The Rules of Investing: “Don’t lose money”

Dear Clients and Friends,

Warren Buffett is famous for saying there are only 2 rules for investing, “Rule # 1: Don’t lose money and Rule # 2, Never forget Rule #1.”  Yet Warren has had his fair share of losses over the years, and it is on this point that I would like to have a brief discussion.  The lessons we learn from great investors sometimes need to be unpackaged and explained in light of our fast-changing world.  Over the years, Buffett has made far more winning investments than losing investments, and time has been the friend of the winners, allowing him to compound at very high rates.  A philosophy rooted in avoiding losses is a worthy goal, but a most difficult practice.

When you take a hard look at the teachings of ultra-successful investors, from Keynes to Templeton to Buffett, you find a common thread in their investment philosophy that bears some discussion.  The common threads are rooted in their concept of risk, their ability to deal with uncertainty, and ultimately their ability to handle their emotions.  Peter Lynch once stated, “The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them.”  Years earlier Ben Graham, the father of value investing and the teacher of Warren Buffet, had summed it up this way: “The investor’s chief problem and even his worst enemy is likely to be himself”.

In dealing with uncertainty, which tends to be the most palpable irritant in our markets today, Keynes once quipped, “When information changes, I alter my conclusions.  What do you do sir?”  The future is always uncertain, even when it looks like there is certainty.  We make educated guesses based upon our knowledge, experience and judgement.  If the variables change, we have to deal with those changes and at times that means we have to reevaluate our position.  Keep in mind, the core philosophy doesn’t change, but the variables do change.

Extreme optimism about the future can many times create risk.  People who are optimistic are willing to pay higher and higher prices for things that may not retain their value.  A new, ground breaking invention that has amazing utility may appear to be a superior investment.  However, as history has shown, the airplane, automobile and computer all ended up producing losses for long term investors.  Buffet is famous for saying, “if a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down”.   Just because something will “change the world” does not necessarily mean that it will make long term investors tremendous profits.  At times, the optimism surrounding the innovation comes at a very high price, making the investment a poor and sometimes lethal investment.

I want to end with what may be the most important quote for clients in today’s markets.  Benjamin Graham once made an important observation about performance that has relevance today.  He wrote in The Intelligent Investor, “The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risks including loss of principal. No strategy assures success or protects against losses.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

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