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Tips To Manage Your Money – How To Not Blow Up Your Account

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Introduction

 

 

Let’s face it. We all want to make some money from the stock market – whether it is some extra income to help pay for your monthly expenses or to help create a nice nest egg for early retirement – this is something we should all strive for. Creating an investment portfolio is tough as it is – but try maintaining that for years, decades even. We live in an economy where the market constantly changes on a dime – and people tend to overreact to every single change in price action. It could be quite easy, in all actuality, to panic at the slightest hiccup of the stock market, causing you to DESTROY your account – with the possibility of damage being almost endless.

So how do you cope with such a dire possibility?

Not to worry, there are ways to help reduce and combat these risks and in this lesson, we will explain to you what these rough patches are, how investors can easily fall into the trap of taking on excessive risk, and above all else, give you valuable tips to mange your money better, in order to keep your investment portfolio afloat.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Economic Draw Downs

 

Managing an investment portfolio can be a little like, well, life. Both have their fair share of ups and downs.

As in life, a portfolio can go through rough stretches from time to time. Some investors refer to these stretches as “draw downs”. These are times when the total value of the portfolio is less than before.

Draw Downs are a normal part of the investing process, but if investors overreact to a draw down, it can spiral out of control and blow up their account.

A blow-up occurs when a portfolio drops by so much that it can adversely impact life events, and even wipe out life savings. Investors experience these blow ups when they take on excessive risk. The last decade is littered with examples of investors taking on excessive risks in individual stocks – starting with the dot-com bust of in early 2000.

Many stocks from the dot-com bubble crashed to zero, and many of the survivors have still not fully recovered. There
were also numerous examples of investors taking on excessive risks before the financial crisis of 2008. During the depths of the 2008 crisis, many financial stocks fell to zero and some investors even lost their entire life savings.

Temptation Is Your Worst Enemy

 

So what makes investors take on too much risk?

There are many factors, one of the most common is greed. Greed can motivate some investors to try to make fast profits with tips or rumors from friends, message boards, or the media.

 

 

Or it can manifest when investors concentrate too much capital in a single stock. This can sometimes happen in an employer-sponsored stock purchase plan.

Also the desire to join the herd, can prompt investors to chase hot trends, only to get burned later. Other times, the desire to get back to break-even forces investors to hold onto losing positions too long.

 

 

And finally, greed can lead to excessive risk-taking when investors use complex trading strategies they don’t fully understand.

 

 

These excessive risk-taking behaviors may cause a routine draw down, and possibly turn into a full-fledged blow up.

 

 

Blow ups are dangerous because it takes an increasingly higher return to recover from the loss.

To illustrate this point, lets consider the return it takes to recover from two draw downs. The first example that I will use is a portfolio with a draw down of 10%.

Some investors think that if you lose 10%, you only need to gain 10% to get back to break-even. In reality, it takes a little over 11% recover from a 10% draw down, which can be a realistic and achievable return.

Now let’s contrast this with against a bigger draw down. Suppose a portfolio loses 50%. A 50% draw down requires a 100% return for a full recovery. This is a big return that will most likely take a very long time to achieve, if ever.

 

 

Recovery And Stability Is Key

 

So how can investors keep their greed in check and guard against blow-ups? It starts with a well allocated portfolio. This is when you spread your funds across multiple asset classes, such as stocks, bonds, commodities, and currencies.

This can help you manage against the risk of a blow up stemming from a single asset class. To further reduce risk, you can diversify each asset through subclasses. For example, stocks can be diversified by having exposure to different sectors, such as technology, healthcare, and financial.

And finally, properly applying position sizing can help investors avoid losing more than they can afford. Proper position sizing involves spreading risks within an asset class and minimizing risk in a single position – this is particularly important with individual securities.

Along with these risk management techniques, investors can guard against blow ups by regularly monitoring and managing their portfolios.

Actively following a portfolio can help investors catch potential risks – such as asset classes moving out of balance – before these risks turn into full-fledged blow-ups.

Investors can help guard against blow-ups and keep their greed in check by actively managing their portfolio, and using risk management techniques such as asset allocation, diversification, and position sizing.

 

Quick Recap

In Review…..

Money Management

  • As in life, a portfolio can go through rough stretches from time to time. Some investors refer to these stretches as “draw downs”. These are times when the total value of the portfolio is less than before
  • Draw Downs are a normal part of the investing process, but if investors overreact to a draw down, it can spiral out of control and blow up their account
  • A blow-up occurs when a portfolio drops by so much that it can adversely impact life events, and even wipe out life savings. Investors experience these blow ups when they take on excessive risk

Investors take on risk because of…….

  1. Greed
  2. Concentrating too much capital in a single stock (position sizing)
  3. Conformity (joining the herd mentality of other successful traders and investors)
  4. Revenge trading to earn back money that was lost
  5. Implementing strategies that they are not quite comfortable with
  • These excessive risk-taking behaviors may cause a routine draw down, and possibly turn into a full-fledged blow up. Blow ups are dangerous because it takes an increasingly higher return to recover from the lost

Investors can mange their money better through utilizing these risk reducing techniques…..

  1. A well allocated portfolio – this is when you spread your funds across multiple asset classes, such as stocks, bonds, commodities, and currencies
  2. To further reduce risk, you can diversify each asset through subclasses. For example, stocks can be diversified by having exposure to different sectors, such as technology, healthcare, and financial
  3. Properly applying position sizing can help investors avoid losing more than they can afford. Proper position sizing involves spreading risks within an asset class and minimizing risk in a single position – this is particularly important with individual securities
  4. Regularly monitoring and managing your portfolio

 

 

And that’s it for another lesson here at Invest In Wall Street. Risk and money management are by far the most overlooked – but also two of the most important aspects that all investors should exhibit. It takes time to develop a more systematic approach when it comes to handling the psychology of the stock market. Just make sure to be patient and curb all emotions and desires, since they CAN and WILL lead you astray as you navigate through the rocky investing waters.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

 

 

 

 

 

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