Manage for Risk, NOT Performance

Placing hard earned savings into financial markets is not for amateurs, yet due to 401k plans there are millions of non-professionals that do exactly that.  Adding money on a regular basis for a time horizon many years in the future reduces some of the anxiety.  Suppose you have accumulated a lot of money, need to invest it, but do not have a long time to either spend or rebuild it in case of market crashes.  This is when investment philosophy should be to "manage the risk  and not worry about the performance."

This is a difficult concept because it is not in the media or advocated by large companies like mutual funds or brokerage houses.  Risk management calls for constant attention to market risk and being active to make changes.  The more popularly promoted investment philosophies are "buy and hold" or "passive" techniques like asset allocation or modern portfolio theory because they are less labor intensive for those whom you entrust your money.

Before your eyes cross and you give up on this counter-intuitive perspective, look at an easy example like owning a house.  After the purchase of a house, the new owner moves in, decorates, landscapes, barbeques in the back yard, etc.  Unbeknownst to the homeowner is that his/her investment in this house changes value every day.  Factors that influence home prices, or "comps," are numerous.  For example, a government can increase property taxes on certain types of real estate.  A sinkhole can happen.  If zoning laws are lax, your neighbor can raise goats or chickens.  The noise and smells are now something you will have to live with; and, in time, you might adjust.  But try selling the house and having a parade of potential buyers come through constantly sniffing and asking, "What's that smell?" or "What's making that clucking sound?"

Good things can also happen while you are in your house.  A new hospital could be built nearby and now the medical professionals want to move into your neighborhood to reduce their commute or response time. 

The point is that negative and positive forces are constantly in play and the homeowner has no control over them.  The seller (or buyer) can only control one variable: When to buy or sell.  The flip side of that (pun intended) is to invest in a house just to make money quickly.  However, when thinking through all the factors that will influence the other side of your transaction, you should come to the conclusion that profit or loss is out of your control, except for your decision on when to buy and sell.

In stock investing there are even more forces at work than owning a house, such as currency risk.  It can be an expensive lesson to see your portfolio sink in value when an unforeseen event occurs.  Instead, what investors could focus on is making the low risk purchase, watch it like a hawk knowing there is some volatility expected, and when the risk goes up, get out.  And then start the process over with another stock (or bond, or stock mutual fund, etc.).