Sunday, September 01, 2019

The moral is - the more you lose the tougher it gets to get back to your original price

Rule No 1: Never lose money 

Rule No 2: Don’t forget Rule No 1 

-Warren Buffett

Can most investors follow the two rules? Not really. Simple behavioral changes can help investors to implement these two rules in their portfolios. 

Consider two investment options, which one will you choose?

The first option offers very large double-digit returns in three years and one large negative return in one year.
The second is a “little boring” option. It offers modest double-digit returns, all positive, in all the four years.

When asked to Choose an option, most investors chose Option A because it shows a higher average return on investments than Option B. 

Take a look at the results which will surprise most investors 

Rs 100 invested in option A became Rs 139 at the end of four years, much lower than Rs 194 accumulated in option B. Option B might look boring, but it is giving very decent stable returns compared to Option A by not losing money.
The point here is to make sure there is no big negative in your portfolio. The idea is to expect and go for reasonable average returns and let it compound over a long term if you wish to make money.

How badly can a single big negative return hit your portfolio?
Suppose if a stock worth Rs 100 falls by 25 per cent to Rs 75. Your stock has to jump by 33 per cent to recover to its original price. Similarly, if Rs 100 stock falls by 50 per cent, it has to go up by 100 per cent to reach its original value. Likewise, if it falls by 75 per cent, the stock needs to gain 300 per cent to recover and if it falls by 90 per cent, it needs to jump 900 per cent to recover
The moral is - the more you lose the tougher it gets to get back to your original price. Little five, 10 or 15 per cent is normal in the market to go down but if you go down around 30-40 per cent it is really hard to recover to your principal.

Preservation of capital, earning a reasonable rate of return and investing in a disciplined manner can help you to avoid big negative returns in your portfolio.