Aug 252013

Rule no. 1: Never Lose Money is the Blackstone Principle of Intelligent Investing. Following Ben Graham’s timeless guidance, the best way to observe the rule is to abide by the Central Concept of Investing: the Margin of Safety.

As Michael Price said earlier this year in his brilliant talk at the London Value Investor Conference:

When you put a portfolio together of cash, which won’t go down, and securities that trade at 60% of their intrinsic value, how much can that portfolio go down in a bear market? (at 5:54)

Answer: a lot, as he immediately hastened to add:

– forgetting ’08. We all need to forget ’08. It wasn’t pleasant.

Or forgetting 1930, as Ben Graham himself would have said, when his Joint Account lost 50%, following a 20% loss in 1929:

(Kahn and Milne, p.18. See also Joe Carlen’s biography, p.158).

Surely, then, Rule no. 1 needs some integration. Something like:

Just kidding. The only way to avoid losing money – if only in nominal terms – is to keep it in cash. But if you want to be an investor, you’d better be prepared to lose money, and occasionally a lot of it. Above all, you should fully understand what losing money really means.

Here is an example: Sam used to manage Mike’s money. Mike was very happy about Sam’s performance, until 2008, when his account started heading south. He kept his cool for months, but after Lehman’s bankruptcy he lost his trust. By the end of the year, with the portfolio down 50%, he instructed Sam to liquidate all positions, withdrew the money and kept it in cash, including the bonus he earned from his employer at the start of the new year, which until then he had diligently reinvested in the account. Mike wanted one thing, and one thing only: stop losing money. And with Nouriel “Meltdown” Roubini, a.k.a. Dr. Doom, warning the world that, like in the ’30s, the downfall was going to last a lot longer, Mike felt relieved: two more years of losses? No, thanks!

As it turned out, Dr. Doom was wrong. By the end of ’09, Sam’s stocks – the old ones he had clung to, and the new ones he had picked up on the cheap – had a strong rebound. Had he not sold, Mike’s portfolio would have ended the year up 80%. So let’s compare:

Mike started 2008 with 100. By the end of the year, when he cashed out, he had 50. Plus 10 he got as a bonus, at the end of 2009 he had 60. Sam lost me 50 – he complained.

But that’s wrong. Had he refrained from liquidating, Mike would have ended the year with 108. It was his decision to sell that lost him 48.

Rule no. 1: Never Lose Your Bearings.

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  One Response to “Rule no. 1”

  1. Thanks for clarifying the commonly misunderstood maxim “never lose money” — very illuminating.

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