What is the most important factor in investing?

Managing Risk
The most important factor in investing is to manage risk.  One aspect of managing risk is to try to understand what can go wrong. Charlie Munger (pictured), one of the smartest guys in the world, from my perspective, constantly uses the phrase “invert, always invert” (Munger, 2008, p.157).  This phrase was first used by Carl Jacobi and referred to numerous times in Charlie Munger’s book titled ‘Poor Charlie’s Almanack’.

 

Turn the problem of risk upside down
Jacobi, a great algebraist from the 19th Century knew that in the nature of things that many hard problems are best solved when they are addressed backward.  Just as in investing, it is very easy to look at the upsides of investment decisions and be blinded by all the positive sentiment created in your own mind.

But what Charlie Munger and Carl Jacobi are meaning when they have frequently said “invert” is to turn the situation upside down.  Look at it without those rose-coloured glasses and consider what could go wrong.  By considering what could go wrong, you are in fact, helping yourself avoid such outcomes. For example, the following questions could be considered before investing:

• Could the company make an expensive acquisition?
• What would happen if the CEO or a key person in the business was no longer there (think Steve Jobs @ Apple)?
• Are consumers likely to continue wanting this product/service in 5 or 10 years time?

Be prepared to be wrong occasionally
Being humble about investment decisions and being prepared to say “I was wrong” can help you keep calm.  Staying calm is one of the best traits you would have in being a successful investor.  If you buy a stock, even after considering the downside risks about what could go wrong, and it still goes down, it doesn’t mean you should sell.  The best thing to do is to take some quiet time to re-examine the reasons for buying the stock.

If upon re-examination, you now believe you were wrong, or some of the facts have changed that caused you to make the investment purchase in the first place, then that serves as a good rationale to sell.

To invert …
If you have re-evaluated the situation and believe you are on a winner, then the price going down presents an excellent opportunity to buy more at a lower price.  This reduces your risk further.  A great business with growing earnings, little or no debt and a bright future will not see its share price go to zero.  So, a lower price serves to increase your investment return on the upside.

Managing risk, coupled with some self introspection, can help you on the way to beat the market consistently.  To do this, “invert, always invert” (Munger, 2008).

*Munger, Charles T. 2008, Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger, Expanded third edition, The Donning Company Publishers, Virginia Beach, VA.

 

This article is published by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.