Rule #1: Don't lose money

Rule #1: Don't lose money

April 17, 2021
Share |

To successfully plan, you must focus on how you can lose money. You must focus on risk.

Once you've taken care of the risk, you can move on to the fun stuff... making money.

The thing is, amateur investors are almost always thinking about making money... the upside. They're thinking about the big gains they'll make in the next big tech stock or their uncle's new restaurant business.

They don't give a thought to how much they can lose if things don't work out as planned... if the best-case scenario doesn't play out.

And the best-case scenario usually doesn't play out. Since the novice investor never plans for this situation, he gets killed.

Author and trader Nassim Taleb summed it up best in his must-read book, Antifragile, when he wrote...

‘The learning of life is about what to avoid.’

Taleb calls this idea "via negativa," which is Latin for the "negative way." More from Taleb in Antifragile...

‘Charlatans are recognizable in that they will give you positive advice, and only positive advice, exploiting our gullibility and sucker-proneness... Yet in practice it is the negative that's used by the pros, those selected by evolution... people become rich by not going bust (particularly when others do).’

It's easy to keep investors engaged with positive advice... Anyone can see a connection between buying a stock, a bond, or an option and making money.

It's much harder to keep investors engaged with "negative advice"... foundational guidance like don't lose money, don't take too much risk, or don't blow yourself up

It's just not sexy – even though it's more valuable.

It's more valuable because you can't make any money unless you first avoid losing what you have. You must avoid loss with every asset and investment.

Only a deep understanding of via negativa can prevent that from happening...

That's why via negativa is the primary secret of the wealthiest investors. Ask any of them, and that's exactly what they'll tell you...

 Warren Buffett once said, "The first rule of investment is don't lose and the second rule of investment is don't forget the first rule, and that's all the rules there are."

 A single edict, don't lose, is all the rules there are.

For Buffett, perhaps the greatest investor of all time, avoiding loss is a valuable, low-hanging fruit. His longtime business partner, Berkshire Hathaway (BRK-B) Vice Chairman Charlie Munger, said it a little differently...

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

Consistently not stupid.

 For example, if you suffer a 50% loss, you must double from there to get back to 0.  Not make 50%.  And this means you lose not only the money, but the time. 

The graphic shows the Nasdaq recovery time - inflation-adjusted, and including dividends.

17 years and 5 months. 

Maybe you were more lucky.  It took many people six years to get back to even after the 2008/9 crash. 

And retirees simply may not have that time. 

This is why I say, "there is more value in  avoiding the losses than by picking the winners".  It took me years to really understand this concept fully! 

Here is an example which makes it clear: 

Assume you are making $100,000, and saving 10%, or $10,000.  Then, your annual expenses are $90,000. 

Also assume you are making 6% on this savings.  In other words, you make $600 on this savings. 

However, if you lose only 1% of your expenses, you lose $900…50% more than what you may make in interest.  IF you can stop this 1% loss, that's equivalent to an 9% return on your money - with no risk.