A Key Secret To Winning As An Investor


What Are The Odds


When it comes to investing, does it ever seem to you that losing is much easier than winning? It turns out the universe stacks the odds against us. For this reason, the single most important key to successful investing is loss control.


The Built-In Mathematical Flaw In Investing


Suppose you buy a stock for $100, then a week later it falls in price by 50%, to $50. If you sell at that point, you experience a 50% loss.


If you’re convinced the price will recover, you may decide to hold onto your stock. Let’s suppose you’re right and the next day the price rises by 50%. You’re back to even again, right? Sorry. Your stock is now worth only $75, not $100. Here is the math to prove it:


Starting Price: $100

Lose 50%: $100 – (50% of $100) = $100 – $50 = $50

Gain 50%: $50 + (50% of $50) = $50 + $25 = $75


The math doesn’t lie: You can’t recover from a 50% loss by having a 50% gain. To recover from a 50% loss, you need a 100% gain. In fact, the bigger your loss, the worse this problem gets.


Protect Yourself From Losses


Many random, unpredictable things cause stocks or other investment prices to fall. Often it has nothing to do with the quality of the investment. There can be a terror attack in the news or a financial panic, and it can lead to a big plunge in price. As we’ve seen, any big decline in price is deadly to your investment, because it takes an even larger percentage rise to recover from the decline. This is why avoiding large losses at all costs is crucial to protecting wealth. Making a concerted effort to control potential losses in your investments is known as “loss control”.


4 Proven Loss Control Methods


Average Cost Investing: Since no one can predict which way the market is headed in a given moment, investors have discovered it pays to split a potential investment into equal parts and invest them at regular intervals, instead of making a single larger investment all at once. Since a stock can be up one day and down the next, this method averages the risk of buying too high with the potential gains of buying low.


Diversification: By holding many different types of investments at the same time, such as stocks, bonds, cash accounts, gold, real estate, and even collectibles, you can mitigate losses. It’s rare when all investments rise or fall in unison. This means your whole portfolio won’t be devastated if one of you investments suffers a significant loss. In fact, some types of investments tend to rise whenever others fall. Plus, you’re less likely to miss out on an unexpected price surge when one investment type gains more than others. Another tip is to diversify within each investment type. For example, hold no more than 5% of your stock portfolio in any one particular stock. Or buy a “market index fund” that invests in most or all stocks at once. Over time, these funds outperform most stock market advisory services.


Investment Insurance: There are various ways to insure investments, although insuring riskier investments like stocks can carry high costs and fees. Some prefer to avoid buying riskier investments like stocks in the first place, and buy safer ones, such as a CD at a bank or an “annuity” from an insurance company. CD’s are insured by the Federal Deposit Insurance Corporation (FDIC) up to a specific preset limit. It’s hard to get a more iron-clad guarantee, though current interest rates place severe limits on potential earnings. An annuity guarantees a positive return, and the insurance company covers all risk. To insure a stock, you can buy a “put option”. If the stock falls, the option will rise to compensate. Remember, to demand full disclosure of hidden risks, costs and fees before buying into an investment.


Stop Loss Orders: Another way to control losses is to use stop loss orders. For example, if you buy into a stock at $100 and want to limit a potential loss to no more that 20% of your original investment, you can set a stop loss to automatically sell it if its price falls below $80. It may be worth noting the point of a stop loss is to limit the risk of loss, not to eliminate it. Many financial advisors believe you should never invest in any security without first setting the conditions for getting out of it. This means knowing when to cut your losses and when to take gains. Because some market segments are more volatile than others it pays get a clear understanding of potential price fluctuations within the segment before setting a stop loss.


Smoothing The Road To Success


Smart investors know the key to accumulating wealth is keep a tight reign over their losses. This avoids the necessity to cover the same ground as they advance toward their goals. Understanding the risks involved in any strategy or investment is essential. If you are unsure of the risks, seek professional advice.



Comments are closed.


Favorite Pages