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Why is downside protection important while investing? Here’s the maths
Remember Warren Buffet's two rules of investing - 1) Never lose money, 2) Don't forget Rule no. 1.
The most common criteria for a DIY investor to select a a mutual fund is to look at the past performance. Mutual fund schemes which are at the top of the returns chart during a time period garner higher inflows as compared to other funds. Most investors fail to understand the importance of downside protection. The most successful investor of the world, Warren Buffet emphasizes on the importance of downside protection as well. Remember his two rules of investing - 1) Never lose money. 2) Don't forget Rule no. 1.
Why is downside protection important?
Lets do some maths here.
If a stock falls by 25% from ₹100 to ₹75, how much do you think it will need to grow to get back to ₹100, the cost price?
The stock will need to go up by 33.33% to get back to ₹100.
Similarly, if ₹100 stock falls by 50% to ₹50, it has to go up by 100% to reach its original value.
If the same stock falls by 75% to ₹25, it will need to gain 300% to recover to its original price and if it falls by 90%, it needs to go up by 900% to recover.
These numbers make it very clear that the more you lose, the harder it becomes to recover your original price.
If you invest in a mutual fund scheme which is steady in its performance, over the longer term you will earn better returns than a scheme which took higher risk and went through a roller coaster type returns during the period. So, don't get carried away by the high returns instead look for schemes offering steady returns.
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First Published:15 Aug 2020, 02:35 PM IST
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