I have a setting on my Google account that helps me track all news on Warren Buffett. (I also follow, who else?, Bill Ackman and Sardar Biglari)
And there was this very interesting title that appears on my email yesterday. “1 Piece of Advice From Warren Buffett That You Can Ignore” (Read more: http://www.fool.com/how-to-invest/personal-finance/2014/12/13/1-piece-of-advice-from-warren-buffett-that-you-can.aspx#ixzz3M1ltzJPC)
Now Warren Buffett is my greatest hero. But I do not exactly treat him like a God. And whenever there is an opportunity to learn about investing, I usually pound at it. I was actually excited to see there might be some interesting angles into what we should NOT learn from the greatest.
Unfortunately, I was disappointed.
In the article, the author points to the famous “Rule #1: Never lose money” as the thing he would advise us not to follow. To defend his proposition, he is basically telling us that it’s okay to be wrong, and the Utopian strategy of never losing money will not work and perhaps entails you to put your whole portfolio into US treasuries.
Now, this is interesting. I basically agree with his points. It’s just that his misunderstanding of Buffett’s quote makes me feel compelled to write this post.
First of all, I actually never recall the actual quote being “Never lose money”. Instead, I always think it is “Rule #1: Don’t lose money” And there is a huge difference between the two. When Buffett espouses his investment philosophy, he always tells us that even though he aims at crossing the one foot bar, he will keep making mistakes. It was never a shame thing for him to admit his own mistakes, as you can read from his shareholder letters. For a man so willing to admit his own mistakes, it sounds strange for him to ask people to never lose money. In other words, it’s simply wrong to imply from this perhaps erroneous quote that Buffett believes losing money is unacceptable.
So what is Buffett really saying?
He is talking about “Don’t lose money”. And that is a totally different idea. This is actually a really really important idea from Buffett. So it is better we do not misunderstand him. The notion behind this famous saying is not to ask people to never lose any money, but to remind people what to really focus on. And that’s to frame your mind into thinking about the downside, instead purely of the upside.
(A little sidetrack here: Even though Buffett is the most followed investor of all time, he is actually not that well understood. There are a lot of superficial “explanation” of Buffett on the Internet. To really learn from him it’s important to know what to absorb and equally important, what not to. Two great sources that come to my mind immediately are Alice Schroeder and Geoff Gannon.)
If you go to YouTube and search for Alice Schroeder, you will find a value investing congress video featuring Alice. That is one of the most important videos on investing you will find on YouTube. One point for you to really digest is what Alice points out as one of a few unique things about Buffett’s investment process: (not quoting from the video at all) Now Buffett is different. Unlike almost everyone else, instead of looking at the upside, Buffett immediately skips looking at a lot of investments because of the potential cat risk involved. He does so by asking one simple question before doing any work on a prospective investment. The question is basically: What are the odds that this investment could fail because of catastrophe risk? In other words, what are the major things that could go wrong? And if he feels like that he can’t size that risk up, he will not consider investing at all, no matter the upside.
Going back to the Motley Fool article, the author obviously lost money with his early investments because he didn’t spend much time thinking about the downside. He thought he would never lose money, in lieu of trying to not lose money by focusing on the downside.
Now, that is not a good example to follow. The author’s last advice, “…never losing money is a Buffetism that I believe can be easily ignored”, is another one to not follow.
Substantia Investing 