"Don't lose money." Avoiding loss should be the primary goal of every investor.

Warren Buffett likes to say that the first rule of investing is "Don't lose money," and the second rule is, "Never forget the first rule."

Avoiding loss should be the primary goal of every investor.

This does not mean that investors should never incur the risk of any loss at all.

Rather "don't lose money" means that over several years an investment portfolio should not be exposed to appreciable loss of principal.


Avoidance of loss is the surest way to ensure a profitable outcome.

Warren Buffett - An Outstanding Allocator of Capital

Warren Buffett

Warren Buffett was born in 1930 in Omaha, Nebraska. 

He took his first degree at the University of Nebraska and then completed a Master's degree in economics at Columbia Business School in 1951. He was supervised and mentored at Columbia by stock-investing guru Benjamin Graham, author of Security Analysis. 

Buffett received the only mark of A+ Benjamin Graham ever awarded in his security analysis class. From this it's clear that Buffett had an extraordinary ability in stock analysis from the very beginning of his career. 

Making Money

Warren Buffett grew obsessed with numbers and money from an unusually early age. It wasn't an obsession founded upon the lifestyle or the wordly goods money could buy. It was a collecters' obsession. Some boys in the 1930s and 1940s collected stamps. Some collected bird's eggs. Warren Buffett collected money. 

He started at the age of five, selling gum and lemonade in the street and he later set up a business, renting pinball machines to local barbers. By his mid-teens, he had made enough money from these earlier efforts and paper rounds to buy land - which he rented to farmers. 

Making More Money

Investing In Stocks

Warren Buffett bought his first shares at the age of eleven - his father was a stockbroker - and stock trading gave the young Buffett a natural outlet for his twin obsessions with numbers and money. 

After completing his master's degree, Buffett worked as a salesman in his father's brokerage. Between 1954 and 1956 Buffett worked for his old mentor, Benjamin Graham, then returned to Omaha, ready to begin his own investing business. 

Making Even More Money

Investing Other People's Money In Stocks

Warren Buffett's progress towards almost unimaginable wealth accelerated in 1957 when he pursuaded friends and family to invest $105,000 in his limited partnership. Then he began the process he is famous for, the process of annually compounding the money he manages extraordinary rapidly.




http://www.warren-buffett.net/

Smart Investing: Don’t Lose Money!

We’ve all been told that in order to create wealth we must take risks and invest, invest, invest. Between stocks, bonds, mutual funds, 401(k)’s, IRA’s and so forth, people are feeling the pressure to invest because they have been taught that it’s the only way to wealth. The problem is many people are losing money. And, though some recover from losses (and some never do), losing money has a much greater negative impact on your wealth than gains do. Let me explain.

Impact of Losses vs. Gains

First, some basic math. I want to show you how losses hurt much more than gains help. Many people are under the impression that if they have a 20 percent loss one year and a 20 percent gain the next, then everything is okay and they’re back to their original investment. Unfortunately, this isn’t true.

Let’s say you invest $100,000. The first year, you lose 20 percent. You’re left with $80,000. The next year you make a 20 percent gain. How much do you have? Remember the “gain” must be calculated from the current value of $80,000, so a 20 percent gain on $80,000 would take your value up to $96,000. You’ve still lost money.

But what if you had a gain first and then a loss, would that make any difference? Let’s see: Again, you start with $100,000. Only, this time, you gains 20 percent off the bat. Now you have $120,000. The next year you lose 20 percent, leaving you with $96,000. There is no difference whether you gain first or lose first; the loss can happen at any point and will still have a greater impact than the gain.

Don’t Lose Money!

Remember the most important rule in
creating wealth, “don’t lose money.” 

In the end, no matter how you choose to invest your money, make informed decisions and look at all your opportunities.

Dan Thompson is a 25+ year financial expert and author of “Discovering Hidden Treasures.” He specializes in wealth creation and retirement planning.

OCTOBER 5, 2010

http://www.quizzle.com/blog/2010/10/smart-investing-dont-lose-money/

Focus on how Buffett best avoids losses

List Your Top 5 Rules for Success in Investing

If I polled 1,000 investors and asked them to list their top 5 rules for success, their answers would differ from Buffett's. Here is what they would probably say:

Rule 1: Take a long term perspective.

Rule 2: Keep adding money to the market and let the magic of compounding work for you.

Rule 3: Don't try to time the market.

Rule 4: Stick to companies you understand.

Rule 5: Diversify.


Few investors would think to mention Buffett's cardinal "don't lose money" rule.

Why?

• Some investors, sadly, refuse to believe that losses can occur, so accustomed are they to the unprecedented rally in the major indexes since 1987.
• Surveys done by mutual fund companies during the past few years indicate that a high percentage of individual investors still don't believe that mutual funds can lose money or that the market is capable of dropping more than 10% anymore.
• Other investors see losses as temporary setbacks or as opportunities to add to their positions.
• Still others, acting out a psychological defense mechanism, try to avoid losses by violating their own rules. They let the ticker tape infect decision making and trade in and out of winners and losers to avoid the psychological trauma of having to report a loss.

Let's examine these issues.

1. Avoiding losses is probably the most important tool for long-term success in investing. No investor, even Buffett, can avoid periodic losses on individual stocks. Even, if you resigned yourself to buying only at incredibly cheap prices, occasional mistakes will still occur. What differentiates Buffett from nearly all other investors is his ability to avoid yearly losses in his entire portfolio.

2. Diversification alone can't prevent losses. All diversification can do is minimise the chances that a few stocks implode (non-market risk or stock specific risk) and drag the performance of the portfolio with them. Even if you hold 100 stocks, you are forever vulnerable to "market risk," the risk that a declining market causes nearly all stocks to drop together.

3. Most investors use the market as their mechanism for avoiding losses. What does this mean? They simply sell when a stock falls below its break-even point, no matter the fundamentals. One highly touted strategy of the 1990s, espoused by Investor's Business Daily, implores investors to sell any issue that falls more than 8% below its purchase price, irrespective of events. Market timers rely on similar strategies. They make short-term bets on the direction of individual stocks and are prepared to exit quickly if the market turns against them.

4. These strategies ultimately degrade into a form of gambling, where the odds of success shrink because the investors' holding period is too short. Other investos avoid losses by continuing to hold poor-performing stocks, sometimes for years, until they rally back above their original cost. To profit from this strategy, you must pin your hopes on the market's ultimately validating your decision.


How Warren Buffett avoids yearly losses in his entire portfolio?

Warren Buffett would rather not place his faith in the hands of investors and traders. The methods he uses to lock in yearly gains take the market out of the equation.

He reckons that if he can guarantee himself returns, even in poor markets, he will ultimately be way ahead of the game.

To learn more, we should focus on how Buffett best avoids losses.

These include:

Timing the market. He is not concerned about the day-to-day fluctuations in the stock market. However, Buffett - whether by accident or calculation - must be recognized as one of the most astute market timers in history.

Convertibles. Some of Buffett's most lucrative investments in the late 1980s and early 1990s involved convertibles, which are hybrid securities that possess features of a stock and an income-producing security such as a bond or preferred stock.

Options. On a number of occsions, Buffett has expressed his disdain for derivative securities such as futures and options contracts. Because these securities are bets on shorter-term price movements within a market, they fall under the definition of "gambling" rather than of "investing." If Warren Buffett does dabble in options, and few doubt he could dabble successfully, he does so quietly. He once acknowledged writing put options on Coca-Cola's stock; at the time he was thinking of adding to his stake in the soft-drink company.

#Arbitrage. Not only did Buffett continue to beat the major market averages, but he suffered few single-year declines along the way. That second accomplishment is, by far, the more remarkable. Buffett's scorecard shows that he has increased the book value of Berkshire Hathaway's stock 35 consecutive years. In only 4 years, did the S&P 500 Index beat the growth of Berkshire's equity. Right from the start of his investment management career, Buffett resorted extensively to takeover arbitrage (the trading of securities involved in mergers) to keep his portfolio results positive. In poor market years, arbitrage activities have greatly enhanced Buffett's performance and keep returns positive. In strong markets, Buffett has exploited the profit opportunities of mergers to exceed the returns of the indexes. Benjamin Graham, Buffett's mentor, had made arbitrage one of the keystones of his teachings and money management activities at Graham-Newman between 1926 and 1956. Graham's clients were informed that some of their money would be deployed in shorter term situations to exploit irrational price discrepancies. These situations included reorganizations, liquidations, hedges involving convertible bonds and preferred stocks, and takeovers.


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There are only 3 ways an investor can attain a long-term, loss-free track record:

1. Buy short-term Treasury bills and bonds and hold them to maturity, thereby locking in 4 to 6 percent average annual gains.

2. Concentrate on private-market investments by buying properties that consistently generate higher profits and that can sell for greater prices each year.

3. Own publicly traded securities and minimise your exposure to price fluctuations by devoiting some of the portfolio to unconventional "sure things.# "

Why Buffett is top in the financial world of investing?

If you understand the rules of the loser's games, you have taken a critical first step toward success in investments.

Warren Buffett sits atop the financial world because he made the fewest mistakes over his 40-year career. His most common mistakes, he admits, are "sins of omission," in which he

• failed to buy a stock that rallied, or
• sold a stock too soon.

Neither type of mistake costs Buffett cash. (Rule 1: Don't lose money)

They are simply lost opportunities.

Avoiding losses is probably the most important tool for long-term success in investing. No investor, even Buffett, can avoid periodic losses on individual stocks.

What differentiates Buffett from nearly all other investors is his ability to avoid yearly losses in his entire portfolio.

The Benefits of Avoiding Mistakes

1. A typical investor who spreads his or her money over a basket of stocks can expect to achieve 10 to 12 percent annualized gains over great periods.

2. The same investor who focuses on the types of stocks Buffett owns - Coca-Cola, Gillette, Capital Cities, Wells Fargo, etc. - could expect to gain perhaps a few percentage points more each year. These stocks have shown a tendency to outperform the market over long periods because they exhibited growth rates greater than the average US corporation.

3. A shrewd, full time investor who focussed on Buffett-like stocks and made sure to buy them at wonderfully cheap prices could add a couple of extra percentage points of gain a year.

But the combined effects of these strategies still don't come close to producing the 33 percent compounded annual gain Buffett attained between the mid-1950s and the late 1990s.

Peter Lynch's managed the Magellan Fund. He bought and sold common stocks like the rest of us, including many of the same types of stocks you probably placed in your own portfolio.

Why, then, did Lynch and Buffett attain vastly superior results? There's got to be more to the story.

We tend to overlook the fact that the success of investors such as Lynch and Buffett derived from thousands of critical decisions they made over the course of decades, many of which were made on the fly; but the majority of which were correct.

In our quest to find shortcut answers to how they did it, we tend to look at only the beginning - that Buffett started with $100 - and at the end - his $30 billion fortune and dismiss the daily rituals that got him from point A to point B. Those rituals, however, are what pushed Buffett's returns well above those of the crowd.

"If everybody had seen what he had seen, he wouldn't have made huge gains from his visions," Forbes magazine once wrote.

The Power of Avoiding Losses

Losses occur for three primary reasons:

1. You took bigger risks and exposed yourself to a higher probability of loss.

2. You invested in an instrument that failed to keep pace with inflation and interest rates (e.g. CDs).

3. You didn't hold the instrument long enough to let its true intrinsic value be realized.

There aren't many ways an investor can avoid periodic losses. The best way is to invest all of your assets in bonds and hold them to maturity. You would, of course, experience an erosion in the value of the bond due to inflation. If interest rates rise during your holding period, the intrinsic value of the bond would fall and the yearly coupon wouldn't compensate you for inflationary pressures.

To reduce the chance of losses, you must minimise mistakes. The fewer errors made over your investing career, the better your long-term returns.

We've seen the advantage of adding extra points of gain to your yearly returns. Earnings an extra 2% points a year on your portfolio compounds into tremendous amounts. Beating the market's presumed 11% yearly return by 2% points would translate into hundreds of thousands of dollars of extra profits over time.

The same holds true if you can avoid a loss. When you lose money, even if for just a year, you greatly erode the terminal value of your portfolio.

• You consume precious resources that must be replaced.
• In addition, you waste precious time trying to make up lost ground.
• Losses also reduce the positive effects of compounding.

The effects of avoiding losses can be studied by considering 3 portfolios, A, B, and C, each of which normally gains 10% a year for 30 years. Portfolio B, obtains zero gains (0%) in years 10, 20, and 30. Portfolio C suffers a 10% loss in years 10, 20 and 30.

• A $10,000 investment in portfolio A would return $174,490 by the 30th year.
• Portfolio B would return considerably less - $131,100 - because of three break-even years. The portfolio never actually lost money, but will forever lag far behind porfolio A by virtue of having three mediocre years. Historically speaking, portfolio B's returns aren't all that bad, for the investor managed to avoid losses every year.
• Portfolio C, by contrast, loses 10% in years 10, 20, and 30. It's return of $95,572 was considerably lower. The effects of those three not-so-unreasonable years is to lop nearly $79,000 off the final value of the portfolio. That's what compounding can do. The actual loss in the 10th year was only $2,357. The loss in the 20th year was just $5,004; the final year loss was $10,619. But the power of compounding turned $17,980 in total yearly losses into $79,000 of lost opportunities.

Buffett once summarized the essence of successful investing in a simple quip:

Rule number 1: Don't lose money

Rule number 2: Don't forget rule number 1