Measure twice, cut once when it comes to investing
July 9, 2015
Investors can learn from the Golden Rule of carpentry, measure twice and cut once. Applying the same degree of quality control on investing will have similar results to a proficient carpenter.
Carpenters have it easy. They have a specific target. Depending on the size of the piece of wood required they carefully measure and cut accordingly.
If a piece of wood should be 5 feet long and is short by a few inches then the objective of that particular piece of wood is not accomplished. That’s why a skilled carpenter will be very careful in cutting the exact length required.
There is no such thing as the ultimate length of a piece of wood. If 5 feet is what is required then 6 feet is not a bonus, it’s just a job not well done.
All this comes about because of the precise measuring ability of a simple tape measure. Many investors would be envious of something so exact and so simple.
In our world of investing many individuals are secretly hoping for that home run investment where they knock the ball out of the park. Who would not want to have purchased Apple back in the days that it was almost going bankrupt?
The upside of choosing that one in a 1,000 stock is huge. You will make lots of money and be able to tell your friends of your financial intelligence for years to come.
Great ammunition to take back to your high school reunion to flaunt it in front of those who never felt you would amount to much. Pride is a wonderful thing.
Investing does have a more precise target than many of us aim to achieve. It is called Modern Portfolio Theory.
Modern Portfolio Theory says that you should arrange your investment portfolio with the least amount of risk possible that will enable you to achieve your target investment return.
If you need a 5 percent return, then build your portfolio accordingly. Do not try for 6 percent because that will require you taking on more investment risk and the whole objective is to eliminate as much investment risk as possible.
Similar to our carpenter example when a 5 foot piece of wood is required and there is no attempt to extend that measurement to 6 feet.
When you have a specific financial objective the starting point is to determine your target rate of return necessary on your investments in order to be successful and achieve your objectives.
You can make a strong case that if you have a financial advisor who suggests a portfolio that can significantly exceed your target then you should consider shopping for a new advisor.
Yes, you would ultimately be happy if you made more money than needed but if the risk you took ended up causing you to fall short of your financial objectives then you will have failed. Reducing the risk of failure is done by managing risk.
Evaluating your investment portfolio should start with the amount of risk that you are taking. Our recommendation is minimize the investment risk while organizing your investments to achieve your target return.
Be precise on what you want to achieve and, like the Golden Rule for carpenters, measure twice and cut once.