Saturday, February 16, 2013

Why The Best Way To Invest Is To Preserve Capital

The stock market is very alluring to many people. It offers the chance to make a lot of money in a relatively short amount of time. However, it also carries great risk. Loss of part or even all of your capital is a real possibility.
You must decide for yourself if the risks in the stock market is worth it or if you want to find returns somewhere else. If you do decide the risks are acceptable, then your number one concern in the stock market should be to preserve your capital.

Why preserve capital?

Why should preservation of capital be your primary concern and not something else such as how much money you've made or whether your profit lags behind those of other people? The answer is very simple.

The stock market is all about using money to make money. Without the necessary capital, you cannot even take part in the stock market. It doesn’t matter how good you are in investing. You can be the greatest and most talented investor and it wouldn't do you any good. Without money, you can't participate in trading stocks.

Preserving the capital you have access to, should therefore be your primary concern once you are into equities. You must protect your capital, even if that means temporarily moving to the sidelines in the form of cash. Cash may not earn you much, but you won't suffer any losses either. Your greatest fear should be that you lose all your capital and therefore can no longer trade in equities.

The more capital you have, the easier it is to make money

Let us illustrate this with the following example.
  • Assume we have two investors with Rs100,000 in capital. Both would like to make Rs50,000 using this capital. A 50 percent return on investment.
  • Investor A is concerned with preserving his capital. His investing approach revolves around this objective. Investor B is more careless and focuses on making money at all costs in the shortest amount of time.
  • Suppose the market is now highly volatile with no clear direction. Investor A decides to wait until things become clearer and stays in cash. Investor B invests and suffers a 25 percent loss.
  • Investor B will now have to double the remaining capital of Rs75,000 to still end up with Rs150,000. A 100 percent gain using the remaining capital.
  • Investor A did not suffer any losses and only needs a 50 percent gain since he still possesses the original Rs100,000 starting capital. Investor A has a much easier road ahead compared to investor B.

Stock market advice and tips

The fewer capital you have, the harder it becomes to reach a certain level of return. The more money you have, the easier it is to make a certain amount of money. Losses have much greater impact, because we need money to make money. Limiting losses should thus receive priority over making profits. As long as you have money, you are in a position to make money. Without money, you can't do anything.

Opportunities to make profits will always come by, but you must be in a position to take advantage when that opportunity arises. That means preserving the capital for when the time comes. It is better to let an opportunity to make a profit go by, if that means risking losing your capital.. Your priority must be to never lose your capital.

What should I do before investing?

With that said, you cannot stay on the sidelines forever. People turn to the stock market to earn a high return on their capital. You cannot do this, if you always stay in cash and don't participate. At some point, you must take risk in order to make a return.

Losses of part of your capital are of course inevitable. No one is right all the time. What you can do is reduce those losses as much as possible. That means taking the time and effort to learn how to manage risk. Finding out how you can limit your losses. What kinds of insurance are there for those trading in stocks. One possible way is by hedging. There may be other ways.

You must be prepared before entering the stock market. Many people tend to jump in without any proper preparation or education and pay a heavy price for doing so. Do not become one of those people. Always remember to preserve your capital.

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