What is risk? First, don't lose

What is risk? You will get different answers depending on whom, and when, you ask.

In 1999, risk didn't mean losing money; it meant making less money than someone else! What many people feared was bumping into somebody at a barbecue who was getting even richer even quicker by day trading dot-com stocks than they were.

Then, quite suddenly, by 2003 risk had come to mean that the stock market might keep dropping until it wiped out whatever traces of wealth you still had left.

While its meaning may seem nearly as fickle and fluctuating as the financial markets themselves, risk has some profound and permanent attributes. The people who take the biggest gambles and makes the biggest gains in a bull market are almost always the ones that get hurt the worst in the bear market that inevitably follows. (Being "right" makes speculators even more eager to take extra risk, as their confidence catches fire.)

And once you lose big money, you then have to gamble even harder just to get back to where you were, like a race-track or casino gambler who desperately doubles up after every bad bet. Unless you are phenomenally lucky, that's a recipe for disaster.

First, don't lose

No wonder, when he was asked to sum up everything he had learned in his long career about how to get rich, the legendary financier J.K. Klingenstein of Wertheim & Co. answered simply: "Don't lose."

Losing some money is an inevitable part of investing, and there's nothing you can do to prevent it. But, to be an intelligent investor, you must take responsibility for ensuring that you never lose most or all of your money.

For the intelligent investor, Graham's "margin of safety" performs an important function. By refusing to pay too much for an investment, you minimize the chances that your wealth will ever disappear or suddenly be destroyed.

"Imagine that you find a stock that you think can grow at 10% a year even if the market only grows 5% annually. Unfortunately, you are so enthusiastic that you pay too high a price, and the stock loses 50% of its value the first year. Even if the stock then generates double the market's return, it will take you more than 16 years to overtake the market - simply because you paid too much, and lost too much, at the outset."


Ref: Intelligent Investor by Benjamin Graham