These are probably the 2 most important rules of investing.
"The first rule of an investment is don't lose [money]. And the second rule of an investment is don’t forget the first rule. And that's all the rules there are."
But why? Why are these the only 2 rules of investing?
Personally, to me, there's a few reasons - beyond stating the obvious that nobody wants to lose monies in investing.
Reason #1 - The retiree with a large EPF without active income.
For this segment of investor, if they are not ultra wealthy (i.e. they still need investment income to cover their lost salaries due to retirement), then, they will be in a permanently precarious position when lose monies because they then have to dip into their capital to spend to live, i.e.
1. There will be a permanent reduction to investing capital, and
2. To provide the same level of investment income as before, they need to target an even higher % returns that comes with higher risks of losing money.
Hence, for these investors, Buffet's Rule No 1 is critical.
Reason #2 - Returns Asymmetry: If you lose 50% capital, a gain of +50% capital won't get you back to original capital.
This is an often forgotten concept, but mathematically, if you start with RM1 million and you lose 50%, the remaining principal is only RM500,000.
Then, if you want to grow RM500,000 back to RM 1 million, then, +50% return is insufficient. This is because 500,000 x (1 + 50%) = 750,000 only.
To get back to RM1,000,000, you need +100% returns.
This is the main reason why you should not dig a big hole, when it comes to wealth accumulation.
A small loss like -5% requires +5.26% returns to get back to 100% since (1-5%) x (1+ 5.26%) ~ 100%.
However, a big loss like -50% requires +100% returns to get back to original capital, since (1-50%) x (1+100%) = 100%.
This is simple mathematics - you must fully integrate this understanding into your subconscious.
Reason #3 - you have many other investment alternatives that doesn't lose monies
3 examples:
1. Put the money into savings account with a solid bank insured by PIDM and earn low interest. Ask your parents, your grandparents, ask your relatives, ask your friends, ask how many of them lose monies because they put monies in their savings account, and odds are, you will struggle to find one that has actually lost monies.
2. Put the money into fixed deposit with a solid bank insured by PIDM. Again, ask the same people and ask how many of them lost monies vs investing in stocks and odds are, you will find nobody has lost monies yet when they put monies into FD. They may lose out in some years to inflation, but they haven't lost monies like they lose in the stock market.
3. Put the money into EPF before age 55 and by the time you turn 55, you can always withdraw like a bank account (perhaps delay a few days for processing but no major drama if plan ahead). Ask 100 people with real life EPF account and ask how many of them have lost monies. Ask 55 and 60 year olds today how many have lost monies. Ask 70 and 80 year olds today if they have lost monies. Odds are, you won't find anyone. Sure, there are always the doomday sayer who says EPF is a ponzi scheme and so on, but Malaysia EPF is not that extreme. If you are approaching retirement today, EPF is still your safest and best investing vehicle for literally doing nothing. On the other hand, if you are a fresh graduate entering the workforce, it doesn't harm you to diversify i.e. contribute to EPF and spare some monies for other ways of investing, such as savings in FD to plan to buy your own home that appreciates in value, assuming you own a basic car that will get you from A to B at reasonable cost.
Other examples is buying your own home to live in.
Or invests in real estate property (a 2nd home, or more) but don't over leverage. The value of a property appears stable due to lack of revaluation but it doesn't mean it cannot go down in the short term, although wait long enough (and assuming you don't over-pay like buy at the peak of the market, don't over-leverage like borrowing too much, unable to service interest and principal causing forced sell, don't make poor decisions like buying at a poor location), eventually, they will go back up (the uncertainty is timing). Ask 100 people who actually bought prudently and held for a long term (at least 10 years) and the vast majority if not all wins (provided they don't over-pay, don't over-leverage and don't make poor buying decisions).
Or invest in a diversified portfolio of a sound, growing, profitable businesses managed by above average management that can be purchased at an attractive price, that pays a stable % of earnings in dividends, combined with EPF + FD to take advantage of the rare stock market crashes. (this is harder to do than it sounds, but easier to do than it looks).
So, you really have so many alternatives that don't lose monies, hence, why should you lose monies in equities?
Reason #4 - if your equity investment goes to zero, you can never recover back.
This applies to the popular warrants / derivatives in KL stock market, and sometimes to the seriously speculative stocks.
The thing is these warrants usually cause the vast majority of speculators to lose monies. The number of speculators who eventually leave the warrant market far outnumber the extremely few speculators who are still punting and claimed to make money since Day 1 (likely, vast majority here are faking).
Sure the gains can be occasionally be spectacular but do this long enough, and ask 100 players and vast majority lose monies. And in too many cases, these warrants goes to zero at expiry date.
The problem is greed + hope combined with leverage. These are lethal combinations that is sure to cause you to lose monies in the long run.
Another famous Buffet quote:
“Having a large amount of leverage is like driving a car with a dagger on the steering wheel pointed at your heart. If you do that, you will be a better driver. There will be fewer accidents but when they happen, they will be fatal.”
Another Buffet and Munger concept:
Reason #5 - 2 x 2 x 2 x 2 x ..... x 0 = 0
What this means is that no matter how many times you doubled your money in the past, all it takes is 1 time of -100% and your entire capital is lost permanently, forever with no chance of getting back into the game.
Reason #6 - you PERMANENTLY lose time to recoup losses and make gains
When you are young, time may not seem important to you, especially when you think you have lots of it. But as you get older, you will learn that Time = Money.
Those sensitive to time and safe returns know that it takes a long time to double your wealth via FD returns. E.g. if FD earns 3% per annum, it takes 23-24 years to double your monies, so, if you lost 50% of your capital due to poor investment in speculative stock / warrants and avoid equity market altogether, it will take you 23-24 years to recoup that loss back, because you will have realized that losing 50% requires +100% returns (or doubling your monies) to recoup back your original investment.
That's an awful long time that has been permanently lost!
Other Rationalizations
Two popular rationalizations.
#1 Tuition Fees.
Sometimes - especially investment "educators" like to quote this - you never actually lose monies because you are paying "tuition fees" to the market.
On one hand, it's a positive thing to look at your losses and there's mental and emotional benefits for thinking like this. It retains your sanity.
However, it is still a permanent loss. The point is - in investing, there is really only ONE score-card. Your P&L. Everything else is excuses. If you don't grow your monies in the equity market after a reasonable period of time, it means you are not suited for investing or trading and you are better off giving your monies to the professionals to manage than DIY yourself.
Your so called "tuition fees" are far too expensively paid. I paid less than RM50-RM100 per lesson on my kid's tuition, you should not need to pay 10 times more for your investing "lessons", no matter how much these "educators" promised you will earn in return after "learning". Sadly, there are some investors who has lost 5 digits, 6 digits or even more in the market and then had to leave the market permanently with that kind of losses with no chance of recouping. That kind of lesson, when compared to studying Finance and Investments in Universities, are far too expensive and far less useful. At least, with a degree in Finance or Investments, you can still look for employment and a salaried employment income! With those ridiculous fees paid to "educators" for 3 or 5 or 7 day courses, which promises "financial freedom", which reputable financial institution would want to hire you and pay you a monthly salary after you "graduate"?
#2 At least I beat the market
Another famous rationalization is - "at least I don't lose as much as the market" or "I beat the market". Yes, market lost 20% and you lost 18%, so, you beat the market by 2%. Wonderful! But is it really?
Again, you started with RM1 million, and now, you lost 18% and your capital shrunk to RM820,000. You beat the market by 2%. Are you happy?
For me, the answer has to be a resounding No! No, I am not happy! Unless this is a temporary loss, with a very high probability that I will eventually beat EPF / market (whichever is higher) by the same margin! In other words, generalized excuses doesn't cut it for me.
There needs to be a very high probability strategy, that will put me ahead by at least the same % win if not more. If I take -20% risk, I want a return with very high probability (at least 75% probability) of eventually gaining +20% returns or more. At least 3 to 1 win to lose odds, if not 5 to 1 or 10 to 1 odds, or better! 75% probability is the absolute minimum. I prefer 95% chance of gaining 20% if lose 20%.
Long term successful business people don't gamble with 50-50 chance. The really good ones already win when they enter the game. To them, their combined business ventures and combined business deals are not gambles but certain wins, even if individual deal may risk losing monies. That's how you should approach investing. Don't invest, unless you are certain that you will come out a winner in the final account after a reasonable period of time.
If you can't visualize with certainty how you will come out winning, don't invest. Instead, park your monies in EPF and at least, this way, you can visualize with 100% certainty that 1, 2, 3, 5, 10 years from now, your EPF balance will be higher.
This is not saying that every stock you invest in will be a winner. The goal is the final account balance that combines all the stocks that you invest/traded in. It is the final account that matters. Whether a minority stock wins (with majority losing) but the total grows the account in a huge way, over time, is far more important than the component performance of that account.
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