Apr 1, 2021
Five risk management tools for do-it-yourself investors
By Dale Jackson
The pandemic lockdown has sparked a frenzy in do-it-yourself (DIY) investing. In 2020 alone, Canadians opened more than 2.3 million DIY trading accounts, nearly triple the number of new self-directed accounts opened in the prior year, according to financial services research firm Investor Economics.
The DIY investing wave is paralleled by a spike in online gambling. For some, it’s the same thing with slightly better odds. But taking investing into your own hands can save in fees, help build a long term portfolio, and teach us how the capital markets work.
The biggest advantage investors have over gamblers is the ability to manage risk. Gambling is mostly an all-or-nothing affair, but here are five things DIY investors can do to limit losses while positioning themselves for gains:
1. Diversification
Don’t put all your eggs in one basket. Like gambling, you should never bet more than you are prepared to lose. If your goal is to accumulate wealth over the long term, be sure the bulk of your savings are preserved in safe investments that grow over the long term. Many DIY investors tend to keep their retirement savings in a registered retirement savings plan (RRSP) where tax rules make them hard to access before retirement.
The tax free savings account (TFSA) is the ultimate investing tool for the DIY investor because it permits just about any type of investment and gains are never taxed. It can also be a good retirement savings tool if it holds a variety of investments spanning sector and geographic lines. It might be wise to dabble in index exchange traded funds (ETFs) with many large holdings before moving on to low volume, high-risk penny stocks.
Diversification also means risk diversification. It’s healthy to have an element of speculation in a portfolio as long as safer investments are there to temper risk.
2. Research
Novice investors might be surprised to learn that big idea they came up with was likely planted in their heads by savvy promotors. Pushing investments on the unsuspecting public is a multi-billion dollar industry that mostly plays on a natural fear of missing out.
If you think a stock is hot, call up a chart and check out its performance over the past year or as long as the stock has been trading. Retail investors are notorious for buying into the hype at the top of a market after a short pop when bigger, short-term investors are looking to cash out.
Also, check out a basic valuation metric available on many investing websites called the price-to-earnings ratio (PE). In any case the true, or intrinsic, value of a stock is based on the company’s ability to grow profits. The PE ratio compares the current market price of a stock to the company’s earnings (profits) per share. Many penny stocks don’t even turn a consistent profit to register a PE ratio and in some cases the price is way out whack with earnings.
3. Education
Many online trading platforms offer tutorials on how to interpret valuation metrics along with other investing basics. Some even offer analyst ratings and technical analysis tools to spot market trends.
DIY investors who want to take it up a notch can enroll in a Canadian Securities Course similar to those taken by professional money managers.
4. Stop losses
Another free service most online trading platforms offer is the ability to set stop losses. A trailing stop loss allows you to pre-set an automatic sell price that remains just below the current price to lock in gains and limit losses.
5. Exit strategy
Never enter a position without staking out the exits. In many ways, knowing when to sell is harder than knowing when to buy. Value investors sell when a stock price exceeds earnings. Some professional money managers automatically review a holding if it doubles in value within a year to determine if the reason for buying it still holds up.
If your investment exceeds expectations, consider selling all or some and distributing the profits into safer investments.
If it tanks, consider selling at a loss and chalking it up as a learning experience.
