by WWM | Jan 23, 2019 | Investment Policy Statements, Investor Profile
Developing a comprehensive investor profile is the first step in creating an Investment Policy Statement (IPS).
The investor profile documents who the investor is today. As well as where they want to go. This includes the individual’s: financial situation; investment objectives; personal constraints.
Financial Situation
To get where you want to go, you need to know where you are today.
It is easier to accumulate $2 million dollars in 10 years if you have $1 million today. Versus starting with nothing. And it is even easier to accumulate $2 million in 10 years if you begin with $3 million. But one path may be the wiser.
Personal Balance Sheet
Prepare a personal balance sheet listing all your assets and liabilities at market or realizable value. The liquidity of the asset will help determine the difference between market and realizable price.
There will be different liquidity considerations for bankable versus physical assets.
A common share traded on a major exchange should be more liquid than your house or vehicle. The more liquidity, the easier it will be to receive market value. The less liquid, the longer you may have to wait to obtain the market price should you want to sell. Or, the less liquid, the greater you will need to discount the selling price in order to make a quick sale.
The balance sheet provides a snapshot of your net wealth at the date of preparation. It will also provide you with your current asset allocation.
The snapshot occurs at one specific moment in time. You will need to monitor and update your situation periodically.
Be Holistic
Take a holistic view when developing an investment plan.
Often, investors “forget” about non-portfolio assets when calculating their investment strategy. Not forget about the asset, but mentally forget that it is an actual asset that needs to be included in the investment mix. If you own a house, then this is a real estate asset. It needs to be factored into your overall asset allocation plan or you will err in your calculations.
The same goes for assets such as pensions through your employer. You need to know what the pension is invested in, if anything, so that you can complement your own strategy.
Statement of Cash Flow
I also suggest preparing a statement of cash flow. What money is coming in the door each month and what expenses are being paid? Any excess is money available for investing.
More likely though, you will not have much, if any, excess. You should review your cash flows and look for ways to cut back in some expenses in order to generate investment ready cash.
This may require some budgeting work.
If you are not an accountant, no fear. There are a variety of inexpensive and easy to use tools to help create balance sheets, cash flow statements, and personal budgets.
Investor Objectives
We have considered investor objectives already.
Categorize Objectives by Time to Maturity
It is important to segment objectives into the short, medium, and long-term.
While you may not plan to retire for 40 years, you likely have near and intermediate goals that must be incorporated into your total investment planning. A car you want to purchase in six months requires near term financing. And the house you hope to buy in five years needs to be reflected in your IPS.
The closer the objective is in time, the less risk you want to take in the investment.
Categorize Objectives by Priority
You should also label each objective as high, medium, or low priority.
That way, if your wealth accumulation falls short of its targets at various points in life, you can still hopefully hit the high priorities.
Quantify Your Goals
In an IPS, I suggest that you try to quantify investment goals as much as possible.
Simply stating that you want to maximize your investment performance or achieve financial security by age 60 is not enough. It is easier to achieve one’s aims by setting specific and realistic targets. Then work backwards to develop an action plan on how to achieve the goal.
If you believe that you need $2 million in liquid assets at age 65 with which to retire, then you can set up various investment scenarios factoring in time to retirement, after-tax returns, and required contributions.
For example, if you are 25 years old, you have 40 years until 65. If you use a tax-deferred investment plan, you would need to invest approximately the following each month to accumulate $2 million by age 65: $125 at 13% per annum compounding monthly; $315 at 10%; $750 at 7%; $1300 at 5%; etc.
The combinations are endless.
And you can clearly see how the compound performance impacts the overall wealth accumulation. Be certain that every dollar (Euro, Franc, Pound, Yen, etc.) you invest goes toward an investment, not a commission, management fee, operating cost, and so on.
Create Milestones
In addition to quantifying specific goals, you should also quantify milestones along the way. Tracking progress as you work toward the ultimate target allows you to adjust variables and stay on course.
For example, perhaps your goal involves investing $500 monthly for 40 years with a 10% expected return. But over time your actual return is 6%. If you wait until year 35 to review your status, it is too late. There is almost no way to recover without a winning lottery ticket.
If you review after 5 years and find lower than expected returns, then you have more options. Make a lump sum investment to become whole. Increase monthly contributions to $1000 until you are where you should be. Or maybe increase portfolio risk to hopefully outperform moving forward. All have pros and cons, but you will need to adjust.
And for the record, I would recommend annual reviews. Possibly more frequent based on the volatility of your portfolio.
Investor Constraints
Individuals have many things that impact their ability to achieve their investment objectives.
We reviewed investor constraints previously. There are many factors you need to consider in your IPS.
Free Cash to Invest
A major constraint for many people is just in having the money needed to invest for one’s goals.
If you need to invest $1300 per month at 5% to meet your objectives, yet your take home pay is only $2000 per month, you will have problems achieving your investment goals.
An added incentive to begin saving and investing as soon as possible.
Three key variables greatly impact an investor’s objectives and constraints: time horizon, phase of the life-cycle; risk tolerance. We will discuss these keys next week.
by WWM | Aug 2, 2017 | Investor Profile
Individuals often consider their goals and objectives when investing, but fail to focus on their personal constraints.
However, investor constraints require equal consideration as they play a substantial role in one’s investment strategy.
Constraints are limitations or restrictions that are specific to each person. Some may be common to many people, others may be unique to that one individual. Today we shall look at a few.
Liquidity Requirements
Liquidity is an investment constraint for most individuals.
The need to always have some cash on hand to deal with daily expenditures or planned purchases necessitates that one avoid certain investment options for a portion of one’s assets.
Three common liquidity needs are emergency funds, planned acquisitions, and investment opportunities.
Emergency Funds
Most investors require a portion of their assets in cash to cover required expenditures, such as mortgage and loan payments, rent, food, transportation and other necessary living costs.
Some experts recommend maintaining 2-3 months spending in emergency funds. In uncertain economic times, when there is a higher risk of employment loss, 3-6 months costs in your emergency fund may be more appropriate.
Another reason for the greater number of months is that many readers are young with relatively low salaries and little in the way of investments or wealth. As you increase your salary levels and begin to build up an investment portfolio, then you may consider reducing your emergency funds to around 3 months of required expenditures.
Short Term Planned Acquisitions
Many individuals plan to make major personal expenditures in the near future. This may be a car, home, travel; anything that requires a large payment at a specific date.
Planned acquisitions require individuals to structure their investments so required amounts are available in cash at the due date. This may result in liquidity constraints as you set aside other funds to make the major expenditure.
For example, investments in venture capital typically have a payback period of between 12 and 14 years. Venture capital is usually an illiquid asset. Therefore, it may be difficult to recover your capital quickly should the need arise.
If you want to maintain $10,000 in liquid assets for emergency funds, you should use it to invest in a venture capital project. In this case, the need for ready cash constrains your investment choices to highly liquid and secure investments.
Investment Opportunities
As you get older and accumulate some wealth, I suggest keeping a small portion of your assets in liquid form at all times. This allows you to take advantage of investment opportunities that may suddenly arise.
If you do not have any liquid assets, then you will have to dispose of another asset in order to purchase the new investment. And when you are forced to sell something at a time other than of your own choosing, often you will not get the best price for it.
But by maintaining about 5% of your wealth in liquid assets, you should always be able to take advantage of interesting opportunities. Obviously, that percentage fluctuates based on your total net worth and desired amounts to hold for unexpected opportunities.
Time Horizon
As we saw in our Life Cycle analysis, investment time horizon can be a plus or a minus to one’s strategy.
As the time horizon until your financial objective decreases, the variety of assets in which to invest also diminishes. Also, the less the time horizon, the less volatility or risk an investor can tolerate in his portfolio.
Tax Issues
After-tax returns are what investors should be most concerned.
You cannot re-invest and earn compound returns on money paid to the government in taxes. Your investment goal should always be to maximize after-tax returns, not gross returns.
Personal Tax Bracket
The tax bracket that the investor is in will impact investment decisions.
If an investor is currently in the highest bracket, she may want to avoid investments that generate taxable income while she is in the top tax bracket. Instead, she may prefer to invest in assets that experience future capital gains. Hopefully, these gains will not crystallize until she has moved into a lower tax bracket.
The same applies to an investor who is in a secondary tax bracket. He may need to be careful about generating too much annual interest or dividend income to avoid being pushed into a higher marginal tax rate.
In both examples, the investors may also be very interested in tax-free investments and/or tax deferred investment accounts. The availability of these investments and accounts varies greatly between tax jurisdictions.
Tax Laws
Tax laws also play a significant role in one’s investment decisions.
In some countries, like Canada, interest income is taxed at a higher rate than certain dividends or capital gains due to tax credits and lower inclusion rates.
If you reside in a country that has different tax rates for different types of investment income, it should affect your investment choices to some extent.
For example, perhaps you live in a jurisdiction where interest income is taxed at a higher rate than dividend income. You have to choose between two investments of equal risk, both offering the same gross return. One pays out interest, the other dividends. You would select the one with the better after-tax return. In this example, the dividend stream.
Many countries offer tax-deferred investment accounts. There are often limitations on annual contributions to the accounts and the possible investments that may be held. Again, this will constrain your investment strategy.
For example, a Canadian Registered Retirement Savings Plan (RRSP) has a 2017 contribution limit of 18% your 2016 earned income, subject to a maximum CAD 26,010. An RRSP will also have restrictions on what investments can be made. A self-directed RRSP provides much more investment latitude than a non-self-directed. But you still cannot hold certain assets such as Bitcoins, uncovered calls, stocks from non-designated exchanges, etc.
Legal and Regulatory
The legal and regulatory environment may also constrain one’s investment decisions.
Typically this is a more important consideration for institutional investors than for individuals. However, there are areas in trusts and foundations where legal issues can be a problem for investment options.
For those of you in public accounting, banking, or law, you may experience issues here.
For example, if you audit a public company, you may be precluded from owning shares in that company. Or if your bank is performing certain work on a company, you may have a blackout period for trading shares in that corporation.
The same may apply in respect of insider trading laws. If you have non-public knowledge, you may run afoul of securities’ laws.
Your sister is president of a publicly traded company and tells you the company is about to be sold for a huge premium. If you go out and buy shares in the company prior to the announcement, you run the risk of being charged with insider trading. You also may run into difficulties if she did not tell you and you coincidentally bought shares a day before the announcement. So whenever there is the potential for issues with an investment, take care.
Unique Circumstances
Finally, many unique circumstances can constrain one’s investment strategy.
Some are self-imposed, others are forced upon the investor.
Certain investors believe in ethical investing. That is, they do not want to invest in companies that they consider unethical. This might include tobacco or alcohol companies.
It may also include companies that operate in certain countries. This was common practice among many investors during Apartheid in South Africa. Today there are countries which by personal choice, or even through laws in some jurisdictions, that prevent individuals from investing in them.
The US currently has legislation that severely restricts trade or investment in Iran. If you try to invest in Iran or Iranian companies, you may be subject to prosecution. Note that this could also be considered a legal constraint.
Other unique circumstances include the ability to purchase certain investments.
For example, a new Initial Public Offering (IPO) may only be available to the best clients of the brokerage house marketing the offering. Or some hedge funds may only be open to investors with extremely high amounts of money. Some mutual funds may no longer accept funds from new investors.
By now you should have some ideas on where you are in life cycle, what some of your investment objectives are, and some of the constraints that you face.
You also may have formed an opinion on your risk tolerance and investor profile.
Next week we will look at asset classes. Probably not too much detail on the actual descriptions, but more how they tie into risk tolerance and one’s investment strategy.
by WWM | Jul 26, 2017 | Investor Profile
Previously we considered how one’s risk tolerance and phase in one’s life cycle impact an individual’s investment strategy.
It is also very important to assess your unique investment objectives and constraints.
Today we will look at one’s investment objectives.
I like to categorize objectives (and constraints) by both time horizon and priority. Time can be grouped as short, medium, or long term. Priorities may be deemed low, moderate, or high.
If you require $20,000 for your wedding in 1 year, that is likely a short term, high priority objective. Planning to buy a brand new (mid-life crisis) sports car in 20 years may be a low priority, long term objective.
While we can go through every permutation, today we will aggregate into 5 groupings. All individuals share these common categories, however the specific objectives within a category will be unique to each person.
Emergency Funds
Although not really an investment goal, it should be an objective to maintain adequate liquidity to deal with any emergencies that may arise. Think of this an an extremely short term, very high priority objective.
I suggest that you hold approximately 3-6 month of basic living costs in liquid funds.
This should provide protection against short term emergencies such as job loss, personal injury, damage or loss of personal property such as your vehicle, or any other unplanned event that will drain your resources.
Liquid funds includes cash and cash equivalent assets. Savings accounts, money market funds, short term term deposits, etc. Assets that can be converted to cash very quickly and at no penalty to you for so doing.
Also, assets that are extremely stable (i.e., very low volatility and therefore low risk), yet have better return upside than simply hiding the cash under your mattress.
I would recommend money market or other funds to hold your liquid assets. These latter funds include certain low risk bond and equity funds, exchange traded funds, capital protection funds, to list a few examples. The keys being that you are able to sell them rapidly at little or no cost on disposal. Also, when you need to sell, the investment will be stable in price and not subject to wide swings (i.e., volatility or risk). This limits the use of equity funds or longer duration bonds.
I would also recommend brokerage accounts that provide money market interest rates on cash balances. Often these are termed, “sweep accounts.” They are useful and offer better rates than bank savings accounts.
I would not recommend holding many of your liquid assets in bank savings or chequing accounts. These accounts tend to pay very little or no interest on cash balances. And even with cash, you should try and get some sort of return.
Near-Term High Priority
This category reflects major goals whose time horizon is relatively short.
Examples may be a new home or vehicle, paying for your education, or even a trip if it is extremely important to you.
As the time to the goal is close, you want to increase the certainty of the investment’s return. You should invest in low risk, stable investments that provide a relatively known result.
Cash or cash equivalents would fall into this area. Short term bonds may also be useful investments. In certain situations, other funds may also be appropriate.
It is important to try and match the maturity of your asset to the expected date of the expenditure.
For example, you have $25,000 on January 1. On July 1, you must pay that amount as principal on a new home. You want to ensure that money is safely available when due. If you invest the money in a 1 year term deposit, you may not be able to liquidate on July 1 without penalty. However, if you invest in a 6 month term deposit, the investment will mature at the same time the money is needed.
If you invest in a higher risk equity fund, the value on July 1 may be greater than or equal to the $25,000 investment. But there is also a higher probability that it will be less than the $25,000 due to the volatility of the asset. If this occurs, you may need to forego the home purchase.
Be sure to match the asset risk-return profile and timing to your objectives.
Long-Term High Priority
This category reflects critical objectives whose time horizon is a long ways off.
An example would be in achieving financial independence at age 65. Another might be to buy a lake house or a winter condo in Florida by the time you are 50.
Because of the long time frame, you have the ability to ride out the ups and downs of highly volatile investments. This allows you to invest in assets that have relatively high risk and (therefor) greater expected returns.
The longer time frame also allows you to invest in less liquid assets. If you are currently 30 and are planning to buy a ski chalet by age 45, you have 15 years to work with. As the date approaches you can find a beneficial time to sell.
Compare that to only investing at age 44 for the chalet by 45. With very limited time, you cannot afford to hold volatile or illiquid assets that may not be disposed of, on time or at a profit, in one year’s time.
Remember, the longer the time frame, the greater the risk you can endure in your investments.
Yes, within reason, that is.
For long time horizons, a wide range of investments are suitable. These include equities, bonds, real estate, and other exotic assets.
Asset classes that we will look at in the next couple of weeks.
Lower Priority
This category may have short, medium, or long time horizons.
These goals have some importance, but they are secondary to the ones discussed above. Usually they are nice to have achieved. But if they are not reached, it is not crucial to your existence.
These usually involve discretionary spending objectives. That is, expenditures that are non-essential or voluntary in nature. Examples include: charitable giving, vacations, buying a boat, non-critical business ventures.
With lower priorities, you can match the investment risk to the time frame as we did above.
Many individuals though, take a more speculative approach in investing for lower priority goals.
As the objective is less important to the individual, the investor may invest in extremely high risk assets in the hope of abnormal returns. If it is successful, great. If unsuccessful and funds are not available to meet the goal, its lack of attainment was not critical.
Entrepreneurial
This category involves entrepreneurial or money-making ventures and covers any time frame.
Portfolio diversification is usually not an issue in this category. Instead, investors tend to take an “all eggs in one basket” view to their entrepreneurial activities.
As you can expect, this is normally a high risk investment with the potential for high rewards (or total loss).
That sums up the categories of investor objectives.
In future, as you develop financial goals, try to determine which classification each one fits into. Then, develop appropriate investment strategies and tactics to attain each goal.
Next we will look at common investor constraints.
by WWM | Jul 20, 2017 | Investor Profile
We previously reviewed how an individual’s risk tolerance impacts investment behaviour.
While risk tolerance is a driver in one’s investor profile, so too are an individual’s unique personal circumstances. Where an individual is at different stages of one’s life greatly influences the risk/return decisions that are made.
Today we will review the Life Cycle view of wealth accumulation. It does not address all the unique issues facing you, but moves us in the right direction to create an effective investment plan.
Accumulation Phase
Accumulation occurs early in your career. When you initially enter the work-force and for the first few years afterward.
Because you are young, there is a long time horizon for investing. Time is extremely important. The longer money is invested, the reinvested income on that money actually contributes more to total growth than most other factors.
Although you are finally earning real money and have the capacity to begin saving, your net worth is likely quite small. It may even be negative if you have significant debt from student loans, home mortgage, or car loan.
During this phase, your priorities may be liquidity for emergency funds, paying down debt, buying your initial or larger home, starting a family, saving for your children’s education.
And yes, beginning to invest for long term growth and retirement.
While you may not have significant savings, starting to invest as early as possible is best. The longer your money can grow, especially if you reinvest the income (and the income on that income), the greater your wealth accumulation (and the less in total dollars you need to contribute).
We will cover this concept soon when we look as the power of compound returns. A very important topic.
That said, paying down existing debt saves significant interest costs. Usually being paid with after-tax disposable income. While beginning an investment program when young is useful, do not necessarily do so by not reducing personal debt.
As we shall also see later, avail yourself of any investment plans that defer, minimize, or avoid tax liability on returns. The longer assets grow for your benefit and not the government’s, the greater the ability to compound returns.
In considering suitable investments, you should focus on relatively high risk, high return, capital-gain oriented assets.
Why?
Due to the long time horizon, you have a greater probability of riding out the ups and downs of high volatility (i.e., high risk) investments that offer greater potential returns.
Consolidation Phase
Consolidation takes place during the mid-to-late stages of your career. While a lesser time horizon than in the Accumulation Phase, the years until retirement are still very long.
By now you have reduced your debt and related cash outflows to service both the interest and principal. Your income and cash inflows exceed your expenses and cash outflows.
During this phase, you should begin to generate more than sufficient savings with which to seriously invest for retirement.
As your time horizon is still long, focus should remain on relatively higher risk, higher return assets.
But as you move through this phase and the time horizon starts to shorten, there should be a progressive shift to lower risk (i.e., less volatile) investment options.
Spending Phase
Spending commences at retirement as employment or business income ceases or slows.
Your debt is gone, your children grown and not needing support, and your required expenses should not be extensive.
Without a salary, income will be derived primarily from your investments and, possibly, pension. As a result, you want to increase the certainty of your returns by investing in lower risk investments.
One mistake made in this phase is to place too much reliance on low risk investments. Low risk assets will result in low returns that may not be adequate to meet your retirement goals.
Also, if returns are not linked to inflation, you may find your real returns worse than expected. At times, even negative. If this occurs, you may be unable to meet your retirement objectives.
A second mistake is to underestimate retirement needs. Yes, you are retired and many of your work related expenses vanish. And yes, with the kids gone, the mortgage paid, etc, many other traditional costs also disappear.
But these will be replaced by increased travel and entertainment costs. Expenditures you may not have made to such an extent previously. These are not “required” expenses. But if you do not factor in these additional costs when planning, it may be a very boring retirement.
In today’s world, you could easily retire between 55 and 62, yet live until over the age of 90. That means you may need retirement income for a at least 35 years.
If all your assets reside in low risk, income generating investments, you may be hard pressed to cover all your needs and objectives until death. With a still lengthy time frame, you may want to keep a portion of your wealth in assets with higher growth potential. Then, with each passing year, continue to slowly shift into safer assets.
Gifting Phase
Gifting is the final stage in your life. Hopefully a long, long ways off for you.
In this stage, you possess more assets than you need until the end of your life.
You begin to gift your wealth to others. This may include family members, but more and more people are becoming involved in philanthropic activities. These include direct donations to charitable or educational institutes. Also, some people set up trusts and foundations with their wealth to contribute directly to their charitable objectives.
Takeaway Thoughts
One takeaway is investments that may be prudent for you in one stage of your life, may not be best in another stage.
In your 20s, it may be appropriate to invest in mutual funds of emerging markets. These funds may exhibit relatively high risk but also offer potentially generous returns. But at 80, those same funds may make little sense in meeting your retirement objectives.
Conversely, at 80, a significant portion of your wealth may be in term deposits and short-term government bonds. This may be prudent in attempting to preserve your capital and generate steady cash flow. But at age 30, having a significant portion of your assets in cash equivalent investments likely is a poor strategy to follow.
A second takeaway is that your life cycle phase is based on your personal situation, not age.
You and a friend may both be the same age. But if he spent 10 years travelling the world as a scuba instructor and has just now completed a 10 year medical program, he may only be in his Accumulation Phase in his 40s. On the other hand, you started your career at age 22 and may have moved on to the Consolidation Phase by your 40s.
Age is not a determinant. Only your personal circumstances.
Getting married and having children while in your 20s may result in a significantly different investment program than for a single person also in their 20s. Life insurance may be one big difference.
A third takeaway is that you must focus on your own unique situation. What others are doing should have little, if any, impact on your investment strategy.
When listening to investment advice or strategies employed by others, always consider their personal situation and how it compares to your own before following their lead.
For example, a German friend tells you about a great potential real estate investment in Saskatoon, Saskatchewan, near where you live. The local market is hot and everyone believes the expected gains will be excellent. For her, it may indeed be a good opportunity. But if you already own a home in the community, a rental property in the same city, and a cottage at a nearby lake, it may not be a wise move.
This is because you may end up with too much exposure to the local real estate market (if you have not already done so) and/or possibly have invested too much in real estate as an asset class in general.
That gives you a few things to consider as you begin to address your own investment strategy.
Coming up, we shall look at common investor objectives and constraints.
by WWM | Mar 21, 2017 | Investor Profile
“What is Your Risk Tolerance?” asked a few questions to help determine your risk comfort level.
I want to flesh those questions out using a classic investor personality model, the Bailard, Biehl, & Kaiser Five-Way Model.
I am not a “fit in a box” guy. It is rare to find someone who is an exact match within any personality model. But understanding how your general tendencies impact your decision making is useful. Learning more about who you are as an investor will ease your shift to become a more unemotional, objective, and successful investor.
Investor Psychographic Models
Investor psychographic models can help investors determine their own risk tolerance.
Pyschographics refers to the description of an individual’s psychological characteristics. It attempts to classify investors based on their personality traits.
There are a variety of models in use today. I suggest you review a couple of models to better understand your own investor profile. In this post, we shall look at the Bailard, Biehl, & Kaiser Five-Way Model.
The key to this model is that it focuses on two personality traits: investor confidence level and preferred method of action.
Investor confidence may range from being totally confident to being wholly anxious in investing abilities.
An investor’s method of action considers how methodical, analytical, and intuitive an investor is in his actions. One’s method of action may range from extreme carefulness or caution to being highly impetuous or reckless.
Confidence and method of action are plotted on two axes and investors are grouped according to their preferences. In this model, there are five possible investor profiles.
Guardians
Guardians are extremely cautious and anxious in their behaviour. Preservation of capital is paramount. Guardians are very risk averse and do not want to incur any monetary losses.
Often, older investors fall into this category. Older investors need to preserve their assets and usually want secure investments with a steady, stable income flow.
That said, new investors may also fall into this category. As knowledge and experience levels are very low, new investors may want to take a cautious and safe investment approach until they gain sufficient skill to move into riskier assets.
Guardians typically invest in government backed bonds or treasury bills, term deposits, preferred shares in public companies, and balanced mutual funds. Low risk of capital loss, but with little hope of significant capital gains.
Celebrities
Celebrities are investors who are anxious but, at the same time, are also impetuous. Not a combination that usually results in long term success.
Celebrities exhibit a crowd mentality and like to invest in the latest hot investments.
For example, if gold is in vogue amongst the media talking heads, Celebrities will invest in gold. Or if a friend at a cocktail party mentions some new biotech company, the Celebrity will want to purchase shares as well.
Whether the investment in question is potentially positive from an analytical perspective or whether it is appropriate for the specific investor are usually not considerations for the Celebrity.
Celebrity investors may be of any age group although I suspect more fall into the young or middle age groupings. This is because over time, Celebrities will not usually be financially successful following this path and move on to more structured investment approaches (or they will have lost all their capital).
Celebrities invest in a wide variety of assets, usually creating a haphazard portfolio. One that tends to be of higher volatility. The only common theme is that the investment is currently fashionable. That often excludes investments in plain-vanilla (i.e. boring) assets such as term deposits, treasury bills, and balanced mutual funds.
Can you just picture a Celebrity discussing his 90 day term deposit at the local bank when all his friends are raving about their shares of Albanian hi-tech companies? Neither can I.
Celebrities are prime candidates for getting caught in an investment bubble.
Adventurers
Adventurers are highly confident, but impetuous.
Adventurers are strong-willed individuals who may be entrepreneurs in their work life. Often successful in business, they expect that success will flow into other areas of their lives. The difficulty is that these individuals do not typically have the time nor the inclination to develop the necessary tools to also become successful investors.
As a result, Adventurers may act rashly and err in their investing decisions.
Adventurers are willing to take chances on their investments and readily consider higher risk assets that offer better potential returns. This would include smaller public or unlisted companies, real estate, venture capital, and derivatives.
Diversified portfolios are considered boring. Adventurers are comfortable investing a significant portion of their assets in one single investment.
Individualists
Individualists are strong willed and highly confident, but they act with care.
Individualists are very rational and analytical in their investing strategies. They understand the relationship between risk and return and take emotions out of their investing style.
Individualists are normally “do-it-yourself” investors, performing their own research and making their own decisions.
As they act with caution and not recklessness, Individualists make less fundamental investment errors than Adventurers.
Individualists invest in a wide variety of assets and develop diversified portfolios. They also tend to be contrarian in their approach and typically have an eye for value. Because of this, individualists may be able to avoid investment bubbles.
Professional investors normally fall into this investor category.
Straight-Arrows
By their vary nature, models tend to classify investors into extremes. In actuality, most investors fall somewhere in between the outer reaches.
Into this comes the Straight-Arrow classification. Where the “average” investor, who possesses some investment experience and knowledge, tends to sit.
Straight-Arrows do not clearly fall into any one category. There is overlap between the different classifications.
Straight-Arrows have some confidence. Not the total level of an Adventurer or Individualist, but substantially more than exhibited by the Guardian or Celebrity.
Straight-Arrows act in a reasonable manner, for the most part. They normally act in a prudent and careful manner, but are still prone to recklessness and following the herd at times.
A Straight-Arrow should be open to investing in a wide variety of asset classes.
And You?
Where do you fit into this Five-Way Model?
Ideally, as an investor, becoming an Individualist is the best case scenario.
For most people who are not professional investors, finding the time and energy to become an Individualist is not usually possible. For these people, becoming a Straight-Arrow should be the goal to best achieve one’s investment objectives.
Straight-Arrows can prosper relying on a structured investment strategy incorporating a passive asset management style.
Straight-Arrows also benefit when working with a professional financial advisor. Straight-Arrows have an understanding of investing and can work in partnership with a professional to develop and implement a prudent investment plan.
If you are currently more of a Guardian, Celebrity, or Adventurer, no worries at this time. By understanding the weaknesses of each category, you can take conscious measures to eliminate the deficiencies in your investor profile and move toward a more well-rounded approach.
I understand that changing basic personality traits may not be easy. Some people are naturally anxious while others are confident. Some are cautious, others are rash. It is all part of one’s inner make-up.
Over time, I hope you will see that a rational approach to investing is the best way to invest. If you do, that will provide you with greater confidence and the ability to take on a more measured course of action in your investing activities.