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How the Market Works

The Secret to Successful Investing – How the Market Works

Posted by kdadmin on September 17th, 2016.

The Secret to Successful Investing – How the Market Works

Huh. Look at that. Now, who told you, on September 2nd, that blithely staying invested in the stock market (SPY) was as brainless as staying in the path of Hurricane Hermine?

I’ll give you a hint. THIS GUY!

Now, let’s talk about the Secret to Successful Investing and How the Market Works …

The Secret to Successful Investing

The secret to successful investing is to limit losses. For every dollar you lose, you have to make up an exponentially higher return to both get it back, and still show a profit. In other words, it’s extremely important to be prudent, even cautious, when making investment decisions. Sure, there is the fear of missing out on gains. But a FAR more dangerous issue is the potential to lose your money.

Amateur investors often feel powerless to defend themselves against losses so they take a macho, brazen, stubborn attitude toward risk. This is incredibly stupid.

Remember the last major market crash, in 2008? How many people have you heard say, “Well we lost a lot, but we’ve made it all back.” This is NOT a rational argument. Successful professional investors didn’t lose a lot in the first place. Consider some math. Imagine you had an investment portfolio worth$500,000, and lost the low average of 40%, you’d be down to $300,000. If you “made it all back,” that means you made an average of 6.4% over the last 8 years. But, what if you had only lost an average of 15% (like some successful professional investors did), and then made the same 6.4% over the last 8 years? You’d have $708,000 now instead of $500,000. That’s an additional $208,000 for simply avoiding the brunt of the storm.

If you lost a lot in 2008, consider what you could have now if you had limited your losses instead. Now how much is successful professional advice worth?

What Does 2.1% in a Day Mean?

Imagine you had this same investment portfolio, but that it contained your life savings. Let’s say you were planning to use this money to do something fun. Like travel, retire, buy a house, improve your house, send your kids to school, whatever. Now let’s pretend that your portfolio is still worth $500,000 and is invested in stocks. What, really, does a 2.1% drop mean? Simple. It means $10,500. Ten thousand five hundred dollars. Gone. Evaporated. You had it yesterday, now you don’t.

How does that feel?

While maybe you couldn’t have bought a new house for $10,000, or paid for your kid’s entire education, you could still have taken a VERY nice trip. Or added a VERY nice deck. Or done one of a hundred other things that would have been far more fun than simply watching the money evaporate in your account.

Pick Two, Any Two

Now, imagine that instead you could pick two of the investments in the chart above. Which two would that be? Certainly notstocks (SPY), but probablybonds (AGG) andcash (CMR.TO). Let’s say that you have that same $500,000 investment portfolio, but instead it was divided between bonds and cash at a rate of 60% bonds / 40% cash. So, what does this same 2.1% stock market drop mean to you? Simple. A paltry 0.18% loss (0.31% * 60%).Which means a $960 loss. Nine hundred dollars gone.

How much better does that feel?

Sure, it sucks to lose money. But losing $1,000 is a LOT better than losing $10,500. AND, more importantly, it’s a LOT easier to make back $1,000 than $10,500. Especially on a $500,000 portfolio.

In fact, you might even feel flush enough to celebrate your limited losses by helping your mate find her very own turquoise beach bicycle at the end of the rainbow. I’d choose this over macho losses any day of the week.

TheBottom Line: Limit Losses

Certainly, everybody who invests in the market loses money at some point. But the magnitude of those losses, and their impact over time, is what separates the pros from the amateurs. Being macho or stubborn and “riding out the storm” is stupid. It’s far better to avoid the storm in the first place.

Just look at my timely comments in Hurricane Hermine: What It Can Teach Us About How the Market Works. By tracking the storm, I was able to avoid personal danger. By being out of stocks, I did the same with my clients’ investment portfolios.

The Next Steps?

I write these articles to educate you. To give you some idea about what is coming and why. I do this in the hope that you’ll be able to read the signs to enough of a degree that you can feel comfortable in what is happening in the economic world, and in how I’m managing your money, or could be …

Learn about bonds. Start here.

Then, contact me to review your portfolio.

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