Monday, April 27, 2015

consider the downside

most people suffer from the hindsight problem.  If you continue buying, and it works out, they say, “See?  He was bold when he needed to be bold, seized opportunity, and was rewarded.”  If it doesn’t work out, they say, “See?  He was reckless and foolish, getting what he deserved.”

To begin, always consider the downside.  If you need motivation, watch the clip of Season 3, Episode 1 of Downton Abbey when Earl Grantham is called to his advisor’s office to discuss the estate’s railroad holdings.  That scene has played out throughout all of history, over and over, among many cultures.  That is what you are seeking to avoid.  If your affairs are managed in a way such an outcome can occur, you are failing your primary responsibility.

We live in a world where crazy things can happen.  There was a point in the past century when companies like Coca-Cola traded for less than the cash in the corporate bank account because it was so undervalued.  There was also a point when that same company traded at an earnings yield significantly less than inflation because it was so overvalued.  There are unexpected earthquakes and fires, tornados and hurricanes, political changes to the tax code and riots, wars and terrorist attacks, technological disruption and shifts in consumer tastes.

Be honest with yourself.  Is your motivation to make money or is it the rush of speculation?  If it is a gambling thing, setup a separate, isolated account, with no margin debt, funded with a fixed amount of money that never touches your actual investment portfolio.  If you find yourself in a situation where you are consistently putting more than 20% of your entire net worth in a single asset at cost (not market), you have the heart of a gambler and need to protect yourself accordingly.

Why word it so strongly?  There are more than 14,000 publicly traded stocks and with a $100,000 portfolio, the entire world of them is open to you.  If you can only find one – a single issue – that is worth such a high percentage of your assets, you aren’t looking hard enough or you are caught in an adrenaline rush.

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