In the field of investing, being correct 55%-65% of the time can earn you a great deal of money if you use a good money management strategy. That is, if just one out of every two of your investments earns money then you can be very successful. However, it is possible to be right 80% of the time and still go broke in the end if you don’t have a good money management strategy in place. All it takes is one or two big losses to wipe out all of your hard-earned gains.
In fact, a good money management strategy is just as important as picking the right stocks or other investments.
If you are like most investors, you have no doubt had the idea drilled into your head from day one that the stock market is just simply too unpredictable to manage, therefore your best and only strategy is to buy a good company and hold that company through the good times and bad times for in the long run good companies grow.
Oh really?
If you purchased IBM, Goldman Sachs, or Microsoft ten years ago then you haven’t made a dime and you would have been better off parking your money in a money market account or a CD [1] where you would have at least earned a couple of percentage points a year. Perhaps the next 10 years will be better, but do you really want to bet on that?
How a Good Money Management Strategy Can Make a Big Difference
We mentioned above that if just 50% of all your investments pay off you can be wildly successful in the markets. Let’s take a look at the numbers and see how this works.
For the sake of simplicity, let’s assume you buy $10,000 worth of stock each in four different companies. Now let’s assume that you use a simple money management strategy in order to control the risk in your investments.
The rules for your strategy are as follows:
- Rule 1: If the price of the stock moves against your purchase price more than 3% you sell and take a loss.
- Rule 2: If the price of the stock moves up 10% you sell for profit [2].
Now, let’s see if this is a profitable strategy. We will assume that two of your investments move up and two fail; the same odds offered by a coin toss.
Stock 1 = $1000 profit
Stock 2 = $1000 profit
Stock 3 = $300 loss
Stock 4 = $300 loss
Total = $1,400 profit
So we see that indeed, this is a successful money management strategy. The numbers of course can be changed and it is not necessary to take profit at 10% for long term investors. One might simply just decide to adjust the sell price higher and higher protecting profits while allowing the price to continue to enjoy gains. Moreover, one might also wish to use a wider margin [3] of error in order to accommodate market volatility.
The bottom line is, if you earn more money on your successful investments than you lose on your unsuccessful investments you ensure that your investment account is always moving forward and never slipping back.
That’s a whole lot better than parking your money in the market for 10 years and earning nothing, right?
Donald D Harder is an investment advisor with over 17 years professional market experience and is President and Chief Stock Market Analyst for Securities Research Services [4], an online stock trading newsletter service. Don served as a financial advisor for American Express Financial Advisors and later served on the board of directors at Nettrader.ru, a mid-sized Moscow-based online securities [5] brokerage. Mr. Harder strictly adheres to an investment philosophy that focuses primarily on reducing risk, for if you manage risk, profits generally take care of themselves.