What did HE mean when he said Never Lose Money?

Posted on by fundooprofessor

A while back I clarified what Warren Buffett really meant when he said:

You should invest in a business that even a fool can run, because one day a fool will.

Now, it’s time to clarify another one of his famous, and often misunderstood quotes which goes like this:

There are only two rules in investing. Rule # 1: Never Lose Money. Rule # 2: Never Forget Rule # 1

Here’s what I think Mr. Buffett really means with those words.

  • It means don’t get into a situation no matter how high the NPV, if it carries even a minuscule probability of financial ruin.
  • It means don’t play Russian roulette — even when the gun has a million chambers in it with a bullet in just one chamber. Or jump out of planes with parachutes which have a probability of opening up 99% of the time.
  • It means don’t do trades that will make money most of the time but carry a small chance of blowing you up. Don’t do what LTCM did. Or many other funds which blew up suddenly after delivering excellent returns for a while.
  • However, it doesn’t mean being loss averse. It’s perfectly OK to lose all your money in a few investment operations so long as they won’t cause ruin at the portfolio level.
  • It means be that one should be risk averse (where risk is defined as probability of financial ruin) but not necessarily loss averse.

END

The thoughts behind this post were triggered because of a tweet by Mr. Samir Arora on twitter for which I thank him.

Published by fundooprofessor

I am Distinguished Adjunct Professor at Flame University, Pune. Previosuly, I was Adjunct Professor at MDI, Gurgaon, where I taught MBA students two popular courses titled “Behavioral Finance & Business Valuation"(BFBV) and Forensic Accounting and Corporate Governance (FACG) for many years. I am also Managing Partner at ValueQuest Capital LLP— an investment advisory boutique which helps its clients invest their capital in good quality businesses.

4 thoughts on “What did HE mean when he said Never Lose Money?”

  1. Sir,

    It is always good to see something from you.
    The last-second bulleted-point appears a bit vague.. how could one ‘lose *all* his money in a few investment operations’ and still remain un-ruined at portfolio level !!
    Probably what is meant by*all* is not really all,, rather the portion allocated to a particular investment operation.

    Regards
    Rajesh

  2. Dear Sir,

    Wonderful post as always.

    To the five points you have mentioned, I would like to add another point which you always advice to any beginner starting off in the investing journey: To start with wide ( or at least adequate) diversification and then move towards concentrated bets as one gets experienced.

    To my surprise, Mr. Buffett or Mr. Munger never approves of such a strategy, though they have always maintained the importance of not loosing money. Am I missing something here?

  3. Sir,

    Thank you for this wonderful post. I have a general question about business strategies :

    Suppose there is a company who has a number of products for different age groups and categories (lets say 3 groups one for kid other for youth, teen and third for professionals) I noticed that rather than keeping all products in a single shop/showroom they are selling through different shops/showrooms.

    Pros : Each shop is focussed on a single category and may be they can serve well to corresponding customer.
    cons : Extra cost of rent/property/employee etc will be there.

    I am unable to understand the reasoning behind this what is the rationale behind this.

    If possible please share your view.

  4. “In the past 50 years, we have only once realized an investment loss that at the time of sale cost us 2% of our net worth. Twice, we experienced 1% losses. All three of these losses occurred in the 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper.” WB 50th anniversary letter.

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