LONDON, 25 May 2005 — When people buy stocks, they think they are playing a game of skill. Whether they gain or lose, it boils down to good or bad luck in both situations. My personal view is that it is not all luck, but it is mainly luck!

Much of what investors do in picking stocks, i.e. the research, the listening, the talking, the reading, etc., is nothing more than wheel-spinning.

Basically, and from experience, the past frequently tells us nothing at all about the future, even though many of us believe it does and many make investments accordingly. This is indeed frightening: How much can one rely on the track records of investment advisors or even the market as a whole in making decisions about investment portfolios? It was argued once that people are often tricked, mainly by the architecture of their own brains, into thinking that things that happen at random are actually happening by design, or for a reason. The truth, however, is that one can make money in the financial markets totally out of randomness.

But how would investors distinguish between being skilled and being lucky? In my opinion, fundamental analysis (using macroeconomic models) is no better than technical analysis (where price movements of a stock are based on a graph of where it’s been), in enabling investors to capture above-average returns.

Generally speaking, there are three essential rules for picking stocks with a semblance of certainty:

First, Invest in a business you understand. A simple packaged product on a supermarket shelf might seem so attractive, but focus should be on the understanding the business that makes the product. Therefore, easy to understand products, often but not always, come out of easy to understand businesses behind it.

Second, Invest in a business catalyst you understand. It is not enough that understanding the business mean you should own a piece of it! Sometimes, simple, easy-to-understand declining businesses aren’t good investments. You need to look at a business likely to produce more cash in the future than it does today so that you, the investor, can book a gain either from a rising dividend or a rising share price, or both.

Third, Invest in financials you understand. This is in addition to the “invest in what you know” because it is especially difficult to understand financials these days.

Historically, as markets top out, the quality of company financials decline. Here is why: Companies take on more debt because they believe that demand will expand forever, and then have to get it off their books any way they can when demand doesn’t materialize, resorting to accounting gimmicks, a la Enron!

Almost every company I looked at recently raised some issue that investors need to be sure they understand before they invest in. Finally, investing in what you understand can be a subjective strategy because each investor comes to the market with a different knowledge base and very different research skills. My advice: If you cannot get your mind around the numbers, by all means find an investment that you do understand. If you understand a specific sector, again by all means, consider a mutual fund or similar vehicle with a solid track record that shows professional managers do understand the businesses. If you are fed up with the market, you are certainly justified.

But how do you protect your investment and limit your losses? The question again: What’s the best investment strategy to protect your long-term future and limit you short-term losses simultaneously?

Simply, if your financial adviser cannot explain it, don’t invest in it!

(Habib F. Faris is a vice president at Clariden Bank, London.)

(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information.)