I recently came across an interesting article on www.about.com which asked the question – should you manage your own investments? Maybe you watch the financial shows on television, read the business section of the newspaper, hear a stock tip and consider managing some of your own investments in a brokerage account of your own. Is this a wise move on your part? Here are some questions and comments the author Joshua Kennon suggests to ask yourself before making that very important decision.
Do You Have an Intellectual Framework for Investing?
Can you quickly state the guiding investment principles by which you operate your investment portfolio and the characteristics you look for in the investments you buy? If you had to think about your answer, you may be making a mistake by managing your own investments. It may indicate that you lack a structural framework that allows you to remain emotionally detached from your investments, a detachment that is vital if you are to make intelligent decisions based upon rational analysis of a business rather than emotional reactions to market changes in market prices.
Can You Value the Cash Flows?
A business is only worth the cash flows that it will generate from now until doomsday discounted back to the present value at an appropriate rate (typically the long-term U.S. Government bond plus an inflation kicker). Without the ability to arrive at an independent, reasonable valuation you can find yourself vulnerable to unethical promoters that simply push seemingly attractive (often high-priced) initial public offerings or the like.
Can You Spot Aggressive Accounting?
Many investors do not realize that the net income and earnings per share reported in a company’s annual report are, at best, a rough estimate. The downside of this is that unscrupulous management can game the numbers to look better than they are by utilizing aggressive accounting techniques. Knowing how to spot these are vital to protecting yourself. Again, if you cannot do it, you should not be investing your own capital without the assistance of a qualified professional.
Do You Understand the Fundamental Business?
You might be surprised how few people actually know how their company makes money. Coca-Cola, for example, does not generate most of its profit from selling the drink you pick up in the grocery store. Instead, it sells concentrated syrups to bottlers throughout the world who then create the finished beverages and sell them to retailers. It is likely that many Enron investors did not understand how the company made money.
Do You Understand Correlation Risk?
How many stocks does it take to be diversified? Philip Fisher talked about this very concept in his famous treatise Common Stocks and Uncommon Profits so many decades ago. Do you understand how you could probably be more diversified owning five non-correlated stocks than twice as many equities in similar industries? Looking at history of investments when troubles come, they often effect entire sectors of the market; witness the banking crisis of the late 1980s or the real estate collapse around the same time.
Are You Emotionally Vulnerable to Changes in Market Price?
I find Warren Buffet’s comment that stocks are the one thing that people want fewer of when they get cheaper. In every other areas of our life, we typically rejoice at a sale whether it is on hamburgers or silk ties or automobiles. As equities get less expensive, many investors typically flee from them. If you are unable to watch your holdings fall by fifty percent or more without panicking or liquidating your positions, you should not be managing your own investments without professional help.