Posted by spshapiro on June 14, 2014 (11:15PM)

I am loathe to make generalizations, since I am aware that it only takes one counter instance to prove it wrong, but I feel strongly enough about the point to say that Every experienced investor has come to realize that it is more important to limit your losses than to hit homeruns. This is not baseball, if you only hit 260-280 here you will not get a million a year, if you hit 300, you will not be an all star. You might survive in the investment game hitting a major league average, but only if you dump the losers before they become wipe outs, but most inexperienced investors haven’t developed the discipline and/or experience to jettison the dross before it weighs too much on your psyche.

You can improve your ‘batting average’ by not swinging from your heels. I have a 5 year old great nephew that I’m trying to teach this lesson, but the penalty from striking out in T ball is nil; you, on the other hand know the penalty for striking out here is a bit greater. You can bat a lot closer to 500, by changing your focus from not just what is the best thing that could happen, to asking also what is the worst. If the worst is “this thing can go to zero”, you might want to look elsewhere. Maybe you can say this about a VERY small percentage of your choices, but not when this is the norm. (Btw, any penny stock is in this class. Period, end of story.)

You can’t say “This can’t go to zero, because five years from now, everybody will want one of them.” Maybe that’s is so, but if they aren’t earning a positive number this year, if their ability to finance the ‘roll out’ is in any question, then they can go to zero. Companies that have positive earnings, pay a dividend, and have a track record of doing so, and especially if they can enunciate a plan for the future that seems to follow a similar track, will rarely go to zero.

As of the moment I have 15 positions out of 53 that are underwater. Do I like that, no, but of course I believe at this moment every one of the 15 will do better in the future. However, if the future resembles the past, by summer’s end, I will have gotten rid of 1-3 of them.  Only 3 positions have any reasonable chance of going to zero. One is in solar, one, natural gas distribution, and one is a biotech. All three together represent 1.4% of my portfolio, so I consider that to be a rather limited risk. I earn more in dividends each year than my total investment in these three.

By limiting your risk, I am not saying you will get rich; I’m saying you will make some money investing. Whether you get rich will have a lot more to do with other things that you learn or are fortunate enough to experience along the way, but just earning a little bit more along the way, isn’t such a bad thing compared to the alternative.