It's not just what you make that counts, but what you don't lose

This past week was a vivid reminder of something I learned early about investing: not losing money is more important over time than getting great returns over the short term.

Let me give an example to illustrate. Suppose you receive a 10% return each year for 4 years, and then suffer a 30% loss in year 5 as the market tanks. What would your returns be? 2.5% cumulatively or 0.5% annualized. If you started with $100,000 you would end up with $102,500.

Suppose, instead, that you receive 8% returns each year for 4 years (under-performing the investor above 4 years in a row), and then went through the same market downdraft but managed to lose only 15%, or half the market drop. What would your returns be then? 15.6% cumulatively or 3% annually. If you started with $100,000, you would end up with $115,600.

Getting great returns for several years in a row isn't enough, you must also manage to keep those returns when an inevitable market downdraft occurs. How can that be done?

In the example above, the 8% returns may have been earned on less risky, higher quality companies purchased at prices below assessable value. The 10% returns, in contrast, may have been earned on more risky, lower quality companies purchased at whatever price the market offered. Not surprisingly, when the market tanked, the higher quality companies purchased at cheap prices didn't go down as far as the lower quality companies purchased without regard to price.

Why doesn't everyone invest this way? Because most people can't stand to under-perform in the short run even though they know that taking too much risk will hurt them in the long run. It takes a lot of fortitude to hold on to quality companies when everyone else seems to be getting rich buying junk. But, in the long run, the race seems to go to the turtle instead of the hare.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.