Rule #1 of Investment – Never Lose Money

Rule #1 of Investment – Never Lose Money


Warren Buffett Investment Rules:
Rule #1, Never Lose Money.
Rule #2, Never Forget Rule #1.

I never truly understand the above rules. In my thoughts, I was asking that how would the approach of preserving capital lead to the vast wealth of Warren Buffett. To achieve great profits, isn’t the most important rule be maximizing the gain? If it is the investment gain that we are talking about, i.e. difference ABOVE the original capital amount, then wouldn’t the preservation of original capital be something taken for granted?

I was only able to appreciate the true meaning of the above rule after I stumbled upon a book, “The Winning Investment Habits of Warren Buffett and George Soros” by Mark Tier.

Too often, investors are lured by the prospects of gaining high returns by taking on excessive risks. But high risk-high return was never the approach taken by the Master Investors. Their winning method is actually, low risk-high return.

To achieve that, Warren Buffett has developed a set of criteria which he uses to access each investment opportunity. These criteria identify investments that are highly probable of achieving positive returns with minimum uncertainty and hence minimum risks. And with the immerse understanding of the investee companies and his required level margin-of-safety for purchase price, Warren Buffett is able to lock-in investments of high predictability based on its own economics and fundamentals, and therefore, he is able to ignore the general economic situation and prevailing stock market sentiment and just concentrate in assessing whether the market offer price is reasonable to him.

With true understanding of the company and periodic review of the company performance (i.e. to measure against expectation), Warren Buffett is able to put large stake in few concentrated investments with much ease in order to maximize profits. As the saying that goes “Diversification is a way to hide one’s stupidity”.

In a nutshell:
1. Preserving capital is the key – never-lose-your-capital
2. Predictability - minimize risk and uncertainty through in-depth understanding of your investment and
3. Buy at price with sufficient margin-of-safety in order to achieve #1 and buffers any unforeseen circumstances