“You Never Lose by Not Losing”
My big bold claim today is that the most important thing an investor needs to concentrate on is not losing their money. In fact Warren Buffet has only 2 Simple Rules of Investing: #1- Don’t Lose Money; #2- Don’t Forget Rule #1. Why is this the absolute most important thing to worry about? That is the topic of today’s article.
Why You Absolutely Cannot Lose 20% or more
Many investors do not realize it, but do you know what return you require to recover from a 10% loss? 10% you say? No, it’s 11%. And the hole you dig gets deeper as the loss widens. As you can see here:
- A loss of 20% requires 25% to break even
- 30% requires 43%
- 40% requires 66%
- 50% requires 100% just to get back to even!
If you were to, say, lose 10% one year, then grow 11% the next, not so bad. But you have lost 2 years of time that you will never get back. Larger losses can result in many years to recover. So the most prudent thing is to ensure you don’t experience those 20% losses in the first place. The last thing you want is to lose 100K on a 500K portfolio, at the same time as using that portfolio for living expenses, and wait 5 years for the portfolio to recover. Then only problem is that I see so many portfolios set up to take just such a loss. This is mainly because the financial system is paid higher fees and commissions to place your money in riskier investments.
Growth, Income, Tax-Savings, or Capital Preservation?
What type of investor are you? When helping people sort out their retirement plan, I hear some say income, some say growth, but I always make sure to talk about capital preservation aka Not Losing Your Money. Why? Because if you focus on growth, you could also lose a lot, which can affect your standard of living and ability to retire in comfort. If you focus on income, you might stretch for higher and higher yields, and take on too much risk of loss, setting you back as well. But if you happen to miss out on some income, or some growth, keeping some of your money in GICs or annuities, at least you don’t lose your retirement. I have seen so many investors chase returns and put themselves in a hole they will never recover from. I have never spoken with an investor who lost their retirement income and security by playing it safe. Not once.
What to Look for in a High-Quality Investment
It is temping to ask “what’s the yield” or “what is the 10-yr track record”. But those very questions, while important, will set you up for failure every time. Some of the more important questions for yield investors are:
- How do they earn the yield?
- Is the income sustainable?
- Is the yield pure cash earnings or generated through leverage (borrowing to magnify gains)?
- How will rising interest rates affect this investment?
And equity investors absolutely need to know:
- What is the standard deviation (how much risk am I taking for each unit of return)?
- How did this investment or portfolio perform during the 2008-09 financial crisis?
Always look for the possible risks, the downside, when examining an investment portfolio or product. I would much rather earn a solid 6% yield than a precarious 9%. Don’t chase the 9.
If you want a secure retirement, follow Warren Buffet’s rules of never losing money, as nobody has ever had to start eating cat food by playing it safe. Make sure you ask the right questions when examining an investment or portfolio (get that standard deviation- it’s so important!). People retire successfully with low debt, living below their means, and avoiding the big loss. It’s that important.