A diet for your demonsA diet for your demons: how to play the market without getting hurt
"Getting Started" by Duncan Hood
Okay, hands up everyone who bought Bombardier shares shortly after 9/11. Anybody? Just as I feared, it looks like I'm the only one.
At the time, I reasoned that the shares must be a bargain. In the weeks immediately after the disaster, the stock tumbled from $22 to $10. Bay Street always overreacts, I thought. Whatever awful things were happening out in the big, bad world, I knew it was a cinch that the intrinsic value of this Canadian stalwart hadn't fallen by half overnight.
I was so sure of my theory that I bet a large chunk of my small portfolio on Bombardier stock, jumping in when it was trading at $12 a share. At first, I had the thrill of watching the stock market perform exactly the way I thought it would. Bombardier shares soared like one of the company's regional jets, hitting a high of $17 in early January 2002. Problem was, I continued to hold onto my shares, thinking they'd go even higher — and instead, they dropped like a stone. Today they're trading at around $3 and I've lost 75% of my investment.
Despite my losses, I like to think that I've come out of the experience a winner. In exchange for a couple of thousand dollars, I've learned three valuable lessons that will stick with me for life.
Lesson No. 1: it's really, really hard to beat the market, at least consistently. There are an awful lot of smart, hardworking people on the Street who spend every moment of their working days sniffing for investment opportunities and developing ulcers in the process. If you think you've spotted a sure bet, you should pause and ask yourself what you know that those pros don't. I wish I'd done that before falling in love with my Bombardier theory.
Lesson No. 2: those folks who talk about the virtues of diversifying your assets may have a point after all. I will never again bet money that I can't afford to lose on a single stock. In fact, I've become a big fan of the Couch Potato portfolio described on Moneysense.ca. This simple strategy splits your money among the major asset classes and ensures that no downturn in a single sector can ever devastate your portfolio.
Which brings me to Lesson No. 3: successful investing is all about psychology. Your own psychology, to be precise. I never worried about diversification before my Bombardier experience because it seemed too boring, too mundane, too middle class — and besides, I was sure I was right. For me, investing was about the excitement of trying to outwit the market and score big. It wasn't about playing it safe.
These days I've struck a compromise with my inner gambler. I put 80% of my money into a properly balanced, diversified portfolio. The other 20% is my beat-the-market money. I use it to buy stocks that I think will soar. Sometimes I'm right and often I'm wrong — but at least I've put a limit on the amount I'm willing to gamble. I still get carried away with enthusiasms like my Bombardier bet, but I'm not going to end up in the poorhouse now that I'm putting no more than 20% of my money on the line.
You may be one of those lucky people who don't need an 80-20 split. If you're completely rational and disciplined, or if active investing simply leaves you cold, you can adopt the Couch Potato technique or something similar and never stray from it. You will do better than most hands-on investors and you will grow your money over the long haul with a minimum of stress.
But if you're like me — if you like trying to figure out which companies will gain as the price of oil rockets up, if you get a kick out of discussing different strategies for tapping into the emerging markets — consider adopting an 80-20 split in your portfolio. By allowing yourself a little bit of fun, you make the tough job of sticking to an investment strategy that much easier.
If it helps, think of the 80-20 rule as being a bit like smart dieting. Most successful diets allow you — even encourage you — to binge occasionally. And that's what my technique does in a different context. The way I see it, a safe, sound investing strategy is a lot like living on poached chicken, vegetables and brown rice. It may indeed pave the road to a long and healthy (financial) life, but you still need the occasional crème brûlée to make that life worth living.
From the November 2004 issue.
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