The Importance of Capital Preservation

Why Capital Preservation Is Important

In the 90's, psychologists Amos Tversky and Daniel Kahneman performed a coin flip experiment. They would say the following to university students:

“I’m going to toss a coin, and if it’s tails, you lose $10. How much would you have to gain on winning in order for this gamble to be acceptable to you?”

“I’m going to toss a coin, and if it’s tails, you lose $10. How much would you have to gain on winning in order for this gamble to be acceptable to you?”

How much do you think the students wanted to make the gamble worth it?

How much would you want?

Tversky and Kahneman found that people were more willing to forgo the chance of winning a lot of money to avoid the possibility of losing. The students would want $20 before the gamble was acceptable. The finding were consistent when the same question was asked to executives and the dollar values were multiplied by thousands. The term that was coined for this sensation was loss aversion. This study showed that people inherently felt the pain from loss was greater than the pleasure from gain.

What Is Capital Preservation?

Capital preservation refers to the methods used by investors to secure their principal and mitigate risk of loss and other downside risks in an investment. All successful seasoned investors know the importance of capital preservation (Warren Buffets rule #1 is never lose money), and it’s apparent that this investing advice is wired in our genes so even new investors understand it as well (even if they don’t know what to call it yet).