Investments don’t always go the way we hope they will. You will learn to make much wiser choices if you always think from the beginning in what ways you might recover principal if the investment starts to decline. The cartoon we showed last week should make the need for this clear.
The alternative is to simply watch in disgust as your capital evaporates. Think ahead! Let’s look at a couple examples…
If your investment started to decline and you know that it is collateralized by real property, then you have some security. If the investment defaults, you can secure the collateral. This is how you recoup your losses. We’ve talked about collateral above, and you should strongly consider demanding it when you are approached about a small business opportunity from someone else.
This is essentially what a bond is in larger scale finance. If a corporation goes under, the stockholders will be wiped out, and the bondholders will sell off all the assets to make themselves whole. Bonds hold the collateral of the entire asset base of the company.
What about in the Stock Market?
Many stock market investors simply continue to hold the security waiting for time to return the value to them. If this is your strategy, there are some important considerations that you need to consider. Does the security have inherent value that you are sure will be realized even in a rapidly changing economic environment? In other words, do you have good reason to think that the market will actually return this value to you in a reasonable amount of time? Or is this perhaps a company that will see its value in real terms decline in the shifting sands of economic transition?
One method that stock investors have depended on for years to receive back the value of their investment (and eventually more so) is the receiving of dividends. Dividends return a portion of the company’s profits to the owners. Over time, they make up a substantial portion of overall stock market returns.
You might be able to handle a small downturn in your stock price just fine if the company is sending you a dividend check each quarter. Always keep in mind when assessing a stock opportunity that there are no guarantees that a stock will continue to pay dividends in the future. What is the company’s history of paying a dividend? Do they have high enough profit margins that they will continue to be able to pay its current dividends even if times get tough? A company’s stock price usually takes a substantial hit when it fails to continue paying its previous dividend, so this can be a double edged sword.
Still, if you’ve done your research and feel confident in the future dividend payments, it can provide a way back from a loss of original principal. So ask yourself, how will I recover from a loss in principal?
This is Part 18 in the series Investment Due Diligence. To use this as a growth tool to better understand your own calling, you might start by reading Part 1, Pt 2, Pt 3, Pt 4, Pt 5, Pt 6, Pt 7, Pt 8, Pt 9, Pt 10 , Pt 11, Pt 12, Pt 13, Pt 14, Pt 15, Pt 16, and Pt 17.