – after all, birds of the same feather flock together.

The main discussion surrounded the pros and cons of different investing strategies. But, my takeaway from the discussion wasn’t about how good or bad the various strategies are. The big realisation I had was the similarity between seemingly disparate investing strategies, something which applies to all strategies. That something is risk management – and it might be the most important thing in investing.

Many investors seem to fall short in investing because they fail to give risk management the attention it deserves. Warren Buffett was famous for staying away from investing in technology companies during the dot-com boom even though any Tom, Dick, or Harry was seemingly making money hands over fist by investing in such companies.

Although sky-high valuations probably entered Buffett’s thinking, it was also the fact that he barely understood those companies which kept him away. This is actually a type of risk management: Stay away from investments which you do not understand.

Of course, that’s not the only risk management tool available. Here’re two more.

Leverage is a double-edged sword

A glance at financial history will show that many investors have lost their shirts because they had engaged in unintelligent speculative strategies that made use of leverage.  Sometimes, even the smartest of investors have been destroyed because of leverage.

I guess you must have also heard of stories of people falling into bankruptcy from “investing” in the stock market. During the 1997 Asia Financial Crisis, even seemingly rich movie stars had fallen into that category. But if you think about it, if an individual’s only investing with his actual savings, how can he ever fall into bankruptcy by buying shares? Even if all his investments fall to zero, he’d just end up with no savings – but he won’t be a bankrupt.

This goes to show that leverage is dangerous for those who do not fully understand it. Investors should think twice – nay, thrice -about the downside risks involved before taking on any leverage while investing.

Slow and steady wins the race

We’ve all heard about the fable of the race between a tortoise and a hair. Investing (and life in general)  is actually a marathon and not a sprint. It is always exciting to hear about friends making 50% returns – sometimes even doubling their money or more – in very short spans of time by “investing” in speculative shares without proper businesses.

But, there are also shares like Jardine Cycle & Carriage  (SGX: C07) and Dairy Farm International Holdings (SGX: D01) which have generated huge total returns over the past decade (1,000% and 811% respectively) as their shares appreciated alongside the growth in their businesses. We do not get many chances in life – isn’t it better to be slow and steady rather than fast and furious?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.