Investing is a risky endeavour. Sometimes losses and bear markets do happen with ASX shares.
We all want to make money from ASX shares, and there are many different ways to do it, with different investment styles.
Although there are a number of ways in which bad investing can end up burning through capital, I try to avoid these unnecessary risks through certain techniques. Three of which I will outline in this article.
If we can avoid some of the obvious pitfalls of investing, then that is already a win for our portfolio's success.
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Avoid binary outcomes
I don't like to consider investments that have wildly alternate outcomes.
A binary outcome suggests that the investment could either go fantastic or terribly. An investment like a speculative biotech or a mining explorer fits this description.
If the biotech's new product is successful and approved by regulators then the market would probably love that news. But, a highly-hyped product that goes on to fail could be a massive disappointment.
A mining explorer may find a great deposit. Or it could burn through all of its cash.
Some investors may be skilled at analysing biotechs, mining explorers or other investments that fit a 'binary outcome', but it's not how I like to invest. I certainly wouldn't sleep as well if my portfolio was full of these sorts of plays.
Margin of safety
Investing is about identifying opportunities where they're undervalued compared to what they could be worth now and/or in the future.
If we initially ignore what the share price on the ASX is, we can try to figure out what a fair price is for the business when taking into account growth projections, its assets and so on. Then, we can figure out if the current share price is attractive compared to our thoughts on what we think it's worth.
The bigger the difference between the current price and the 'fair' price, the bigger the margin of safety is.
Investing in ASX shares where the market has clearly priced in a lot (or all) of the potential of a business makes me cautious about choosing it.
We can still choose great ASX growth shares, but we can be strategic about the price and when we invest.
No diversification
I love investing in appealing companies with compelling outlooks. However, I think every investor should have some diversification in their portfolio.
That means I'm not going to have all of my portfolio invested in just a couple of businesses. Something could go wrong for one of those two businesses.
It also means I'm not going to have all (or most of) my portfolio in just ASX bank shares or just ASX iron ore shares. Businesses in the same industry face similar risks, so if a major risk eventuates it could cause widespread declines in the portfolio.
I like to be invested in a number of businesses that are listed in different countries, which lowers risks but doesn't necessarily lower my returns.
