Preservation of capital is the key to making money – Don’t lose money! – July 2, 2018
It does not matter if one is playing sports, games of chance or investing. If one gives up too many points or loses too much money, it’s very hard to come back from losses. If one loses 50% of their capital, one would have to make a 100% gain just to break even. So if you start with $1,000 and lose $500 you will have to double your money in order to get back to the starting line. That kind of math should be enough to scare the daylights out of anyone.
Here are some examples of accounts starting with $1,000:
– “Trader A” loses 5% or $50 on the first trade. “Trader A” is down to $950. She then makes a profit of 6% on the second trade and moves her account value up to $1,007. She then makes two more trades with 6% gains each. Her account is now worth $1,131 on four trades that averaged 3.25% gains.
-“Trader B” loses 50% on the first trade. “Trader B” is down to $500. He then makes 3 straight trades with 25% gains on each trade. Unfortunately, even after those three great trades, his account is only worth $976. To add insult to injury, his four trades averaged 6.25% gains.
In short, it is very hard to dig oneself out of a big hole. “Trader A” limited her losses and ended up way ahead by compounding small profits. “Trader B” took a big loss and still could not get back to even after compounding huge gains.
Games of chance
Blackjack is the only game where the player has a chance, providing that the house does not skew the rules by nitpicking. Computers have figured out that by properly using a basic strategy, players can statistically almost break even with the casino. – http://www.blackjackbee.com/blackjack_odds.php – Using card counting and increasing the size of one’s bets can skew the odds in the player’s favor. Of course casinos shuffle up or use automatic computer generated dealing machines to prevent card counting. They also try to catch and then ban card counters from playing.
Video courtesy: Wired
Poker is a game where one can win using many strategies designed to fold one’s cards quickly when one is dealt a bad hand. By not tossing money into every pot, one will have enough money to bet when that great hand is dealt to them. Of, course that does not account for bluffing or playing crazy games like one sees on TV poker championship games. Kenny Rogers – yada yada.
Other games of chance like Roulette, slot machines and so on are a waste of time. The odds are skewed in the house’s favor and the more one plays the more one depletes one’s stash.
Stock Market Strategies
There is no one stock market strategy that is the best.
1 – For the average investor looking for a retirement nest egg, a simple lifetime strategy of putting their savings into a well-diversified portfolio will perform the trick of both compounding and preserving capital. The larger the percentage of one’s income one consistently puts into a sound long term diversified investment portfolio managed by a prudent top asset manager, the more one will reap the benefits of compounding. The more asset managers one uses, the less risk. Don’t get crazy, with the number of accounts and diversify by investing in your own home and you will do just fine.
Here is a compound interest calculator courtesy the SEC. Click here and enter the amount you can save for say 30 years at just a 6% annual return. You will be amazed:
2– The person looking for huge gains can do so by sticking with a basic investment approach. Learn an investment discipline and stay with it. I would suggest that if one wants to go this route, one should still deploy a savings strategy like number 1 above.
Here are some risk control ideas if one chooses this route:
-Diversification. The more one diversifies, the less one can lose. For example, assume one limits each portfolio investment to 5% of their portfolio. Even a 50% loss on one investment will cause the entire portfolio to drop by only 2.5%.
-Stop losses. A 50% loss should never be tolerated. In the above example let’s assume that a 10% stop loss limit is used to control risk. A 10% loss on one 5% position will limit the entire portfolio’s loss to .05%. That is much better.
-Know what you are investing in. Do your research on the potential investment. Use the internet and any tools you can get your hands on to perform due diligence. What category does the company fall into? Is the company performing speculative biotech research on a FDA phase 1 drug? Are clinical trials in advanced stages? Is the company a steady cyclical one such as a railroad that grows slowly but rides the ups and downs of the economy? If you are a growth stock investor, know why the company is growing and how far out into the future growth is projected? The list is endless, but the more you know about the investment, the less your potential risk will be.
-Value investors should know the company’s balance sheet and management cold. They should slowly scale into depressed positions and know their investment time frames. Warren Buffett has been known to make large purchases of depressed stocks over long periods of time. He has stated that he does not intend to make a profit right away. He is willing to live with small losses for a while. In his eyes he is buying companies and he does not care about the stock market which will eventually come around to his view point. His time frame is very long and he knows about his investments better than you or I. I could never hold a losing position that long.
Some of his famous depressed bargain basement buys include American Express, GEICO and the Washington Post (Which over the years morphed into Buffett becoming Disney’s largest shareholder (until he was recently surpassed). His studies of those companies are legendary. The point is that he knew what he was looking for, put in the work and invested when he was sure he was buying great companies at very low prices.
Warren Buffett’s manner of risk control was to compound only 10 -12 great investments that he knew like the back of his hand into the cornerstones of a great growth portfolio. Of course today, Berkshire Hathaway is too large to utilize that strategy. There is nothing large enough that can have a great impact on BRK.A.
Warren Buffett’s other point of genius was to use risk free leverage to his advantage. He bought insurance companies that had enormous pools of wasted cash on the sidelines. He then analyzed what the safest optimum amount of cash was really needed to pay off claims and invested the excess into new businesses. He basically became an actuary.
Tomorrow I will show how I used risk control recently. I can’t go into every area of risk control. That would take a book. Just be aware that if you chose this path, you had better learn how to preserve capital.