Creating a buffer against the blows (a.k.a. mistakes)

Feel free to reach out to PSG Wealth adviser  Dawie Klopper CFP ®  directly.

This line of thought may also be applied to investing. You may take a chance selecting an investment offering the potential of good returns at a relatively low risk, but ask yourself if you will be able to stomach the negative consequences of failing to get the desired investment results and losing a sizeable chunk of your money in the process.

Just consider your frame of mind if you were to lose 20% of the value of an investment, comparing this to how you would feel if you have realised a 20% profit on another investment. Most of us feel the pain of losing money much more intensely than the joy of making a profit.

Take, for example, the quiz game “Who wants to be a millionaire?” You may set a safety net. This means if you provide the correct answers to all the questions until you reach the safety net, you will not lose the amount you have reached. Usually, the first safety net is set at R10 000, and then you have the option of establishing a second safety net. Most participants will link the second safety net to say question 10 out of the total of 15, enabling them to win R80 000 if they make it to that level. If you get it wrong before you reach the second safety net, you fall back to R10 000. Imagine how such a participant would feel if he or she got stuck at R70 000 having to revert to R10 000.

To successfully negotiate all sorts of challenges and chances, you need to consider a so-called margin of safety with which you are comfortable. In my first example above, you can lose your life. So, it is not a good idea to play Russian roulette, as the price to pay when things go wrong is far too high. In the last example, you may well take part and tell yourself anything you gain is a bonus.

In my previous piece, I wrote about someone who wanted to make some extra bucks from his crypto investment in order to buy a bigger wine farm, and how things turned south afterwards. Then you must ask yourself whether the extra gains were worth the trouble when things did not work out. Was there any room for a mistake? It is difficult to plan for mistakes or undesired outcomes.

Remember, though, that things are not always perfect. There are always cycles – shares go up and down. Will you be able to stomach negative results with your equity investment? How would a declining equity market affect your retirement plan if the markets do not rise by 12% p.a. anymore and experience a 30% drop one month before your retirement date? Will you still be able to retire? That is why it is important to have a margin of safety in place in your investment portfolio. Perhaps you should have a cash buffer somewhere, to see you through the next bear market. In 2008, Warren Buffett said, “When forced to choose (between holding extra cash or the chance of extra profits), I will not trade even a night’s sleep for the chance of extra profits.”

So, rather opt for the smaller farm instead of ending up with nothing. Make sure that anything you plan includes a margin of safety. Consider the downside, planning for lower growth than statistics suggest. Rather be safe than sorry.