What being your own Chief Risk Officer means for you:
In the institutional investment world, a Chief Risk Officer – or CRO – is the one who makes sure that the investment decisions a fund or firm makes can’t destroy the entire portfolio.
When a CRO does his job, he should be invisible. But the most conspicuous risk management stories come from the CROs who didn’t (or couldn’t) do their jobs.
Take the MF Global debacle from late 2011: The firm lost $1.6 billion of customer funds after blowing up its own proprietary trading account in October 2011. That’s just a handful of months after the firm fired its former Chief Risk Off icer, Michael Roseman, for waving the red flag over the size of bets being made. Bear in mind that MF Global was actually right about the investments it made. The f ir m just didn’t sur vive long enough to see its bets bear fruit. It made TOO BIG bets, and even though they eventually turned out right they still destroyed the company before it could reap the benefits.
If that doesn’t show you the value of being a good risk manager, nothing will…
More importantly, if major f ir ms are paying huge salaries to hire CROs to keep an eye on their portfolios, why wouldn’t you want to apply the same principles to your own portfolio?
Three ways to make sure you manage your portfolio’s risk well
1. Know how small is too small!
One of the fastest ways to lose a ton of money in the market is by investing WAY too small.
If you pick too small investment amounts – well then you’re paying MASSIVE costs without getting big gains.
How small is too small?
Well, if you buy only R1,000 in a share your brokerage will come out to around R150 to buy the shares. The day you sell you pay another R150.
Say the shares grew by 50% that means you will bag about R200 at the end of the day. If the shares grew only 20% you’d end up losing R100!
If you have an inexpensive broker you could start with R3,500 into a single share. But that’s the bare minimum, I typically say R5,000 per share.
2. Know how big is too big…
The flipside of investing too small is going too big… And that’s an even bigger sin!
So, how big is too big?
Well to me there are two ways to calculate this, but remember this is for penny share investing. Not for trading.
Not for safer blue-chips.
Method 1 – Never bet more than 10% of your portfolio on a single share. So if you have R100,000 portfolio you can put R10,000 into a single share. This simply ensures that no single share wipes you out.
Method 2 – If you have only star ted investing recently you might not have a R100,000 portfolio. In this case I’d say you mustn’t invest more than a quarter of your monthly salary into a single share.
WHY? Well, a loss of that size is manageable. It doesn’t break you ‘psychologically’ when you have to take it.
But say you earn R15,000 a month. Now you save R30,000 up over two years and invest ALL of that into a single share…
That’s great if you g row it by 200%+ like we’ve done with Poynting and AdaptIT this month. But what if it’s a 30% loser?
Then you lose R9,000. Nearly a month’s wor th of work, or a year’s worth of savings.
I can guarantee you, this happens and you’ll quit investing. So manage your risk!
3. Don’t Fear Cash
You may have heard that “Cash is a trade”.
It’s tr ue – even though it may feel like you’re doing nothing by sitting on cash, it can be ever y bit as valuable as having an open trade.
Owning a portfolio that’s 100% cash isn’t the same thing as being gun-shy about your trading. When the market’s out of alignment or you’re just feeling rattled, you need to approach a cash position as an active position just like any share you buy. Contrar y to popular belief, having a por tfolio full of cash is “doing something” in this market.
Part of the reason cash is such a cr ucial position to take at times is the fact that markets don’t just go either up or down. Instead, volatile markets can easily whipsaw you out of positions as shares churn sideways.
So, there you have it: Three ways to manage risk and be your own personal Chief Risk Off icer.
Remember, these things next time you’re tempted to put more money on the next SURE THING than you should, more than you are comfortable with. It’s a bad idea, just like it’s a bad idea to invest a tiny amount, racking up high costs and risking losing money even though a share goes up!