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The Single Indispensable Habit of Great Investors?

Posted by: Brian Dennehy
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What do great investors do? How does it differ from what most other investors do? Right now, this is more important than ever, with these thoughts in mind:
 
·         Stock market falls of 50%+, led from the US, are a certainty if history is any guide
·         But timing is unknown
·         You have only made profits once they are in the bank
·         If your investments fall by 25%, you need 50% gains just to make up the lost ground
·         Many investors still don’t understand the latter, and the power of compounding gains year on year
 
[Thank you to Preserve Capital by Investment Master Class onValuewalk.com for sourcing nearly all of these quotations from some of the world’s most successful investors]
 
 
“The first rule of investment is don’t lose money. And the second rule of investment is don’t forget the first rule. And that’s all the rules there are”
(Warren Buffett)
 
Avoiding loss is the most important prerequisite to investment success”
(Seth Klarman)
 
This means it is important to understand the possible scale of your losses…
 
“The definition of a great investor is someone who starts by understanding the downside. You must make the judgement in advance as to how much downside risk you are willing to take”
(Sam Zell)
 
If the downside is 50%+ you must be realistic about your ability to avoid this on the hoof – you must plan for stuff going wrong from the outset…
 
“People insure their house a necessity, but when it comes to their portfolios, because of the ways things are framed in the press, they don’t look at them in the same way”
(Nassim Taleb)
 
You protect your house but not your life savings? Madness. You must decide the size of the loss you are prepared to tolerate.
 
“Avoid big losses. That’s the way to really make money over the years”
(Julian Robertson)
 
“It’s our clear belief that one of the most effective ways to compound wealth is to minimize drawdowns
(Charles de Vaulx)
 
“Trying to avoid losses is more important than striving for great investment success”
(Howard Marks)
 
Minimising drawdowns? A 10% loss? More? Just make sure you have made that decision before you invest. Write it down! This is your stop-loss – literally stopping the loss getting intolerably larger.
 
“When it comes to compounding, I’m not sure everyone understands that percentage losses and gains are not equal. I’ve always managed to avoid the large losses. Imagine something as simple as that being one of your secret sauces” (Frank Martin)
 
It’s basic maths. If your investments fall 50%, you have to make gains of 100% just to make up that lost ground. That is equivalent to 10 years of the average stock market gains, more or less. 10 years!
 
“The trick is to avoid losers. Losers are terrible because it takes a success to offset them just to get back to break-even. We strive to preserve capital on each investment. It does not always work out that way, but that is the goal” (David Einhorn)
 
“An investor is more likely to do well by achieving consistently good returns with limited downside. An investor who earns 16% annual returns over a decade, will perhaps surprisingly, end up with more money than an investor who earns 20% a year for nine years and then loses 15% the tenth year”
(Seth Klarman)
 
“The trick in investing is not to lose money. That’s the most important thing. The losses will kill you. They ruin the compounding rate and compounding is the magic of investing” (Jim Rogers)
 
"Safety. Considering the downside is the single most important thing an investor must do.  This task must be dealt with before any consideration can be made for gains"  
(Irving Kahn)
 
Dynamic Fund Ratings are a very powerful tool at rescuing you – you can expect returns somewhat higher than those achieved on average by the stock market from year to year. But you limit the compounding power of that great tool for fund selection if you allow yourself to suffer unnecessary falls.
 
"We believe in the power of compounding and the simple math is that you can't compound very well if you suffer too much on the downside”
(Tom Perkins)
 
“The power of compounding is so great that our first job as investors is to avoid anything that might short circuit this”
(Ira Rothberg)
 
"Capital preservation is the best way to grow capital over time.  To most effectively compound returns you have to mitigate your downside - that's just basic math."
(Mark Thompson)
 
“I spend most the day watching my losers because if those are being managed correctly the winners take care of themselves”  
(Steve Cohen)
 
But you can’t have a strategy to avoid losses just at times when YOU think there are risks of sharp falls. The biggest storms come out of blue skies.
 
Risk control is invisible in good times but still essential, since good times can so easily turn onto bad times” (Howard Marks)
 
"Since you don't get advance warning about what kind of environment is coming next, you should always be concerned about preserving your money
(Seth Klarman)
 
You have to keep your emotions and ego under control.
 
“Thoughtful investors can toil in obscurity, achieving sold gains in good years and losing less than others in the bad. This, in my opinion, is the greatest formula for long term wealth creation – but it doesn’t provide much ego gratification in the short run”
(Howard Marks)
 
Talking of ego, you must be prepared to learn this stuff. But it isn’t so easy when you are young – we all were once, we get this!
 
"When you’re young, oftentimes you don’t worry about something going wrong. I guess as you get older you worry about that, because you’ve had a lot of things go wrong." 
(Henry Kravis)
 
If you are prepared to learn, it can certainly help you avoid some very big and painful holes. There is much to learn…
 
“Few gain sufficient experience until they reach that period of life in which they have one foot in the grave”
(Henry Clews)
 
As you are here today, you have decided you don’t need to wait that long.
 
Stop-losses are a vital part of your investing plan. Write down the level of your stop-loss before you invest. There are links to more on how to apply a stop-loss below, under Further Reading.
 
If you decide not to have a stop-loss, that’s fine. But write that down too, and why you have made that decision. 
 
Accepting small losses with a stop-loss is irritating. But enduring big losses is devastating. 
 
Thank you for reading. Last word goes to the man who opened today:
 
“An investor needs to do very few things right as long as he avoids big mistakes
(Warren Buffett)
 
 
FURTHER READING
 
 
Topic: Fund analysis


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