Preservation of Capital. Not losing money.

#Losing money is worse than not losing money. 

Some math makes clear why value investors act conservatively.

Picture a portfolio that realizes a 50 percent loss in a year. Not one that started the year with stock that just happens to have halved in price 12 months later. One that actually realized a 50 percent loss. One that began on January 1 with cash, bought stock during the year, sold that stock later in the year, and on December 31 had half as much cash as it started with. What would it take for the portfolio to get a fresh start?

It would need a 100 percent return the next year just to get back to zero. That’s hard. 

Consider soccer. If a player takes a shot on goal and misses, nothing happens to the score. The player gets a fresh start with the next ball. But if soccer was investing, the player would get negative points for missing. Goals would be required just to get back to zero.

That’s why value investors behave with such restraint. We put capital preservation first. We do so because the mathematics of our missed shots is punitive.




#When capital preservation is underemphasized

When capital preservation is underemphasized, returns suffer. 

Returns suffer because losses add up like weights. 

This truth isn’t evident to those who believe in the risk-return trade-off. They see the subordination of capital preservation as a step toward outperformance. And those believers constitute the majority. 

Perhaps that’s why the asset management industry has such staggering failure rates. Most actively managed equity funds—those that pick individual stocks—don’t beat basic market indexes.

Most. That’s the output of a blind majority.




#Repel Losses

Two practices help to preserve the value investing model’s ability to repel losses.

A.  The first is to keep it current. 

Think of the model as having three layers (Figure 21.1).

1.  The top layer is the general guidance:

• know what to do, 
• do it, and 
• don’t do anything else. 

2..  The middle layer gets more specific, insisting that investments be

• understood, 
• good, and
• inexpensive.

3.   The bottom layer is more specific still. It’s all of the lower text:

• the six parameters of understanding,
• the historic operating metrics,
• the cognitive biases, and so forth.

FIGURE 21.1: The value investing model


The top layer is permanent.
Knowing what to do, doing it, and not doing anything else is so durably commonsensical that one might even apply it to other endeavors.

But the bottom layer could change.
Both accounting standards and disclosure requirements will evolve.

• For example, the Federal Accounting Standards Board might mandate some new calculation of operating income such that ROCE has to adapt. 
• Or perhaps the SEC will eliminate related-party transaction reporting such that the number of shareholder-friendliness indicators has to be trimmed down to three. 
• The more time that has passed, the more important it is to be aware of such developments.

B.  The second practice is to think in percents. 

One should focus on the total return expressed as a percentage, not on currency amounts.

• A 20 percent realized loss is not okay just because the actual damage was only $1,000. 
• And a $1,000,000 gain is not impressive if it represents just a 2 percent annualized return.

Thinking in percents nurtures habits that perform faithfully over a lifetime.

• Discipline learned in the early years of little capital works just as well in the later years of more capital. New tricks aren’t required just because of more zeroes.

When one thinks in percents, the absolute gains follow. 

• They follow because value investing is remunerative. 
• That provides most practitioners with enough motivation to stay with the strategy. 

#Value Investing has other benefits too

But since I committed to it at the end of the last century, I’ve come to see that value investing has other benefits as well.

• For one, it keeps me engaged with the world. 

Turn on the serendipity spigot, and suddenly everything applies. Shopping, news, traffic—all become inputs just as worth processing as financial statements. The instants and fragments of everyday life become relevant in a vivid way.

• Second, value investing is, at root, truth seeking. 

It takes inherently hazy situations and chases the facts. What’s this thing worth? I see a realness in that.

• Third, it rewards a long-term perspective. 

It compels me to consider how enterprises will develop over time. Part of that drill is picturing civilization years forward. That carries an aspect of foresight that I like.



#Value Investing benefits at personal level 

That long-term perspective applies on a personal level as well.

• I hope to keep value investing long after other lines of work would have become difficult.

Making presentations, attending meetings, and flying overseas all get harder with age. But value investing requires none of that.

• I’ll do it for as long as I have all my marbles. 

My younger loved ones are standing by to let me know when the first one plinks out.

• Above subsistence and below gluttony, there’s little correlation between net worth and happiness. 

Money just doesn’t produce life’s great joys. Those come from those loved ones, from health, and from other sources that don’t care much about geometric means, depreciation schedules, or enterprise values.

• But an absence of money can keep one from the great joys. And therein lies value investing’s promise. 

It gives one the freedom to fully embrace what really matters. To be able to drop everything and lavish attention on such gifts, fearlessly, and at times of one’s choosing—That, I think, is what rich is.




Summary

1. Capital preservation is a value investing priority because of the mathematics of realized losses.
2. The risk-return trade-off blinds most asset managers to the primacy of capital preservation.
3. Most actively managed equity funds fail to beat basic market indexes over time.
4. The bottom layer of the value investing model is the part most likely to change.
5. Thinking in percents encourages habits that work over a lifetime.
6. Value investing has benefits beyond remunerativeness.


Reference:;
Good Stocks Cheap - Value Investing with Confidence for a Lifetime of Stock Market Outperformance.

"Don't lose money." Avoiding loss should be the primary goal of every investor.

Warren Buffett likes to say that the first rule of investing is "Don't lose money," and the second rule is, "Never forget the first rule."

Avoiding loss should be the primary goal of every investor.

This does not mean that investors should never incur the risk of any loss at all.

Rather "don't lose money" means that over several years an investment portfolio should not be exposed to appreciable loss of principal.


Avoidance of loss is the surest way to ensure a profitable outcome.

Two reasons why investors lose money in the stock market

1.  They buy poor quality stocks.

2.  They pay too high  prices.  

Golden rules for losing money. To make money, sometimes it's better to first concentrate on not losing it.

This article explains the classic investment mistakes that, to be successful, you should avoid at all costs.

To make money, sometimes it's better to first concentrate on not losing it. 

Investing successfully poses many challenges. Here are some of the techniques that can help you to rise to these challenges but first, one of our favourite tools, from mathematician Carl Jacobi.

He was fond of saying, 'invert, always invert' and that's what we're going to do here.  Instead of looking at how to make money, we're going to look at great ways to lose it. That way you can aim to minimise your mistakes-a vital part of investing successfully.

So here they are, classic investment mistakes guaranteed to ensure woeful performance.

1. Trade fast and trade often

Charlie Munger, Warren Buffett's business partner, often refers to the huge mathematical advantages of 'doing nothing' to your portfolio. Let's blindly ignore the very large tax benefits of holding stocks for the long term and just consider the impact of brokerage.

Someone who 'turns over' (buys and sells) all the stocks in their portfolio several times a year is at least a few percent behind the eight ball, even with internet brokerage rates as low as 0.3%. Add up the brokerage from your last tax return to see what we mean.

There's also an important, but less measurable, benefit to taking a longer-term approach. It makes you think long and hard about which stocks to include in your portfolio. When you are considering buying a stock for 10 years or more, you tend to pick quality businesses. And that can only be a good thing.

So, if your intention is to lose money (and enrich your broker), trade fast and frequently.

2. Follow the mainstream media

Hopefully, you are somewhat against this particular human folly.  Most people, though, aren't so resistant.

Munger refers to a human condition known as 'incentive-caused bias' and it explains the functioning of media quite nicely. There's a widely held belief, and it may be correct, although declining newspaper circulations suggest otherwise, that emotional, confrontational, dramatic coverage sells more papers than rational, factual reporting. Hence the tendency to induce panic in investors when calmness would better serve their interests.

But incentive-caused bias doesn't just affect the media. Just look at how honest managing directors can first convince themselves, then their board, then their shareholders, how an offshore acquisition or hostile takeover will be great for everyone, especially themselves. Generous options packages offer a fitting explanation for many examples of corporate foolishness.

To lose money, avert your eyes from a factual assessment of a situation and bury yourself in the opinions and arguments of those with a vested interest in convincing you of the veracity of their own opinion.

3. Follow fads or 'hot stocks'

In his highly recommended book Influence: The Psychology of Persuasion , Robert Cialdini talks about another human condition known as 'social proof'. The evolution of the human species, and sheep, was greatly assisted by a tendency to follow the crowd-safety in numbers and all that.

Anyone who thinks that social proof is solely the preserve of the historian should study the mania of the dot com boom. Millions, gulled with the fear of standing apart from the crowd, played a huge role in firing the mania. Conformity still dictates many areas of life but following the stockmarket crowd can be a costly mistake. As Buffett says, 'you pay a very high price in the stockmarket for a cheery consensus.'

That's why we are most often excited when others are depressed and fearful when others are optimistic (see our review of FKP on page 6). And it explains why we're worried about China, nickel stocks and other areas like the spate of listed investment company floats that are currently running hot.

If you're intent on seeing your net worth dwindle, follow hot stocks and sectors.

4. Beat yourself up over lost opportunities

'Right decision, wrong result'. In an imperfect activity like investing, mistakes are absolutely inevitable. But, odd as it may sound, sometimes even when you're right, you're wrong.

To call tech stocks overvalued in mid-1999 was undoubtedly correct. But for the next six months, as speculators pushed prices higher still, it sure didn't feel correct. It's a fact of life that someone will always be getting rich a little quicker than you are. But then again, they may become poor just as quickly by adopting the same approach.

If you take the conservative decision not to invest in a stock, and it goes up anyway, don't fret. Just be patient-other opportunities are often just around the corner. But if you are interested in blowing your capital, now's a good time to capitulate and buy at these higher prices.

5. Buy cyclical stocks at the top

There is the natural human tendency to extrapolate recent events. So when a cyclical stock like a steel company or property developer has a few tough years, investors tend to make the assumption that the bad times will last indefinitely. This can sometimes offer good opportunities for the canny investor.

In the same way, when these stocks show a few years of good results, thanks, for example, to strong Chinese metal demand, a booming property market or some other factor, the market tends to extrapolate the good times. It's the same mistake made at different ends of the cycle. Just at the peak of a cycle, investors can confuse a cyclical stock with a growth stock and bid the shares up, perhaps to a very high PER. But when earnings are at a peak, that's exactly when cyclical stocks should be selling on a low PER. When earnings fall, as they inevitably do with a cyclical downturn, the shares come crashing down. Farmers-who are used to the feast/famine cycle of a life on the land-seem less susceptible to this folly than most.

6. Follow overly acquisitive management

In his comprehensive book, Two Centuries of Panic , Trevor Sykes says that 'more companies are ruined by bad management than by bad economies'. We'd most definitely agree. Overly acquisitive managements-those hell-bent on growth, seemingly at any cost, are especially prone to getting into trouble. How so?

Acquisitions often involve large amounts of debt which thereby increase risk. As interest rates rise, for example, a growing portion of cashflow has to be diverted to service debt rather than deployed in the business or paid out as dividends. Secondly, acquisitive managements, often suffering from delusions of grandeur, can overstretch themselves. And, finally, acquisitions tend to cloud the company's financial accounts. This can fool bankers and shareholders for a while but by the time the gravity of a tough situation comes to light, it's too late. The collapse of speedily built empires like Austrim, Quintex and Adelaide Steamship are stark reminders of what can go wrong. Backing such management is almost bound to help lighten your wallet.

7. Invest in rapidly expanding financial institutions

Depending on the riskiness of the borrower, a financial institution might make a 'spread' or 'margin' on loans of anything from 1% to 5% per year. But when a loan goes bad, it can lose 100%. It's a risk that must be managed very, very carefully. Warren Buffett once remarked that a bad bank manager can flush all your equity down the toilet in your lunch hour.

And watching the accounting ratios like a hawk won't always save you either. In banking, growth can actually be used to hide bad loans temporarily (as, perhaps, we are about to see). A bank that is experiencing a high rate of loan delinquencies can easily halve that rate temporarily by writing new loans and doubling the size of its loan book-after all, a new loan takes time before it can go bad. But hastily made new loans are likely to be of poorer quality than existing ones.

This is why we get worried when financial institutions aim for rapid growth. Bank of Queensland, on which we have a negative recommendation, has targeted a 5% share of the national home loan market in 3-5 years, compared to its current 2.5% share. To achieve that, we suspect it will have to offer lower rates, or take on riskier business, to wrestle market share from the other banks-especially as it tackles markets outside its home state. If you want to improve your chances of ending up in the financial poorhouse, put your money into fast-growing financial institutions.

8. Work to the 'greater fool' theory

Some investors seem happy to buy expensive stocks, knowing full well they're overvalued, because they feel confident that someone else will come along and pay an even higher price. That's what happened in the dot com boom and it's what seems to be happening in the current nickel boom. Many investors buying nickel stocks now believe them to be overvalued, but assume they'll get even more overpriced-as in the Poseidon boom of the early 1970s. It's financial musical chairs for suckers and is likely to end up costing many investors a bundle.

9. Buy 'gunna' companies rather than 'doer' companies

'Gunna' companies are those that are 'gunna' do this and 'gunna' do that. Such unproven companies, and their attendant management teams, are a great way to lose capital. But even well-established companies can be 'gunna' companies. Management will explain away the poor performance of the last few years and concentrate on what it will do in the future. Chances are it will be putting on a similar show a few years down the track. While those sticking with proven companies and managements should do well, if you're aiming to lose money, buy 'gunna' companies.


http://shares.intelligentinvestor.com.au/articles/140/Golden-rules-for-losing-money.cfm#.UkN5yssayK1

Preservation of Capital is the first aim.

Since preservation of capital is Warren Buffett's first aim, his primary focus is, in fact, on avoiding mistakes and correcting any he makes and only secondarily on seeking profits.  

This doesn't mean he spends most of his day focusing on what mistakes to avoid.  By having carefully defined his circle of competence, he has already taken most possible mistakes out of the equation.  As Buffett says:

"Charlie and I have not learned how to solve difficult business problems.  What we have learned is to avoid them ....  Overall, we've done better by avoiding dragons than by slaying them."

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Avoiding loss should be the primary goal of every investor

Warren Buffett likes to say that the first rule of investing is "Don't lose money," and the second rule is, "Never forget the first rule." I too believe that avoiding loss should be the primary goal of every investor. This does not mean that investors should never incur the risk of any loss at all. Rather "don't lose money" means that over several years an investment portfolio should not be exposed to appreciable loss of principal.

While no one wishes to incur losses, you couldn't prove it from an examination of the behavior of most investors and speculators. The speculative urge that lies within most of us is strong; the prospect of a free lunch can be compelling, especially when others have already seemingly partaken. It can be hard to concentrate on potential losses while others are greedily reaching for gains and your broker is on the phone offering shares in the latest "hot" initial public offering. Yet the avoidance of loss is the surest way to ensure a profitable outcome.

A loss-avoidance strategy is at odds with recent conventional market wisdom. Today many people believe that risk comes, not from owning stocks, but from not owning them. Stocks as a group, this line of thinking goes, will outperform bonds or cash equivalents over time, just as they have in the past. Indexing is one manifestation of this view. The tendency of most institutional investors to be fully invested at all times is another.

There is an element of truth to this notion; stocks do figure to outperform bonds and cash over the years. Being junior in a company's capital structure and lacking contractual cash flows and maturity dates, equities are inherently riskier than debt instruments. In a corporate liquidation, for example, the equity only receives the residual after all liabilities are satisfied.  To persuade investors to venture into equities rather than safer debt instruments, they must be enticed by the prospect of higher returns. However, the actual risk of a particular investment cannot be determined from historical data. It depends on the price paid. If enough investors believe the argument that equities will offer the best long-term returns, they may pour money into stocks, bidding prices up to levels at which they no longer offer the superior returns. The risk of loss stemming from equity's place in the capital structure is exacerbated by paying a higher price.

Don’t Lose Money: The Most Important Law of Lasting Wealth

By Dr. Steve Sjuggerud 

Friday, December 29, 2006 

Steve Sjuggerud’s note: Today’s DailyWealth is the fourth in our holiday series of issues written to help make you a better investor. For the most important law of lasting wealth, read on...

Let’s face it – most people don’t know when to sell a falling stock. So they’re frozen into inactivity, saying, “Should I just keep holding and hoping, or should I cut my losses now?”

This state of indecision is usually permanent, and often continues until you hear the all too familiar phrase, “well, it’s too late to sell now.”

One of my good friends lost it all following the “it’s too late to sell now” principle. He bought a ton of shares in a cable company based on his friend’s recommendation that it was supposed to take over the world. The shares soon tumbled in half, and his friend, who knows about the cable business, told him to buy more, so he did. The shares tumbled in half again, and he bought even more. He finally stopped buying when the shares hit a dollar a share. The shares eventually traded for pennies.

After you’ve read today’s essay, if you follow the advice in here, your constant state of indecision will be gone. You’ll never lose another night’s sleep worrying about which way your investments will go tomorrow. Because, unlike most investors, you’ll have a plan – knowing when to get out, and when to stay in for the biggest possible profits.

Buying stocks is easy. There are thousands of theories out there for why and when to buy. But buying is only the first half of the equation when it comes to making money.

Nobody ever talks about the hard part – knowing when to sell.

In order to invest successfully, you need to put as much thought into planning your exit strategy as you put into the research that motivates you to buy the investment in the first place. So please read closely here, and think about each point...

How Do You Evaluate Businesses?

In business and in stocks, you’ve got to have a plan and an exit strategy. When you have one, you know in advance exactly when you’re going to buy and sell. The strategy I’m going to show you will allow you to ride your winners all the way up, while minimizing the damage your losers can do. But before I get into the specific strategy, consider this business example...

Let’s say you’re in the tee-shirt business. You’ve made a ton of money on a tee-shirt business in the States, and you’re now in the Bahamas looking for new opportunities. You size up the market, and you figure you can make money in two markets: in golf shirts, geared at the businessman, and in muscle-tees, geared toward the vacationing beach-goers. These are two products clearly aimed at two different markets.

You invest $100,000 in each of these businesses. At the end of the first year, your golf shirts are already showing a profit of $20,000. But the muscle-tees haven’t caught on yet, and you’ve got a loss of $20,000. There are numerous reasons why this is possible, so you make some changes in your designs and marketing and continue for another year.

In the second year the same thing happens – you make another $20,000 on your golf shirts, and you lose another $20,000 on your muscle-tees. After two years, the golf shirt business is clearly succeeding, and the muscle shirt business is clearly failing.

Now let’s say you’re ready to invest another $100,000 in one of these businesses. Which one business do you put your money into? The answer should be obvious. You, as a business owner, put more money toward your successful businesses. But as you’ll see, this is the opposite of what 99% of individual investors in America do...

How Do You Evaluate Stocks?

Let me start by asking you a question – what does “owning shares of stock” actually mean? This isn’t a trick question – as you know, it means you’re a partial owner of the company, just like you’re the owner of the tee-shirt company in this example.

Owning your own business isn’t fundamentally any different than owning a share of a business through stock. However, most people treat them exactly the opposite...

Let’s say the shares of your two tee-shirt companies trade on the stock exchange.

They both start trading at $10 a share. At the end of the first year, the profitable golf-shirt company is trading for $12 a share, and the unprofitable muscle-shirt company is trading for $8 a share. At the end of the second year, the golf shirt company is trading at $14, while the muscle shirt company is trading at $6 a share.

Which shares would you rather own?

Even though you know you should buy the winning concept based on the business example, most investors don’t do so in their stock investments. They keep throwing good money after bad hoping for a turnaround. They buy the loser.

The Trailing Stop Strategy

In stocks (and in business, I believe), you must have and use an exit strategy – one that makes you methodically cut your losses and let your winners ride. If you follow this rule, you have the best chance of outperforming the markets. If you don’t, your retirement is in trouble.

The exit strategy I advocate is simple. I ride my stocks as high as I can, but if they head for a crash, I have my exit strategy in place to protect me from damage. Though I have many reasons I could sell a stock, if my reasons don’t appear before the crash, the Trailing Stop Strategy is my last ditch measure to save my hard-earned dollars. And it works.

The main element to the Trailing Stop Strategy is the 25% rule. This is where I will sell any and all positions at 25% off their highs. For example, if I buy a stock at $50, and it rises to $100, when do I sell it? If it closes below $75 – no matter what.

Don’t Let Your Losers Become Big Losers

So with my Trailing Stop Strategy, when would I have gotten out of the failing muscle-shirt business? You already know the answer.

Remember, the shares started at $10 and fell immediately. Instead of waiting around until they fell to $6 as the business faltered, using my 25% Trailing Stop, I would have sold out at $7.50. And think of it this way – if the shares fall to $8, you’re only asking for a 25% gain to get back to where they started. But if the shares fell to $5, you’re asking for a dog of a stock to rise 100%. This only happens once in a blue moon – not good odds!

Take a look at how hard it is to get back to break even after a big loss...

You’ll Never Recover
Percent fall in share price	Percent gain required to get you back to even
10%	11%
20%	25%
25%	33%
50%	100%
75%	300%
90%	900%

So what’s so magical about the 25% number? Nothing in particular – it’s the discipline that matters. Many professional traders actually use much tighter stops.

Ultimately, the point is that you never want to be in the position where a stock has fallen by 50% or more. This means that stock has to rise by 100% or more just to get you back to where it was when you bought it. By using this Trailing Stop Strategy, chances are you’ll never be in this position again.

Good investing, Steve

http://www.dailywealth.com/1041/Don-t-Lose-Money-The-Most-Important-Law-of-Lasting-Wealth

Don’t Lose Money!

W. Clement Stone once said, “If you cannot save money, then the seeds of greatness are not in you.”

Throughout the history of American enterprise, you’ve heard the words, "work hard and save your money." Work hard and save your money. It is the oldest rule for success in America. It’s so important, as a matter of fact, that W. Clement Stone once said, "If you cannot save money, then the seeds of greatness are not in you."

Saving is a Discipline
Why is it that saving money is so important? Because saving money is a discipline and any discipline affects all other disciplines in your life. If you do not have the discipline to refrain from spending all the money that you earn, then you are not qualified to become wealthy and if you do become wealthy, you’ll not be capable of holding on to it.

The Law of Attraction
A principle with regard to saving your money is the law of attraction. The law of attraction is activated by saved money. Even one dollar saved will start to attract more money. Here’s what I suggest that you do. If you’re really serious about your future, go down and open a savings account. Put as much money as you can into it, even if it’s only ten dollars. And then begin to collect little bits of money, and every week go down and put something into that account.

Attract More Money Into Your Life

You will find that the more you put in that account, the more you will attract from sources that you cannot now predict. But if you do not begin the savings process, if you don’t begin putting something away towards your financial independence, then nothing will happen to you. The law of attraction just simply won’t work.

Invest Your Money Conservatively
Once you begin to accumulate money, here’s another rule. Invest the money conservatively. Marvin Davis, self-made billionaire, was asked by Forbes Magazine, "How do you account for your financial success?" And he said, "Well, I have two rules for financial investing." He said, "Rule number one is, don’t lose money." He said, whenever I’m tempted, whenever I see an opportunity to invest where there’s a possibility I could lose it all, I just simply refrain from putting the money in. Rule number two is, whenever I get tempted, I refer back to rule number one. Don’t lose money.

Get Rich Slowly
George Classon says, in The Richest Man In Babylon, that the key is to accumulate your funds and then invest them very conservatively. One of the characteristics of self-made millionaires, one of the characteristics of old money in America is that it’s very cautiously, conservatively and prudently invested.

Don’t try to get rich quickly. Concentrate rather on getting rich slowly. If all you do is save ten percent of your earnings, put it away, and let it accumulate at compound interest, that alone will make you wealthy.

Action Exercises
Here are two things you can do to apply these lessons to your financial life:

First, open a separate savings and investing account today. From this day forward, put every single dollar you can spare into this account and resolve to never touch it or spend it for any reason.

Second, whenever you consider any investment of your savings, remember the rule, "Don’t lose money!" It is better to keep the money working at a low rate of interest than to take the chance of losing it. Be careful. A fool and his money are soon parted.

Posted by Brian Tracy on Jul 25, 2008

http://www.briantracy.com/blog/financial-success/dont-lose-money/