What is Capital Preservation? and Why It is So Important For Investors!

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The Principles of Wealth Preservation

Why Avoiding Permanent Capital Loss is the Most Important Rule Of Successful Investors?

"Preservation of capital is key to survival in this business"
Christopher Parvese

Intro

Have you ever Wondered how the most successful investors are able to generate consistent returns without getting completely destroyed by unexpected events or stock market movements?

There are many reason for their success.

Reasons vary according to investor's personality, methodology and philosophy as well as capitalization.  So, all in all, It can't be explained in single words. But...

There are very common behaviors among successful investor.

And their success is not purely based on luck, access to privilege information a.k.a Insider trading or the extensive conspiracy theories floating around.

Is it possible that they have such privileges? Do they know what is going to happen before you?

Sure, it is. They Might and there is nothing we can do about it!

The fact that they have access to information first hand is not a crime; it is part of being players in their field.

As any other entrepreneur in the globe, they try to be ahead of the curve and in their particular case they have power ( Money = Power)

But with so many people fighting for good opportunities, even that may fail.  So it leads us to the question?

What Sets Successful Investors Apart?

Well, There are some common principles and behaviors that lead them not only to make money on the long run but also allow them to sleep well when things go wrong.

And one of them is CAPITAL PRESERVATION.

Table Of Contents

The Goose Of The Golden Eggs

Taking Care of The Goose!

Have you ever heard Aesop's fable The Goose of Golden Eggs?

Most likely you did, but in case you wondering why I am presenting this fable here, the next paragraph will help clear any doubts.

Once upon a time there was a farmer who owned a Goose. One morning, going to check the nest as he usually did, he found a heavy yellow Egg.

Initially he found that someone had played a trick on him.

The egg was heavy as lead and he was ready to throw it away but decided to take it home.

After careful evaluation, he discovered that the egg was made of pure gold.

From there on, the goose laid a golden egg every day.

Soon after, the farmer took the egg to the market and sold it.

He became rich, very rich and life was very good.

But, as it happens in life, the farmer became very impatient. The goose was laying just one golden egg a day.

He wanted more.

He was hungry for more and had a brilliant idea:

Kill the Goose, cut it open and get all the golden eggs inside her at once!

Well, unfortunately for the Countryman, upon cutting the goose open, he found no golden eggs.

Now, his once very precious goose is dead.

There won't be more golden eggs.

Now, you ask yourself,  why did you waste our time with this old fable?

Because Aesop's story fits picture perfect the mentality of most non-professional/retail investors (traders) active in financial markets.

Your initial capital, your principle,  is your Goose of Golden Eggs!

You should treat your capital with patient and care. Your main goal should be to keep your goose healthy and safe for many years to come.

Short term performance, a quick Vanity Gain shouldn't be your main priority.

With that out of the way, we can now deal with the fun part of the story!

Which is....

How professionals make their Goose lay Eggs for them on the long run.

What is Capital Preservation?

Capital Preservation is the term used by investment industry professions to define an unique and important investment principle: Protect the Absolute Value of an asset or in layman terms, to preserve and protect the value of capital available to invest.

Theoretically, the principle started with economists exploring the principles to protect assets from Inflation erosion and the loss of purchase power so that individuals could buy the same amount of goods and services in the future.

Historically, it was a way to recognize that money set aside to be available when clients would need them in later stages of their lives.

Within investment industry circles, capital preservation is a mantra that resonates strongly with all responsible and successful investors.

In plain English it means AVOID LOSSES AT ALL COSTS! To win you must first NOT LOSE. Because losses destroy saving and portfolios.

Preserving assets comes before everything else. It is often the first aspiration of most successful investors.

Avoiding severe losses allows professionals to find the road to success and consistent growth.

Retail or private investors are impressed by performances and high returns; Professionals are far more impressed by the ability to avoid losses.

Look, We could discuss  for hours the Here is the real deal:

Professionals focus on protecting the downside first.  There are two compelling reasons for this behavior:

Minimizing losses allow them to reinvest and explore the compound interest principles

Second,  they limit their exposure to the uneven (asymmetrical) relation between losses and profits.

Protect Your Capital ( Your Hard Earned Money!)

Why Avoiding Permanent Capital Loss is the Most Important Rule Of Successful Investors?

Capital Preservation = Beat Inflation, Achieve Prudent Growth, Avoid Large Losses on The Long Run!

The Most Important Important Rule is Don't Lose Money!

REALLY?

Tell Me Something New!

Listen, I know that most of you have heard that a thousand ( maybe Million) times.

But, it is an important principle.

Well, this particular Warren Buffet quote has been published, printed and shared inside and outside investment circles for decades.

Sure, it makes sense but it is far more difficult to implement than otherwise advertised.

Investors, principally younger or less informed ones, start investing with the objective to make money.

Younger investors are far more interested on huge returns than they are concerned about preserving capital.

Retail investors focus on the Upside possibilities while professionals are worrying about the downside protection.

They live and think in the opposite sides of the investment spectrum.

Most Private or retail investors trying to select stocks (Pick Stocks) have are hoping to find the new Apple or Microsoft to make some serious money and forget about the rest.

Selecting stocks isn't easy.

There isn't a perfect method out there able to provide us guarantees.

We can sure find the die hard Value Investors, Growth Investors (Bill O'nneil IBD Followers) and trend followers.

They all present arguments proving the superiority of their preferred methods.

These methods all have positive and negative factors.

None of the above guarantees gains. And they all have inherent risks.

But they do have one factor in common:  They all preach Downside Protection!

Why Successful Investors Avoid Losses At all Costs?

Losses hurt far more than profits provides value.

As mentioned in a previous article covering the topic in details, the asymmetric nature of losses and profits is very unforgiving.

The first reputable investor I heard speaking in depth about and really open about this concept was Ken Fisher back in 1997.  He has repeated this mantra is several occasions.  Here are his words in a nutshell:

“Consistency is the key. It is close to impossible to get a good, long-term, rate of return if you suffer serious negative numbers en route.  It’s the math.  A single year that is down 30% means you have to get 30% per year positive returns for the next four years to get back on track for 15% annual average.  Or, if you score 20% annually for four years, and then suffer a 30% decline, your five year average return is only 7%”

As many other investors, he was stressing the impact that losses have on investors bottom line.

Now, what he said is common knowledge in the industry.

Sure, Warren Buffet - due to his Age and Longevity - has been one of the so called pioneers.

Even before Buffet, there were investors who understood these principles.

Others have shared their wisdom in their own style and particular way.

Here is what some very accomplished professionals have said about Capital Preservation and Avoiding Losses:

Jim Rogers, George Soros Partner at the Famous Quantum Fund,  Today based in Asia and without any doubt e legendary investor:

“When I buy or sell something, I always try to make sure I’m not going to lose any money first. If there is good value, then I’m probably not going to lose much money even if I am wrong.The trick in investing is not to lose money. That’s the most important thing. If you compound your money at 9% a year, you’re better off than investors whose results jump up and down, who have some great years and horrible losses in others. The losses will kill you. They ruin the compounding rate and compounding is the magic of investing ”

Baupost's Seth Karman, The Margin of Safety man says"

Avoiding loss is the most important prerequisite to investment success”

Paul Tudor Jones, Hedge Fund Manager/Legend and philanthropist

“Don’t focus on making money, focus on protecting what you have. The most important thing for me is that defense is ten times more important than offence. The wealth you have can be so ephemeral; you have to be very focused on the downside at all times."

George Soros, I don't think Soros needs an introduction does he? The famous Billion Dollar Pound Trade and His Forays into the Thai Crisis should ring a bell...

Well, just in case, here it is a brief synopsis: Soros is a Hungarian-American investor, business magnate, philanthropist, and author. He is considered by some to be one of the most successful investors in the world.

"Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected. I am more concerned with preserving the Fund's capital than its recent profits, so that I tend to become more liberal with self-imposed limits when my investment concepts seem to be working"

Ed Wachenheim, Hedge fund Legend:

"I emphasize that our first goal is to control the risks of permanent loss.  When we analyse a security, we first look for the attributes that will protect us against incurring a loss that cannot be recovered within a reasonable period of time.  We will not commence analysing the positive attributes of a security until we are convinced that the risks of permanent loss in the security are relatively low" 

And the list goes on....

We could spend days, if not weeks, quoting them.

However, that is not the objective in this post.

I am just emphasizing the importance of this principle and providing you solid arguments to support it, so you can start your investment efforts with the correct mindset.

There is an article  in the archives that deals with the asymmetric nature of losses and gains.

The article explains in detail how the impact of high percentage losses have on capital appreciation and long term growth.

How To Increase Your Probabilities of Success Managing Your Own Money?

To Increase Your Probability of Success and Achieve Your Investment Goals, you should assess in what type of investment category you fit best.

Are you someone that has already made enough money and wishes to perpetuate and protect your wealth?

Or, Are you a business owner or active employee with some capital set aside to build a safety net for uncertainties in the future?

These two types of investors fit very different profiles and have different risk appetites.

Regardless what type of investor you are, there is a common thread to help increase your chances of becoming a successful investors: Focus on a single style and be prudent!

By following sound practices and being consistent in whatever path your decide to follow, you will most likely have positive results.

If you believe that Value Investing is the way to go, focus solely on following these principles without second guessing what you are doing.

Guarantees? No, none or whatsoever!

We wish there were, but unfortunately they only exist on fantasy and wishful thinking!

Only time will tell if your decision is correct. Results will speak for themselves. And I will stress here once and for all:

Value investing, for example, requires time... Years not Months!

If you start to measure results in months you are simply fooling yourself.

It is all about patience and being able to withstand some very wild swings on equity that may occur along the path.

And, make sure you set goals.

As much as I am using and quoting successful investors here, their objectives, availability of capital and horizons are often very different from yours.

So please, don't try to buy and hold stocks forever, just because Warren Buffet said you should do so.

He use stocks to acquire businesses. He buys them and become an active member within that organization.

Therefore his views are quite unique.

You and all other investors with much less financial power and influence, should look at things a bit differently.

We should focus on different types of firms and extract profits to give us the rewards we are looking for and accept that more often than not you will sell to early and other times you will exceed you stay.

Accept it and move on!

Last Words

Whatever Happens, PROTECT YOUR CAPITAL!

You noticed that all of the Investment Masters we mentioned in this article focus on the downside first.  

The reasons are two fold.  

Firstly losses impede the function of compounding which is the key to investment success.  

Secondly, profits and losses are not symmetrical.  If you lose 50% it takes a gain of 100% to get you back to square.  

Please try to follow their advise to avoid disasters that may cost you more than you could possible afford.

Before making harsh and emotional decisions, Looking ahead to the next twenty years!

Please remember that there is no guarantee that investing solely in one asset class or firm, maybe only equities, will deliver the best results.

Just stop before acting and reflect upon the next sentence:

if your capital is precious and irreplaceable, do you really need to take on such a high level of risk? 

But Warren Buffet does it, right?

And...

He said, we all can!

Well, he does because he has the means to do so and he is not the average guy just trying to pick stocks on weekends! 

Yes we can... Try!

Focus on preserving your capital and avoid getting caught on useless pursuits.

The majority of investment funds available today are attempting to beat an index and do not contain an objective to preserve capital.

And more often than not they pay the price.

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