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Building Blocks

A strategy is defined by taking into consideration different elements. Both the goal it serves, and the impact it has, can somehow be subdivided in what I like to call building blocks. Again, none of those are mutually exclusive, nor is the list below exhaustive. Building a strategy merely consists of giving a good thought about your (financial) actions.

In defining your strategy, one of the most important questions to ask yourself is what risk you are willing to take, or able to take. Recall that risk & return are linked, and that the more risk you are willing to take, the more potential return you may have, but also the more potential losses you may suffer.

When answering this question in terms of strategy definition, investors tend to split up their wealth into different risk classes. Meaning that with some part of their wealth, they might be interested in high risk assets, let's say cryptocurrencies, all the while they maintain a part in medium risk asset class, let's say stocks, while still having a part of their wealth in safer assets such as bonds, savings accounts or even cash. By doing so, they try to reap benefits of the high risk (and high performing) assets, while maintaining a financial stability required for a comfortable financial life.

Another way of looking at risk and return, is by asking yourself the question, how wrong can things go with my investment before I am financially hurt? When taking into account the probability of this 'wrong' happening, you might get a clearer understanding of whether you invest within your financial comfort zone. For example: 'If in invest all of my wealth in cryptocurrencies, how wrong can things go before I'm financially hurt?'. If you're answer is that cryptocurrencies should not fall by more than 10% in their value, and knowing that cryptocurrencies suffer both price increases and decreases of more than hundredths of percents a month, it doesn't take a genius to say that this is a wrong strategy for this person's case.

Risk & Return

age

Inherently connected to the risk appetite of an investor, is his age. Usually, the older the investor, the less risk he or she is willing to take. This merely results from the fact that usually, an investor reaching retirement age wants to enjoy his wealth.​ Now, if I were a young investor, and I invested at a wrong time, let's say just before a major recession, I would still have a lifetime in front of me to recover from this bad decision. If I am old however, and my investments are supposed to support me financially once I am retired, I wouldn't have the capacity of recovering after let's say a major market recession (or whatever investment devaluation I'm exposed to). It is for that reason, that older investors usually divest from riskier assets into safer assets in order to be less exposed to strong volatility.

Liquidity refers to the speed at which you can liquify, or sell an asset in exchange for cash. The higher that speed, the more liquid an asset is. Liquidity of an investment plays a role in the question 'How fast should I be able to liquidate my assets?', or rephrased 'How fast would I need the cash?'.

 

Let's say an investor has a portion of cash at hand and he has the intention of buying a house. Nonetheless, he wants it to be the perfect house, which he hasn't found yet, and for which he knows he might be searching for quite some years before he finds anything he likes. Since he is a good investor, he wants to invest that cash in the meantime. The moment he will have found a house, he will need the cash fast, so his choice should be to invest in highly liquid assets. An investor looking to invest as retirement income on the other hand, doesn't necessarily require liquidity. 

  • Examples of liquid assets include exchange-traded stocks, exchange-traded bonds, cash, savings accounts, cryptocurrencies,...

  • Examples of non-liquid assets include real estate, venture capital stocks, long-term fixed deposits (depending on the terms & conditions),...

Liquidity

Investment Horizon

The investment horizon refers to the duration during which an investor plans to remain invested. This partially answers the question on when an investor plans to liquify those assets and either re-invest them, or keep the wealth in cash for other purposes.

Some investments have pre-defined durations like time deposits, or bonds. Other investments have undefined durations like savings accounts, or stock investments.

How well do you understand financial instruments and how much time do you want to spend on monitoring them. It seems quite obvious to me that an art director with no experience, nor interest in finance & investments what so ever, will not partake in an active management of his funds. He will rather trust on financial institutions, or financial planners to manage his wealth while he can focus on his passions. A financial MBA student might find it fun and challenging to spend a couple of hours a week to manage (at least a part of) his funds actively by testing out new tools and new approaches.

Financial litteracy & time commitment

Side Benefits

Besides the obvious wealth increase, properly managed investments might serve additional benefits. Some examples include:

  • For the sake of learning: Managing your own investments might be exciting and teach you to broaden you skills in various ways.

  • Investing in real estate might take your sorrows away in finding a place to live in. Living in a place you own gives you a security about having somewhere to live.

  • Acquiring financial independence by earning an additional income, for instance as a Popular Investor on eToro.

Investment strategies
examples