If your portfolio earns 50% in one year and then loses 50% the next year, you are back to the same level, right?

Wrong!

Your two year return is still a negative 25%.

Here’s the calculation. Rs 100 becomes Rs 150 in year one, and then halves to Rs 75 in year two. So, net-net, you are down from Rs 100 to Rs 75 over two years, which is a -25% decline.

This seems elementary, but a lot of us miss this simple math.

Anyways, the point I am trying to make today is not about our innumeracy, but that to achieve a high return over a long period of time, we must focus on minimizing our mistakes.

As you analyze industries, business models and financial statements, place considerable emphasis on what can go wrong and the potential impacts those negative turns of event could have. Frequently remind yourself that it is important to look down first before looking up, and that you must be focused first on return of capital rather than return on capital.

This obsession with the downside reflects a mindset captured nicely by Gotham Asset Management’s Joel Greenblatt, who says, “If you don’t lose money, most of the remaining alternatives are good ones!”

So, you must ask yourself ‘what is the downside risk on this investment?’ and leave a comfortable margin of safety.

You may not score big on every investment, but avoiding large losses will do wonders for your overall long-term return.

Here are the best things I am reading and thinking about today –
 

• Jason Zweig asks whether you are an investor or a speculator –
  

  An investor never buys purely because an asset’s price has been going up and never sells merely because its price has been going down. An investor uses internal sources of return – dividends, rising future profits or asset values – to estimate what an investment is worth.

  A speculator buys and sells on the basis of recent fluctuations in price. A speculator uses external sources of return – primarily what he thinks someone else might pay – to estimate what a speculation is worth.

• Barry Ritholtz wrote about the five questions investors should ask themselves, one of which includes ‘how do I know when I am wrong?’ –
  

  Regardless of your positions, what is your objective measure that informs you that something you did was in error? If you do not have any sort of metric that easily determines if a position or allocation or even a belief is in error, then how can you ever course correct?

  Most of us hate to admit error. Everybody is wrong all time, and refusing to acknowledge that lacks all humility. Being wrong present a wonderful opportunity for learning, growth and improvement. Don’t hide your errors but embrace them.

• Ben Carlson wrote a post for Fortune magazine on when you should sell your stocks. One reason he outlines is when you have been proven wrong about an investment thesis. He writes –
  

  This one is more relevant for those who hold more concentrated positions in single stocks or niche ETFs. Every investor should perform a premortem that signals when it’s time to pull the plug and bail on an investment idea that simply didn’t pan out.

  This can be harder than it seems because What if I just wait until it breaks even?! or What if it rallies right after I sell?! are both rather compelling arguments in a loser position.

• I am no fan of investing in gold, but it’s always good to hear out different perspectives. Like here is a post from Nick Maggiulli, wherein he puts forth his arguments on why gold is valuable –
  

  …why is gold valuable? Is it its historical demonstration of proof of work? Or its chemical properties that allowed it to rise to such prominence in the first place? Or maybe it’s its modern usage as a portfolio diversifier for global investors?

  Maybe it is none of them or maybe it is all of them. The main thing that I learned while researching gold is that value is in the eye of the beholder.

  Some of you will see gold as an outdated tool of crazies and conspiracy theorists who own lots of guns and canned goods. Some of you will see gold as the last bastion of hope in a world where the U.S. dollar is certain to implode.

  If I had to guess, I would say that the truth is somewhere in the middle. As we digitize our world and find other ways of storing value, gold has more competition than ever before. However, if you think that one of the longest-lived signals demonstrating proof of work in human society is going to be discarded anytime soon, think again.

  Invest accordingly…

• “If you fail on Monday, the only way it’s a failure on Monday is if you decide to not progress from that.” Here is the American basketball legend
  Kobe Bryant on being process vs. outcome driven. Combine this with my recent post on Bryant’s mentality and how investors can learn from the him to win at the stock investing game.

   

  * * *
  That’s about it from me for today.

   

  If you liked this post, please share with others on , , , or just email them the link to this post.

  Have a great weekend. Stay safe.

  With respect,
  — Vishal