George Soros once said. “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” This principle lies at the heart of successful wealth creation in the investment world.
So, what really is the secret to thriving in the stock market? To make wise investments where you have an unbelievably attractive, asymmetric payoff profile and having the ability to identify when you are wrong quickly.
Consider this: From 1926 to 2022, just 0.1% of globally traded businesses, specifically roughly 25 companies, were responsible for a significant portion of wealth creation. It’s like an old saying “fish where the fish are”. These are the opportunities that can turn your life around.
For instance, investing in a stock that yields a 20% annual return over 25 years can amplify your investment by an astonishing 100 times. Imagine turning £10,000 into £1,000,000!
To illustrate the power of exponential growth, consider these examples: If you put 1 grain on the first square of a chessboard, and double it on each square until the 64th one, you would have 1.4 trillion metric tons of rice. This is more than 2,000x the annual production of wheat.
If you would invest £1 per day for 200 years at 7% per year, you would have more than £6 billion.
Doubling £0.01 every day for 30 days leads to £5.37 million. Interestingly, in compounding, most gains often occur in the final stages, like the last 7 days of a 30-day period.” As Charlie Munger stated, the first rule of compounding is to never interrupt it unnecessarily. Because if you miss the last 7 days you would have missed most of the gains.
Have you considered how compound interest can impact your investments? Let’s have a look at the table below:
Percentage loss vs Required gain
For example, if you invest £1,000 in a company and the stock drops by 33%, you’re down £330 and need a 50% gain to break even. Let’s assume the FTSE 100 yields 10% annually, recovering your loss will take over 7 years.
Once you realise you’ve invested in the wrong company, you believe the business is not financially prepared to withstand storms internally without raising capital from the market and the business loses its competitive edge, the best thing to do is sell out and find another investment opportunity to better use the capital. Make sure you are not selling for market timing only as history shows we do not have a good track record of timing the market.
However, if the business experiences temporary setbacks whilst its competitive advantage is still strong, it’s run by an exceptional management team, the fundamentals are improving (such as profit and investment opportunities to invest their cash at a higher rate), it’s better to start topping up your holding at a lower price as the share price continues to fall. If suddenly the share price rises by more than your average price, your investment will be profitable. This is the beauty of pound cost averaging. If you are wrong you have time to adjust your investment and that provides a margin of safety for downside correction.
The second key question is when is the right time to review your investment? Is it after a 30% or 90% drop in the stock? First, make sure you know what you own, but if the facts or story have changed, you should also change. It is not a good feeling to be down 90% and then find out you were wrong. Even worse, you’ll need 900% to recover from your losses. This can easily knock you out of the game, especially if it constitutes a large portion of your portfolio.
This reminds me of what legendary investor David Swensen said, “In many instances, value investing proves fundamentally uncomfortable, as the most attractive opportunities frequently lurk in unattractive or even frightening places.” The key to success in investing is having a long-term perspective, coupled with discipline, patience, and decisiveness. When a stock price rises, it attracts buyers; when it falls, it’s often hastily discarded. If you believe in the long-term potential of a stock, keep investing as the price drops.
It’s tough to stay rational under pressure, especially when everyone around you seems to be making a fortune in a bullish market. As Benjamin Disraeli said, “Action may not always bring happiness, but there is no happiness without action.” If you wait for the right investment when the odds are on your side, and when you find it, act with conviction, courage and rationality, that’s the essence of successful investing.
Awet Ghirmay, Head of Investment Research
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Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
