Is that the Sound of Hooves I Hear?

By Mark Hing (originally published in the March 2000 Issue of Computer|Sense Magazine)

The bulls are running in the streets. Not like they do in Pamplona, Spain, mind you, instead they represent a sustained rising stock market. Stocks have been advancing for over a decade, and show no sign of abating. I think Superman best summed up this technology-fueled run when he said, “Up, Up, and Away.” Some of the more optimistic among us cling to the words of another great hero, Buzz Lightyear, and join his shouts of, “To Infinity and Beyond.” Unfortunately the bulls won’t last forever, they’ll eventually tire. Then the bears will have some fun.

In the meantime, however, people from all walks of life are jumping on the stock market bandwagon. And why not? With a forgiving market and annual returns of over 100% within reach, what’s not to like? In a market where a trained monkey can make money, smiles abound. However it’s a wise person who plans ahead. Knowing what to do before jumping on the bull can mean the difference between investing and gambling – wealth and bankruptcy, or at least making a few bucks and having to meet a margin call. The trick is to know how to manage your risk.

Rather than trying to make a quick profit, you should be looking to minimize your downside risk. The key concept, that bears repeating again and again, is the preservation of capital. No capital. No investment. No profit.

Of course in heady times such as these, it can be difficult to remember such concepts. So far, all downturns (or corrections) have resulted in a buying spree that serves to send stock prices right back up again. It wasn’t always so in the past, and it won’t always be so in the future.

Therefore it makes sense to assess yourself. Your strengths, your weaknesses, and your tolerance for pain – or risk as they like to say in the financial world. If your stock portfolio dropped 70% next week, and stayed down for the foreseeable future, how would it affect you? Would your lifestyle be affected significantly? Would you have trouble sleeping at night? Would you sell at a loss and vow never to invest in stocks again?

These questions will help you determine whether you’re sufficiently diversified amongst the various asset classes (i.e. stocks, bonds, real estate, money market funds, etc.). Your answers will also tell you whether you should be in the stock market at all.

If you’re still game, the next step is to formulate an investment plan. If you’re in for the long haul, a “seat of the pants” strategy is not going to work. Granted, it may work in today’s investment climate. But long term? Forget it.

Once you have a well thought out strategy (and you’ve objectively assessed yourself), stick with the plan – day in, day out. Be consistent and logical. And watch out for the dynamic duo of killer emotions: greed and fear.