Previously, I wrote an opinion essay about “ what to do with capital”. I examined as many alternative deployments as I could trust, from putting cash in your mattress to owing a your own company, and sent it off to you. I am going to revisit that essay and analyze it against what I have learned during these past many years. But, yesterday I was out walking my one year only, big white, Samoyed dog, Zane – really cool dog, by the way – and it was a long walk – 5 miles, hour and a quarter – and I started running some ideas through my head that maybe the better question to think about was: “what not to do with capital?” Or, even sharper, “ How to lose your capital?”
The thought is relatively primal. If you are able to avoid all of the ways people generally lose money than you are likely to be in pretty good shape when you need to navigate through a major market downturn, when all investors should suffer through a market based value decline, but one which an investor can properly navigate, especially if the investor has sufficient reserves not to need to sell into a down market.
In this sense, my first cut is thinking about an individual investor.
I thought it might be interesting to think about this subject, in this way.
How to lose capital?
- Trust another person to make the choices for the deployment of your capital.
- Your advisor may not be smart/experienced
- Your advisor may have a personal agenda – personal wealth creation/financial stress – that does not always align with yours.
- Your advisor may deploy your capital in high risk alternatives, of which you have not been made aware.
- Your advisor may be a thief, wearing a tailored suit. (Bernie Madoff. The people who invested with him were generally pretty smart folks, at least in their fields. They were also greedy and lazy.)
- Building on the above, not putting the time in to understand, as best possible, the entire ins and outs of your investments.
- Make investments that are dependent on macro market movements. In this sense, you are acting like a trader without having the skill of a trader.
- Using significant leverage as a way to better position your investment for abnormal market returns.
- Concentrating your wealth on one or two seemingly very good investments.
- Buying mutual funds/managed funds on the basis of historical returns and not paying attention to the present day portfolio composition and the investment strategy of the manager.
- Buying stock in any single company without having your own investment thesis for buying the stock. Many sources, from Morningstar to the Motley Fool, will provide you specific recommendations and analysis to buy or sell a stock. But an investment thesis must be more than “Morningstar recommends” and it must be yours.
- Investing in someone’s else deal. The prospectus for most investments understates the difficulty of building revenue and understates the cost of building the operating engine. Someone else’s deal is more like a venture capital investment for an individual. It may not have a place in most individual investor’s portfolio since most venture capital deals do not return capital.
- Getting involved in any investment opportunity that might require you to sign a personal guarantee.
- Getting involved in any investment opportunity that might require you to pledge an asset of material value.
- Getting involved in any investment deal, even with just one other person, that would require some kind of joint and several risk exposure.
- Failure to do the obvious homework.
- Structuring the investment portfolio in such a way that a multi-quarter downturn in the markets would force the investor to raise cash by selling into a falling market.
- Investing in alternative investments without fully recognizing that the associated much higher than market returns are also exposing you to much higher risk.
- Making investments into schemes where you do not control liquidity.
- Investing in trades – thinking you are a hedge fund manager – even when you explicitly understand the details of the trade, and especially when you do not.
- Not understanding how your investments will behave during a material economic recession.
- Staying with an investment even after your investment thesis has gone stale.
- Investing passionately instead of dispassionately.
I will finish this thought with a singular push-back. If you are trying to out perform the market you may be motivated to take some of the risks discussed above. No doubt, some of the risks identified above can be reduced through maximum diligence and hands on involvement.
