Nuggets of insight can help you reap a golden payday

AMID the wealth of research I continually read, there periodically appears what you might call a nugget, something that strikes a chord, usually because it simply makes absolute sense or perhaps provides an explanation of a subconscious thought.

Recently I stumbled across a great example that I think is worth sharing. It was in an interview with a fund manager for whom I have an increasing regard, and whom the market is beginning to wake up to.

The key statement was the fact that in a good year a successful fund manager will typically make decisions that are wrong 45 per cent of the time. What differentiates the successful manager from the herd is their ability in knowing how to respond in such circumstances.

I have been privileged to work closely with some of the very best managers in the market, and I know this to be true.

I can reflect on occasions where managers have enjoyed sector-topping performance, but rather than brag about their great stock picks they will focus on how many mistakes they made along the way.

I have also known managers who will doggedly defend stock selections that are plainly wrong, and the simple difference is they tend not to be around for too long.

There can be little doubt that the importance of the above facts relate to all investors. If we're being honest, we all tend to focus on our great calls rather than confess to judgments that proved to be mistakes. Sadly, too often we fail to address these matters and as a result achieve less with our investments.

Given the fragility of economies, not least our own, it is perhaps worth remembering that return of capital is as important as return on capital and there is an increasing requirement to be responsive to change.

Becoming aware of the fact that roughly half of investment decisions prove to be wrong (and, remember, that is among the best managers) prompted me to think about those occasions where I have advised people to realise a loss on an investment.

It is one of the hardest disciplines to practice. However, it can ultimately prove to be rewarding because it is something you never forget, and perhaps contributes towards you becoming a better investor.

The alternative choice, which is to do nothing and convince yourself that in the long run things will be fine, may well prove destructive. Even if things do work out well in the end, you have certainly not been at all cautious in your approach.

I believe this matters, as in most cases investors are seeking a decent return on their invested capital, either to allow an income to be generated or to achieve returns that are positive in real terms. What they do not enjoy is the erosion of their capital.

Given prevailing low interest rates, to achieve a return in excess of cash is hardly challenging, and arguably can be secured with little risk to the underlying capital. However, it will require a degree of vigilance and a commitment to act when things change.

Just as it is important to back your convictions to a sufficient level to make a difference, so it is crucial to always consider the cost of being wrong, and to be committed to acting when you are. Simple, really.

• Ken Taylor is director of Mackenzie Taylor Wealth Management.