Creating a Discipline Part I

Risk management, Asset allocation, and Research

Let us make something clear from the start: a discipline is a process that is ever evolving; one that is designed to help enhance market returns and limit risk. Disciplines can be used on their own as devices to filter stocks or in conjunction with each other, to find investments that work in concert within a portfolio. A discipline should not be used as an excuse to blindly follow strategies that may have worked over the previous 12 months. It is not a process that is sold to you by a stockbroker intending to help keep you out of the investment process altogether.

Remember a Aesop fable about the goose and the golden egg? It is the story of a poor farmer who one day visited the nest of his prized goose, finding at her side a glittering, yellow egg. Convinced that it must have been a trick, he was about to throw it away before he quickly changed his mind…but he didn’t. He decided to take the egg home for analysis. To his delight, he discovered that the egg was pure gold. The farmer became fabulously rich by gathering one golden egg every day from the nest of his special goose.

As he grew richer, he became greedier and more impatient. Hoping to secure all the gold at once, he killed the goose and opened her, only to find nothing inside. What can be learned from this story is that growth is a daily grind composed of successes, failures, lost opportunities, progress, and change. Thinking that wealth can be attained in one fell swoop is dangerous and often results in losing a fortune.

The next task is to find out about your overall investment preferences. A risk tolerance assessment is a good place to start. Best defined as the amount of psychological pain you are willing to endure from your investments.

For example, if your risk preference is high, you might feel fairly comfortable investing in options contracts or other investments that are very volatile. The preference for lower risk would lead you toward more conservative investments that do not tend to have large fluctuations in value. Some also call this your “sleep factor.”