Rule number 1 - Buffett
Rule number one is, “Don’t lose money.”
Rule number two is, “Don’t forget rule number one.”
I must admit that I have always found this rule particularly uninspiring.
Yes, I understand the concept of “margin of safety.” I also know there’s nowhere to hide. There's risk in holding cash, bonds, gold, commodities and/or stocks. For me, stocks are easier to analyze. I prefer them to the alternatives. American stocks in particular are potentially less risky. There's more publicly available information about U.S. stocks than about any other asset class on the planet.
Thanks to the SEC, we know there are profitable companies out there that have more cash in the bank (after deducting all liabilities) than the stock sells for. That's as safe as it gets.
And then a tsunami comes along, 9/11 happens, Chavez or Kirchner nationalize something and/or management, aided by well-paid accountants, lies about the true state of the company.
Such events are somewhat unknowable and wholly unpredictable. More importantly, they can cause you to lose money regardless of your margin of safety.
That is why I find rule number one so uninspiring. There are many reasons investors lose money. Some of those reasons are within their control. “Don’t lose money” applies to the outcome. At best, the thoughtful investor is able to control the process.
Rule number 0 - Munger
Mozart became the most famous composer in the world but was utterly miserable most of the time, and one of the reasons was because he always overspent his income. If Mozart can’t get by with this kind of asinine conduct, I don’t think you should try.
Since I heard that, I have been taking it very seriously. I am now not spending 25% of my after-tax income. As Munger would say, I avoid a lot of dumb stuff by sitting on my hands. My friends and family haven’t noticed any lifestyle changes. They may or may not have noticed I smoke two cigars a month instead of two a week. I use my bike more often. My wife noticed our phones now accept inbound calls while she is calling outbound (Voipbuster/SIP). It's amazing how much money you can not spend without anyone noticing.
In any case, next time you scoff at a company with a single-digit net margin, think of your own personal “net margin.” How much cash do you have left in the bank after taking care of your expenses ?
Why is this important in the context of value investing?
1) As a consistent net buyer of stocks, you will be glad to see stock prices go down. You have a steady stream of excess cash to deploy. It gets easier, emotionally, to be bullish when others are fearful.
2) You can reduce your portfolio turnover. You don’t have to sell something to buy something else.
3) With 25% “net margin” and an assumed 8% rate of return, you can reasonably expect your personal portfolio to be worth about 20 times your annual cost of living within your lifetime.
4) You have instantly become a full-time value investor. When you're busy not spending money, you are accumulating wealth. On the rare occasions that you are spending, you will be more aware of the price you are paying and what you are getting in return.
5) You reduce risk on all levels. Should your income take a hit, you have lower costs and you will have saved up more. Also, if you make a serious investment mistake (rule number 1), you live to invest another day.
In short, underspend your income. Become a full-time value investor today.