It’s Not The Money You Make; It’s The Money You Avoid Losing

I won’t let my clients invest in bitcoin.

I have doubts about whether cyber currency works. I have concerns about bitcoin’s adverse environmental impact. I also don’t like how bitcoin can facilitate cyber ransom, drug trafficking, terrorism, and slavery.

And I know investing in bitcoin could cause my clients to lose a lot of money.

If you invested in bitcoin in the last 12 months, you’ve only known an express ride straight to the top. In one year, bitcoin rallied from $10,000 per coin to $60,000, fell back to $30,000, then rallied to a recent high of $65,000.

But I remember when bitcoin first became popular in 2018. Bitcoin topped out at $20,000, then fell to $4,000 a few months later, delivering an 80% loss to latecomers who bought at the peak.

With investing, if you avoid significant losses, the gains will take care of themselves. An investment that gains 100% in the first year and loses 50% in the second year leaves you back where you started. An investment that gains 7% in the first year and 7% in the second year leaves you ahead by 15%.

While 7% returns may seem puny, when applied consistently it means you double your assets every 10 years.

That means $100,000 doubles to $200,000 in 10 years, then reaches $400,000 in 20 years and $800,000 in 30 years.

If you started out with a risky investment and lost half your money upfront, it might take you 10 years to get back to break even, and your investments would only be worth $400,000 after 30 years. That initial $50,000 loss cost you $400,000 in future wealth.

In my early 20s, when I first learned to invest with my Morgan Stanley employee account, I made rules for myself. I would only invest $1,000 at a time and never allocate more than 10% of my portfolio to any single position.

I was making a good salary, so losing money on the way to learning would not hurt my standard of living. Some investments did well, some lost half and some went to $0.

The money I lost I regarded as the cost of tuition. I was learning what constituted a truly valuable company and what a healthy portfolio looked like.

Those early losses were the building blocks of my investing knowledge. The more I learned, the more I developed criteria for individual investments and my portfolio as a whole.

Ultimately, here’s the system I developed — the same one I use today when investing $500 million worth of assets for more than 200 client families.

Quantitative Analysis

We use numerous recognized metrics like price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and operating margin. We compare these metrics across companies within the same industry group and stock market sector.

Tesla and Ford both make cars. Based on quantitative analysis, Tesla’s valuation is 20 to 30 times greater than Ford’s. We admire Tesla’s technology, but we only invest in Ford.

Qualitative Analysis

After we apply the quantitative analysis and screen out the companies with overly aggressive valuations, we still have to ask this question: Do the numbers make sense?

Consider that 20 years ago, a high-flying company named Enron went from Wall Street darling to bankruptcy in less than a year.

Through the late 1990s and into 2000, Enron’s numbers looked great — phenomenal growth rates with execs on the covers of business magazines.

My clients clamored with me to invest, but I would not. I could not understand what Enron was doing to grow revenues and earnings 20% to 30% per year when most utility companies grew 3% to 5% each year.

My skepticism served me well.

Between 1998 and the peak price in July 2000, the stock price rallied 450%, then crashed to $0 18 months later as Enron’s financial reporting turned out to be entirely fraudulent.

Technical Analysis

Technical analysis is the art and science of understanding supply and demand for a particular stock, commodity, or even bitcoin by reading charts.

Quantitative and qualitative fundamentals establish long-term price levels while technicals control the short-term price.

We won’t buy anything exhibiting what I call a “ballistic” chart, characterized by rapid and accelerating price appreciation in a short timeframe. Like every rocket, the fuel cuts out eventually and the rocket falls back to earth.

We own a lot of Amazon, eBay, and Priceline, which we purchased not during the ballistic phase of the internet bubble of 1997 to 2000, but after the stocks collapsed 70% to 85% between 2000 and 2002.

You must cultivate a philosophy of “risk management” in your investing.

Building capital is hard. Destroying capital is easy.

David Edwards is president and wealth advisor with Heron Wealth based in New York City and advises clients across the U.S. and around the world. Dustin Lowman contributed additional research for this column. Edwards and/or his clients hold positions in Ford, Amazon, EBay and Priceline.

This post originally appeared as a column on International Business Times