Know yourself before you invest

  • Set your investment goals before putting any money into funds.
  • Know yourself. Your investing personality is a key to intelligent fund selection.
  • Younger investors should emphasize growth funds. As you approach retirement, income and safety should be your main priorities.

It was a week like none ever seen before.In five trading sessions, between April 10 and 14, the Nasdaq Composite Index recorded its two worst down days ever, en route to a dizzying 25% free-fall.Not to be outdone, the venerable Dow Jones Industrial Average, still the most-watched market indicator, recorded its biggest one-day loss in history, dropping more than 600 points.

The TSE 300 didn’t fare quite as badly, but the one-week drop of 10% was no picnic for investors either.

Mutual funds, especially those with a heavy high-tech weighting, reacted accordingly. By the time the week was over, many were showing 30-day losses of greater than 20%. A few were down more than 30%.

Never mind that many of these funds had just finished racking up eye-popping one-year returns. When you see your assets lose a quarter of their value just a few days, the natural tendency is to get somewhat antsy.

The nervousness was compounded by the fact that most investors in high-tech funds were relative newcomers. They weren’t around for the big gains of 1999 and early 2000. They had just jumped on the bandwagon, many of them during RRSP season, and were stunned as their newly-acquired units plummeted in value.

If you found yourself waking up in a sweat during that tense week in April, worrying about your money, it was a sign that your fund portfolio isn’t properly designed for your investment personality.

Many investors have become overly aggressive in the past couple of years, swept along by the excitement of Nasdaq and high tech.

It’s not just younger, inexperienced people who have succumbed. At a seminar in February, a woman in her fifties came up to me and asked how she could invest her RRSP money in a Nasdaq index fund. I explained the options, but suggested that she might want to think twice about making such a move. Nasdaq had enjoyed a huge run, I said. That couldn’t continue and the risks were high. Someone in their thirties could ride out any correction, but at her age. . .

Nothing I said mattered. She was adamant. She was tired of the poor returns she was getting from her current mutual funds. She was going to invest a big chunk of her money in Nasdaq! I only hope she eventually decided that putting most of her RRSP assets into that one basket might not be such a good idea after all.

Market tremors are as inevitable as earthquakes along the San Andreas fault. Everyone knows they are going to happen. We just can’t predict exactly when.

The moral of this story is simple. Before you decide which mutual funds to purchase, you must know exactly what your investment goals are. There are mutual funds to suit every need — the trick is matching up the right fund with your particular requirements.

To help you determine your personal priorities, I’ve developed a self-test to identify the type of investment personality you have. Take a moment to complete it now, before reading on.

  A – agree B – disagree C – unsure
I require regular investment income.      
Safety of capital is essential.      
Growth is not an important factor.      
I am not prepared to take more risk for a higher return.      
I don’t want a manager with an aggressive style, even if he’s good at it.      
I am within ten years of retirement.      
I cannot afford to lose any money.      
My spouse says mutual fund invest- ing is too risky.      
I’m using RRSP/RRIF money.      
I’m more concerned with a comfortable lifestyle than with being rich.      

Give yourself two points for every A answer, one point for every B response. Any Cs count for zero.

The higher your point total, the more conservative you are, and the greater the emphasis you should place on mutual funds that focus on steady income and protection of capital. If you scored 15 or over, you should concentrate on T-bill funds, money market funds, mortgage funds, and bond funds.

If your score is in the 7 – 14 range, you appear more willing and able to take greater risks in order to obtain better returns. In this case, you should be looking more seriously at equity funds (Canadian, U.S. and foreign) and precious metals funds.

If your total score is less than seven, it’s an indication you have done very little thinking about your investment objectives. You should take time to consider what you want to achieve before going any further.

Your personal investment goals will be influenced by several factors, including:

Age: The younger you are, the more risk you can afford to take, although it’s not a good idea to go overboard. If your first investments go sour, you may end up spooked for life. That’s why it’s a good idea to begin with a low-risk fund, such as a mortgage fund. This will allow you to gain some investing experience while keeping your money out of danger. As you develop a feel for what you’re doing, you can move on to other types of funds.

Investing experience: One of my cardinal rules for investors is to never put money in things they don’t fully understand. Knowledge comes with experience, so until you feel comfortable with what you’re doing, you’d be advised to set a goal of investing only in funds with policies and objectives you comprehend and agree with.

Income needs: If you’re relying on money from your fund investments to live on, you’ll want to select one that provides a regular income stream.

Family situation: The greater your family responsibilities, the less money you can afford to risk. A single person with no dependants can usually absorb investment losses more readily than a married couple with three kids and a mortgage.

Retirement plans: The closer you are to retirement, the more conservative you should be in your investment choices. You may no longer have the time to ride out a serious downturn in the stock market or a precipitous drop in the price of real estate or gold. This doesn’t mean you should abandon growth funds entirely, however — you need some protection from inflation, which is unlikely to stay low forever. But these funds should comprise a smaller portion of your portfolio.

Your financial ambitions: Some people feel they absolutely must be rich — whatever the risk involved. If you’re one of these, an aggressive growth fund will be the way to go. Others only want to enjoy a comfortable lifestyle, free from financial worries. They’ll choose more conservative funds.

All these factors must be taken into account in setting your mutual fund investment objectives. Only when you feel you know exactly what you want to achieve, and why, should you move on to the next stage.