Saturday, January 23, 2010

Lessons from the crisis

Many people lost considerable wealth during the dramatic market sell-off.
People do not learn from past crises. Investors have a short-term investing mentality and they are still chasing the next best idea or fund. They need to learn to diversify and stay in the market.

Example of a customer whose idea of diversification is to split his investable amount of $50,000 into different China funds, something which is deemed risky as the investment is concentrated in one country.

Investors wanted higher returns thus many decisions were based on short-term market views. These views could be as short as a few days or weeks, whereas frequently the investment vehicles would have a longer tenure. Often, the only investment strategy seemed to be to generate returns. This led to a lot of ill-considered portfolios which appeared fine while markets were going up, but suffered considerably when correction happened.

Even when markets started to recover from March of last year, many investors remained on the sidelines and did not benefit from the substantial rallies. These were the ones who had become influenced by fear and who had therefore become much more risk averse in their investment decisions. Uncertainty is stopping them from making good investment decisions.

There is a way out which is, investing regularly rather than in one lump sum. The rationale is that if one is regularly investing during a financial crisis, the cost of entry is lower and investors can accumulate units at lower prices. This will augur well for them when markets eventually rise.

But it all boils down to the basic. Taking more time to understand client’s investment experience and needs; educate clients on the potential impact of their decisions with more emphasis on the total portfolio; and developing longer term investment goals.

Investors must take time to better understand their emotions as investor. Too many were all too willing to ignore risks when markets were rising, but quickly scared when they turned downwards. Investors who have clearly understood their investment goals and who have allocated funds accordingly are less likely to be panicked out of markets at the lower levels.

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