Would You Take Investment Advice from a Gambler? Perhaps You Should!

Investing Without A Clearly Defined Strategy Could Have Dire Consequences For Your Portfolio

By Anthony Rhodes

A little while back, I had an opportunity to purchase a stock for a client, which had been on my watch list for some time. The company was Amgen; a multi-billion dollar biotechnology giant, which had been trading around the $60-$65 dollar range. After analyzing the company, I determined an appropriate entry level for purchasing the stock to be $51. This meant that in the event that its price dipped to these levels, I would strongly consider buying it (not withstanding any fundamental changes to the company, of course). Over the period of about a week, the price of the stock began to fall; from $64 all the way down to $54! At this point, I immediately became confronted with a buyers' dilemma: Should I take advantage of the drop and purchase now, or should I remain diligent and wait to see if the stock will continue to fall to my entry price of $51? I of course waited, and although the stock subsequently turned around from there, neither my client nor I were upset at not capitalizing on this opportunity. You see, we both understand that adhering to a doctrine of discipline will ultimately benefit an investor more often than not. And although this example could be perceived as a failure to some investors, its point is to highlight a few of the most important components of investment success: creating a strategy, monitoring your results, and remaining committed to your discipline, during the good times and the bad.

This very valuable lesson is our subject of discussion for this week. If you are investing your hard-earned money in the stock market, and have yet to develop a clearly defined investment strategy, your actions are tantamount to gambling! So appropriately, here's some age-old wisdom from someone with a bit of success in that department. And although his words are more customarily associated with Hearts than charts, they just so happen to be good investment advice, as well.

Know When To Hold 'em

 When developing your investment strategy, it's important to determine the price in which you eventually would like to sell a particular stock for, before the actual purchase of that stock takes place. This includes calculating the potential gains you would expect to receive from the stock, and (barring no unforeseen events) holding on until that price is met. This technique is aptly called establishing a price target, and it should precede the purchase of every stock in your portfolio. For example, if you are considering buying a stock for $15, you should have an idea of what price you would eventually like to sell that stock for (let's say $22) before you actually purchase the stock. Also, once that number is determined, it becomes equally important for you to remain committed to that price, without adjusting it in an attempt to gain greater profits. This discipline teaches a mechanical approach to investing, and as a result, attempts to eliminate our emotional tendencies from interfering with the process. While doing so, it also helps to eliminate one of the most familiar and dangerous enemies of investment success: greed.

Know When To Fold 'em

Just as a price is determined regarding when exactly to sell a stock for a profit, one should also be established for selling at a loss, as well. The stock market is a finicky beast, and despite our anticipations of success, no one is guaranteed a winning stake in the companies of which they invest. Fortunately, we can safeguard the extent of our losses by instituting a tactic, which clearly defines the selling price of a stock if it begins to head south. This technique is known as establishing an exit strategy, and it allows an investor to calculate the amount of money he or she is willing to lose given a worst-case scenario. I advocate the use of this method because it helps to quell another familiar emotional enemy: fear. If an individual purchases a stock for $25, and sets an exit price of $18, he knows exactly how much money he would lose if the stock begins to head in the wrong direction, thereby eliminating his fear of losing the full investment amount. Incorporating this strategy will greatly improve your ability to manage your investments in a more effective manner, and as a consequence, is a technique that no portfolio should be without. 

Know When To Walk Away

All that glitters is not gold. Many individuals unfortunately learn this lesson the hard way, and investors are no exception. When approached with a "can't lose" proposition regarding your investments, be it from a professional, friend or colleague, remember that if it sounds too good to be true, it usually is. When applying this proverb to all of your investment decisions, you eliminate the prospect of being caught up in one of the many nefarious schemes that unfortunately plague this business of ours. Of course, not all investors comply with this preventative measure. In fact, for a technique, which appears so fundamentally obvious, it actually goes underutilized, despite year after year of complaints of misconduct from investors of all walks of life. From Hollywood actors to school librarians, the message is loud and clear: fraud is an equal opportunity destroyer, and those who attest immunity from its grasp are simply being naïve. The implementation of this simple tactic could very well keep fraud, scandal and infamy at arms' length regarding your financial affairs. And although it won't bullet proof your portfolio from all indecent deeds, I'm quite confident that you'll feel a great deal better with it, than without it.

The keys to investment success are similar, if not identical to those, which determine the outcome of just about any business enterprise. Above all others, a strategy remains the single most important determinant as to whether an endeavor will ultimately become successful or not. So, in the future, if you ever find yourself in the company of an individual who's attempting to manage their investments without one, don't hesitate to pass these tidbits of information along. And if their reception to these pearls of wisdom is met with indifference, and in rare instances even refusal, simply resort to the final portion of guidance being proposed by our esteemed and resourceful gambling advisor: Know when to run!

(Anthony Rhodes is a Registered Investment Advisor and owner of wealth management firm The Planning Perspective www.theplanningperspective.com )