If you've been invested in the stock market for the past five years, there's a good chance you've made a substantial amount of money. Just imagine if you'd had the money you have now invested in the 1970s, 1980s, or 1990s!
Investing mogul Warren Buffett doesn't have to use his imagination. Buffett is CEO of Berkshire Hathaway, (NYSE:BRK-A) (NYSE:BRK-B) a conglomerate that owns around five dozen different businesses from a variety of sectors. He's been an investor for more than 60 years, and in that time he has turned about $10,000 in savings into a fortune now valued by Forbes at close to $74 billion!
Warren Buffett and I don't always see eye to eye
Throughout the years Buffett has coined many memorable phrases and investing idioms that investors have taken to heart to help shape their own investing strategies. Many of them are downright genius. A personal favorite of mine has always been "Be fearful when others are greedy, and be greedy when others are fearful." In other words, when emotions get the better of traders, you can use that opportunity to pick up great companies at a bargain. Conversely, when your taxicab driver has the next hot stock tip, that's when you should worry.
However, I can't say I agree with everything Buffett has ever said. One of the most famous quotes accredited to Buffett is the following: "Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1."
It's a fairly harmless quote conveying that Buffett and his Berkshire team of investors are out to make money on every transaction and with each buyout. But I don't agree with this piece of logic.
Even the best traders in the world are only correct about 60%-65% of the time. Warren Buffett, the Oracle of Omaha, even had to admit defeat after selling overseas grocer Tesco at a loss. In sum, I believe that placing the utopian idea of never losing money into the minds of investors can be downright dangerous.
It's OK to be wrong
Every investor strives to make money when buying a stock, but not every investment will ultimately be successful. Whereas Buffett's quote implies that losing money is unacceptable, I believe money-losing investments help us grow tremendously. By losing money, investors become more acutely aware of why their investing thesis failed. The earlier an investor can recognize these danger signs -- and to be clear, I'm talking about a material change in a company's business model, not just a single weak earnings report -- the sooner he or she will be able to remove that stock from their investment portfolio before it becomes a financial drag.
In addition to teaching us why some stocks fail to live up to our expectations, losing investments remove any illusions of invincibility, which can be downright dangerous in the investing arena.
When I was in my late teens and early 20s, I had a hard time believing that I could ever be wrong. I assumed that because I had rigorously screened and scoured the stock market for the cheapest stocks based on a handful of valuation metrics, I had found surefire winners despite the fact that some of their business models were in jeopardy. My stubbornness wound up costing me all of my money on some of my trades.
Money-losing trades have a way of reminding us that investing is a lifelong learning process. This, I believe, is critical to keeping investors on track over the long term.
This utopian strategy wouldn't work
Conversely, we have to consider the other angle here which is what an investment portfolio would look like if an investor's sole purpose were to avoid losing money as Buffet describes. In this type of portfolio we'd likely see the safest investments imaginable, such as U.S. Treasury bills, AAA-ranked corporate bonds, or even bank CDs.
The problem with a strategy like this is, while mitigating risk and all but ensuring you don't lose any of your capital, the real money implications can yield undesirable results. Because government bonds, and banks CDs have such low yields at the moment, it's possible they may not outpace inflation over the long run. In other words, while your nominal dollar figure is increasing, your real money figure relative to inflation isn't going anywhere -- and that's bad news if you're expecting to retire comfortably!
There needs to be some degree of risk and loss-willingness in your investment strategy to not only grow wiser as an investor, but also to have a shot at outperforming inflation over the long run.
In the end, Warren Buffett has arguably contributed more wisdom to the investing world than anyone in his generation. However, never losing money is a Buffetism that I believe can be easily ignored.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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