How Fragile are your Investments?

Seems obvious but the most important feature in growing your wealth is to avoid losing it. Have you considered how your favourite investments might perform in more difficult times?

As investors (humans), we focus too often on the potential upside, the rosy picture. We count our chickens well before they hatch and do a poor job of considering the worst case scenario.

Real success in investing comes from compounding. Its the later years (+25) where compounding nirvana really occurs. The greatest investors spend more time concerned with avoiding big losses to allow the greatest runway possible.

“What happens when you are wrong is everything with investing. You must construct a portfolio to survive those times”

Seth Klarman

Lots of things can and will go wrong with investing. We miss things in our analysis, management make mistakes, regulations change, cycles will cycle. It’s important that your investments are robust to the difficult to predict events — the black swans.

So what makes an investment fragile?

1. Debt. Whether its debt in the company you are investing in or debt you are using to invest yourself. Debt enhances losses.

2. The absence of strong cash flows

3. The absence of tangible assets supporting the price you pay

4. Investments we struggle understand

5. Paying too high a price

So often we fail to see how fragile our investments actually are. A company can perform extraordinarily well for 98% of an economic cycle then be severely impacted when the cycle turns.

In Australia we have had 26 years without a recession. Most sectors barely missed a beat during the GFC. This has provided investors a false sense of security. It’s hard to see the underlying fragility of an investment when all its done is go up.

The concept of investment fragility was coined by Nassim Taleb.

“I’d rather be dumb and antifragile than extremely smart and fragile, any time” - Nassim Taleb

We are at the advanced stage of this investment cycle. Like all others, an investor’s risk appetite increases and interest in weird and wonderful instruments is prevalent. The word safety becomes less important than return and we often here the four words ‘it’s different this time’.

Bitcoin & other cryptocurrencies are a perfect example of this. It’s a bubble and my cab driver this morning confirmed it for me.

FOMO (the fear of missing out) is real in investing. It’s easy to convince ourselves on the merits of an investment if others are making money and we are missing out.

Stick to your circle of competence. If you don’t understand it — don’t touch it.

Minimise you own debt levels and those of the companies you invest in — that is where the carnage usually occurs.

Be Unreasonable. If it’s expensive don’t buy it. Wait for the market to come to you. Holding cash is ok.

Your capital is precious so ensure you have invested in companies and securities robust to economic downturns and out of the ordinary events.

‘If making money is a slow process, losing it is easy done’ - Ihara Saikaku.

Protect what your hard work has built.