From the pen of Karin Iten…

Dear Investment Academy Reader,

Over the years, I’ve had many people email me asking how they can make big money on the markets. I always tell them the same thing with high reward comes a tremendous amount of risk.

The truth is, not everyone is suited for this high risk/high reward environment, others are at home here. And the worst thing is most investors don’t know this until they lose a wad of cash.

That’s why today I’ve asked investment strategist, Bengt Saelensminde, to help you find out whether this avenue of income is for you or not – before you find out the long way.

Enjoy…

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What type of investor are you?
By Bengt Saelensminde

At the tail-end of the nineties, I was working for a well-known City stockbroker. There I met a young ambitious fund manager who had risen to prominence.

His European unit trust was beating all the competition and attracting millions of pounds from investors. How did he do it? No one knew. For three years, his fund just went up and up and up.

But then, when the market hit the skids in the second quarter of 2000, the fund’s fall from grace was as swift as it was shocking.

It’s usually only when things go wrong that the truth comes out. And after the event, when millions had been lost, it became startlingly obvious what had been going on.

Of course the clues were there. Maybe you’ve already spotted them. This was the late nineties and the fund manager was a young ambitious chap. What sort of stocks do you think he favoured?

Not many people had noticed that his “Europe fund” had unwittingly morphed into a “Europe TMT fund”. The letters TMT standing for technology, media and telecoms. Unbeknownst to even the fund manager himself, his bias for TMT stocks had been giving him a massive advantage.

And this is a big danger for all of us

In other words, if you have an investment bias, it’s very difficult to by-pass it. Yet to remain loyal to a bias is to court ruin.

We all have an investment bias and most of us don’t even know that it’s there.

To graduate from mediocre to great investors, we need to learn the lessons of this fund manager. As philosopher George Santayana puts it:

“Those who fail to learn from the mistakes of their predecessors are destined to repeat them”

So let’s have a look at some of these biases, perhaps better termed, investment styles...

#1: The adventurous investor
The adventurous investor favours growth shares. The dividend isn’t too important, as you’re looking for a chance to make a killing if the share doubles, triples, or perhaps even better. The “story” behind the company overrides what the accounts tell us. The rationale being, if the story plays out, then profits will follow.

#2: The income seeker
As the name suggests, you’re after income from your shares. A high dividend yield is the goal. Of course, it’ll need to be a sound business, able to grow the dividend too. You’ll sacrifice some capital growth tomorrow, in favour of a handsome dividend today.

#3: The value, or fundamental investor
You’re looking for a decent business at a knock-down price. It’s the Warren Buffett school of investing. You’re a bargain hunter, focusing on the accounts, particularly the balance sheet.

#4: The opportunist
You’re a short-term trader, looking for market anomalies to make a quick profit. Lots of small profits can add up to great returns if you make the right bets. You like volatile markets as they offer more profit opportunities.

#5:The defensive investor
You favour safety above all else. Blue chips and pooled funds like unit trusts to reduce volatility. You don’t like volatility, you’ve got a “steady as she goes” attitude.

Understand your bias and use it to your advantage

You’ll probably find that your style works well in certain markets, but then lets you down in others.

At the moment, the market favours the adventurous – growth shares have been driving the stock market recovery. There have been plenty of profitable trades for the opportunistic too. Day traders last seen in the internet boom are the latest come-back kids according to global stockbrokers Barclays and TD Waterhouse.

Value and income investors made fortunes in the post-internet recovery, but have been left scratching their heads right now. They’re wondering why this recovery is playing out so differently to the last one.

After a good run for one type of investor, things tend to swing in favour another. To make the most of these cycles, we need to understand our bias, and then know when to switch it off.

If, like me, your bias is towards the adventurous, then it may be time to by-pass your natural inclinations. I suspect that the value investors and income seekers will have their recovery too.

Just hang in there till then.

Good investing...

Bengt Saelensminde
for the Investment Academy