Mistake # 1: Discounting the Downside
“Rule Number 1: Never lose money. Rule Number 2: Never forget rule number 1.” – Warren Buffett
The Problem: In portfolio construction, downside risk is more important than potential gain. The issue is that a majority of firms do not calculate a discreet downside estimate, but do calculate an upside price target. Investment research often concentrates its efforts on determining a price target if a thesis comes to fruition even though downside risk has a more profound impact on portfolio returns.
For example, assume you have a $1 billion fund. If that fund is up 50 percent this year and down ....