Investment Process Ι Common Errors in Investment Management

ΙInvestment Process Ι Common Errors in Investment Management.

Explanation of the investment process

This is a procedure involving the following five steps:

1. Setting Investment Policy

This initial step determines the investor’s objectives and the amount of his investable wealth. Since there is a positive relationship between risk and return, the investment objectives should be stated in terms of both risk and return.

 2. Performing Security Analysis

This step is the security selection decision: Within each asset type, identified in the asset allocation decision, how does an investor select which securities to purchase. Security analysis involves examining a number of individual securities within the broad categories of financial assets identified in the previous step.

 3. Portfolio Construction

This step identifies those specific assets in which to invest, as well as determining the proportion of the investor’s wealth to put into each one. Here selectivity, timing and diversification issues are addressed. Selectivity refers to security analysis and focuses on price movements of individual securities.

4. Portfolio Revision

This step is the repetition of the three previous steps, as objectives might change and the previously held portfolio might not be the optimal one.

 5. Portfolio performance evaluation

This step involves determining periodically how the portfolio has performed over some time period (returns earned vs. risks incurred).

Common errors in investment management

Following are the Common errors in investment management

  • Not having a clearly-defined investment plan. A well-thought-out investment plan does not need frequent adjustments, and there is no place in a well-managed plan for speculations and “hot picks”. Investment decisions should be made with an investment plan in mind.
  • Investors become bored with their plan or the rate of growth too quickly, change direction frequently, and make drastic rather than measured adjustments.
  • Investors tend to fall in love with securities that rise in price and forget to book their profits. Profits that are not realized are just book profits; they may disappear when the market goes down, While one should not be in a hurry to realize his profits, it is also true that he must not become so blinded by the beauty of unrealized gain that he forgets the basics of prudent investing.
  • Investors often overdose on information, leading to “paralysis by analysis”. Such investors are likely to become confused and indecisive. Neither of these is good news for the health of an investment portfolio.

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