As I mature as an investor, it is becoming ever more clear that to be successful in this game over the long run, one has to be good at not just making money but keeping it.
In fact, I would argue that keeping it is far harder than making it in the long run. Unfortunately, most investors neglect this critical building block and focus on upside potential over anything else, including risk.
Building wealth
Of course, generating profits is an integral part of investing. An investor is not going to get anywhere if they don’t try to increase the value of their capital. But capital preservation should feature at the core of any investment strategy. The system is structured where the only way to make more money is to have money in the first place; a lower starting point sets you back enormously.
This principle goes all the way back to Benjamin Graham’s teachings. The so-called godfather of value investing believed that an investor‘s primary objective should be to protect capital and growth should come second. That’s why he developed his value investing strategy. He wanted to protect capital at all costs, with capital growth coming second.
One of the best examples of how the strategy works in practice is Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). I know it is a bit of a cliche to say that this company is one of the best organizations for protecting and growing capital, and there are plenty of other examples, but I think it is the best known and easiest to dissect given the availability of information about the enterprise.
The perfect example
Over the past couple of decades, Warren Buffett (Trades, Portfolio)‘s conglomerate has been a market-beating investment to own. However, the conglomerate has suffered periods of underperformance. During these periods, it has suffered criticism for not taking on more risk and capitalizing on market opportunities.
A couple of years ago, in one of the company’s annual general meetings, a shareholder asked the Oracle of Omaha why he hadn’t invested the company‘s enormous cash pile in a low-cost tracker fund to achieve higher returns rather than leaving it invested in lower-yielding Treasuries while he waited for opportunities.
This question is the perfect example of how impatient some investors can be. Investors can be so impatient in chasing returns they neglect to focus on the most important objective of all: preserving capital.
Buffett has said that he wants Berkshire to be equivalent to a savings account for its investors. He has achieved this aim. The corporation focuses on building value, and that is clear in its portfolio of investments.
Not only does it have a robust balance sheet with lots of cash and no debt at the corporate level, but it also owns a portfolio of companies that operate in a niche sector with strong competitive advantages. That means these businesses should provide cash flows for their owners during all economic environments.
Buffett also refuses to get involved with speculative securities. He is looking for profitable companies that have an established market niche. This is all part of his ambition to minimize the potential for capital loss and preserve capital.
Some investors might argue that this approach does impact returns in the long term. I would not disagree with that statement. One might be able to achieve higher returns with more exposure to growth equities and less exposure to utilities and cash. Nevertheless, that is not the point. The goal is not to achieve the highest returns possible but to protect and grow capital over the long term.
A marathon, not a sprint
Achieving high returns with a risky strategy might be possible for a couple of years, but there are only a handful of examples where investors have been able to achieve high returns year after year for decades.
Some of the most successful investors of all time have concentrated on achieving positive absolute returns year after year. That doesn’t mean chasing high growth. It means focusing on predictable and steady growth.
This might not seem like the most exciting approach, but investing is a marathon, not a sprint. Thanks to the power of compounding, the investors who can achieve positive returns year after year will achieve the best returns in the long term.
