For those that like to dabble in investing as a hobby, you know the feeling when something is too good to be true. You’ve probably lost money at some point in your life on a speculative investment – the “hot stock” of the day or the latest Tech IPO that’s supposed to revolutionize the world. As professionals at Cox Capital who deal with investments everyday, we’ve seen it all and can offer this simple piece of advice to ensure long-term success – DON’T LOSE MONEY! It sounds simple, but believe us when we say that this is absolutely the holy grail of investment principles! Avoiding losses is the polar opposite of what you see advertised by brokers and the mutual fund firms these days (especially in the midst of major bull markets).
Today we want to mathematically prove what being conservative can do for you. Uninformed investors believe that you need to take excessive risks to capture above-average returns. This is not true. The reality is that conservatism and consistency of returns is a far better strategy. Consider two portfolios: the ‘Consistent and Steady’ portfolio and the ‘Gee-Whiz’ portfolio. Our Steady portfolio produces annual returns of 7% per year while the Gee Wiz produces choppy returns in a pattern of +20%, +20%, and then -20%. Observe the growth below of $100,000 invested in each of these strategies:
The results speak for themselves – after 20 years of compounding at these two different patterns, the Steady portfolio grows to be about $80,000 more than the speculative portfolio. Even though both portfolios have 3-year averages of around 20% (7×3 = 21 vs. 20+20-20 = 20), the long-term results are drastically different. Why? Because of what we like to call “stock market math.” In the world of investing, a large loss requires a disproportionate gain just to break even. Consider this example. You buy a stock at $10 and it subsequently drops to $5 – you’re down 50%. But for the stock to go from $5 back to $10, it now requires a 100% return – how often does that happen? Look at General Electric (GE), at one point one of the most widely owned stocks in the world. It is down 80% from its peak in the early 2000s – this will require a 400% gain just to get your money back! By avoiding these types of situations, it can do wonders for your portfolio in the long run. Check out the chart below illustrating this gain/loss-break-even concept:
Successful Investors understand that “stock market math” is the most important thing to know about investing. When considering an investment, think “How much can I lose?” as opposed to “How much can I make?” How many people look at investing this way? Not many, but it is extremely effective. You will beat your gambling neighbor every time – and with a lot less stress along the way just by being conservative and avoiding losses. This is a huge part of our investment philosophy and one of the key drivers of our strong long-term results. If we can leave you with any piece of wisdom, it is to think twice about that speculative investment. Instead, aim for consistency and safety – it will yield much better results in the long run!
Thanks for reading our blog! Check back often to see what we’re up to. You can easily subscribe by typing your e-mail in the box on the right sidebar.
This is not an offer or recommendation to buy or sell any security and does not constitute investment advice.