By Dr. Jim Dahle, WCI FounderWarren Buffett's first rule of investing is “Don't lose money.” It's a wonderful maxim, kind of like, “Don't catch a falling knife.” I think it's bad advice, though. I think much better advice comes from a quote whose source I have been unable to find but it goes something like this:
“It is the duty of the investor to lose money from time to time.”
Now, “duty” may be too strong a word, but I think it's actually really important to lose money as an investor. If you're never losing money, you're not making as much as you possibly could.
‘You Don't Lose If You Don't Sell' Is Bunk
There's a school of thought out there that basically says if you don't sell, i.e. realize your loss, you haven't actually lost money. That's a load of crap. When your stocks or your investment property or your house or your bond fund goes down in value, you absolutely do lose money whether you sell it or not. Maybe it helps you to stay the course with your investment plan if you pretend that isn't true, but you're only deluding yourself.
More information here:
Why ‘You Don’t Lose Money Until You Sell’ Is Bunk
Losing Money Is Part of the Game
I've lost a lot of money in my lifetime as an investor. I've lost it on many occasions. I've had investments go to zero. I've tax-loss harvested six-figure losses on multiple occasions. I started paying attention to my investments and the value of my home and businesses relatively early, so I've lost all amounts of money. Three figures, four figures, five figures, six figures, seven figures. Maybe more. What does that mean? That just means I had money at risk.
By putting that money at risk, however, I've earned lots more money than I've ever lost. There's a parable in the Bible. It's lengthy, but I think it's worth reading in its entirety. It probably really isn't meant to be a financial lesson, but we're just going to look at it from a financial perspective.
“For the kingdom of heaven is as a man traveling into a far country, who called his own servants, and delivered unto them his goods. And unto one he gave five talents, to another two, and to another one; to every man according to his several ability; and straightway took his journey. Then he that had received the five talents went and traded with the same, and made them other five talents. And likewise he that had received two, he also gained other two. But he that had received one went and digged in the earth, and hid his lord’s money.
After a long time, the lord of those servants cometh, and reckoneth with them. And so he that had received five talents came and brought other five talents, saying, Lord, thou deliveredst unto me five talents: behold, I have gained beside them five talents more. His lord said unto him, Well done, thou good and faithful servant: thou hast been faithful over a few things, I will make thee ruler over many things: enter thou into the joy of thy lord. He also that had received two talents came and said, Lord, thou deliveredst unto me two talents: behold, I have gained two other talents beside them. His lord said unto him, Well done, good and faithful servant; thou hast been faithful over a few things, I will make thee ruler over many things: enter thou into the joy of thy lord.
Then he which had received the one talent came and said, Lord, I knew thee that thou art an hard man, reaping where thou hast not sown, and gathering where thou hast not strawed: And I was afraid, and went and hid thy talent in the earth: lo, there thou hast that is thine. His lord answered and said unto him, Thou wicked and slothful servant, thou knewest that I reap where I sowed not, and gather where I have not strawed: Thou oughtest therefore to have put my money to the exchangers, and then at my coming I should have received mine own with usury. Take therefore the talent from him, and give it unto him which hath 10 talents. For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath. And cast ye the unprofitable servant into outer darkness: there shall be weeping and gnashing of teeth.”
The key line in this parable, at least for our purposes today, is
“Thou oughtest therefore to have put my money [into the market], and then at my coming I should have received [my principal] with [interest].”
You're SUPPOSED to lose money. You're SUPPOSED to put money at risk. If you only ever invest in investments that won't go down in value (savings accounts, money market funds, I Bonds, CDs, whole life insurance (the cash value, not the premiums)), you're not going to earn enough to reach your financial goals. You may not even earn enough to beat inflation sometimes. You need your money to do some of the heavy lifting or you will need to maintain a savings rate of more than 50% for your entire 30-year career just to retire to the same standard of living you're at now. One of Jack Bogle's cardinal rules was “Invest You Must.” You have to invest, and for most investors, you have to invest most of your assets into risky investments like stocks, real estate, and small businesses you control.
We track our net worth each year. It generally goes up, sometimes by impressive percentages. The first year it went up by an infinite amount since it started at zero. The second year it went up by almost 4,000%, and it was 300% the year after that and 105% the year after that. Since then, it has gone up most years by anywhere from 17%-78%. The last couple of years? Not so much. In 2022, it went up only 2%—our savings barely overcame the drop in value of our investments. And in 2023, despite the investments doing great, our net worth dropped by 11% (WCI didn't have such a hot year financially and makes up a substantial part of our net worth).
Others have seen their net worth decrease at times, too. It might be a drop in the value of a major asset like a business or a home. Or there's a terrible investing year (especially after retirement when savings can't help cushion the blow). Divorce or disability can wreak havoc on a net worth, too. That's all part of taking risks. If you've set up your financial life such that your net worth cannot drop, it isn't ever going to get very big.
More information here:
Best Investment Portfolios — 150+ Portfolios Better Than Yours
The 15 Questions You Need to Answer to Build Your Investment Portfolio
Get Over Your Fear
I often run into WCIers who are so afraid to lose money it causes them to invest suboptimally. I want to change that mindset and those bad financial habits. It shows up when people come into a windfall and want to dollar cost average it. If they actually calculated the worst-case scenario, they would usually find it is fairly trivial. Their fear is irrational and silly. In other situations, it's paralysis by analysis. They're so afraid to make a mistake of commission (investing in the wrong thing or at the wrong time) that they make one of omission (not investing at all). Not making a decision IS making a decision.
Or they tell themselves something like:
- “I'll look for a better job next year” or
- “I'll ask for a raise next time” or
- “I'll figure out this Backdoor Roth IRA thing soon” or
- “I'm going to pay my cousin's college roommate 1.5% of my assets to put me into crummy loaded mutual funds because I'm afraid to learn how to manage money myself” or
- “I'll figure out what to do with my student loans when I have some extra money.”
It's fear. It's procrastination. It's a real problem. Education helps, but it takes more than just knowledge. Personal finance is 90% personal and 10% finance, 90% behavioral and 10% math. Get over your fears and get going. Phil Demuth, a psychologist turned investment advisor, was talking about asset allocation when he gave this advice, but it seems relevant to all of these topics (the bolding is mine):
“Even if risk tolerance existed and could be measured accurately, why would it be an important factor when considering how to invest? You should invest in the way that has the greatest prospect to fulfill your investment goals. That might mean taking more or less risk than you would prefer. If you are a sensitive soul who can brook no paper losses, the solution is to get a grip, not to invest ‘safely’ if that locks in running out of money when you are old.”
I understand that it hurts to lose money. Deferring gratification, not taking that big trip to Europe so you can put $25,000 more toward retirement, or skipping that kitchen remodel so you can put an extra $50,000 toward retirement and then watching that portfolio drop in value by $25,000 or $50,000 is really painful. But you've got to do it. And the sooner you get used to it, the sooner you will be a good investor.
Build a reasonable, diversified portfolio, fund it adequately, and stick with it through thick and thin. In a decade or two, you will see that your willingness to lose money resulted in you having far more money than you ever thought possible. You had to lose money, at least temporarily, in order to make money.
What do you think? How did it feel the first time you lost a significant amount of money? How about now when your portfolio takes a dive? What can novice investors do to get used to losing money?
I find that I had much more fear earlier on in my career. Student loan debt felt so scary when in actuality I have way more to lose after 20 years of accumulation and a family that I support. Statistically I have probably lived half of my life already so I feel like there is less long term pressure. I wonder if this is usual or not?
KJV? Old school! I had to reread that passage in the NIV to understand it better lol.
KJV all the way. I’m here for the thees and thous. My wedding vows included a (the) Book of Ruth passage from the KJV. I dread to imagine how that would sound from the NIV. Not even gonna look.
Is this time different? With the government being dismantled and everything being done….will there be such huge changes to our economy and markets that maybe this time the drawdown in the markets should not be bought because it is not clear that the markets will recover this time?
Maybe, but I wouldn’t bet that way. Stay the course with your investing plan has always been the right answer in the past.
If possible, would appreciate a post or several posts on how these sweeping changes will affect our economy and markets in the long term. Short term effects are obvious. Thanks!
I suspect Jim’s crystal ball is no less cloudy than the rest of ours.
For sure. That sort of post would all be speculative. And people would just whip it out in 5 years and point out everything I got wrong and how I must be wrong about how they should use retirement accounts or invest in index funds or buy disability insurance or whatever.
I figure if the stock market (US and or world) goes to h**l banks and paper money and gold won’t be worth much. So I’m in index funds AND garden tools and knowledge and practice (and books so I’m not internet dependent), and maybe a little ammo etc. Old enough to go through Y2K panic in rural Texas so I’ve already decided having tobacco on hand or in my garden for trading purposes is too immoral for me, and storing petrol not worht the risks. Alcohol in glass bottles can also be used for sterilizing purposes though. (But back then I had a friend who planned to give me a horse to go Dr Quinn Medicine Woman around the neighborhood if Y2K was actually a thing. SHE planned to head for the hills with her rifle and a string of horses.)
“Until such time as the world ends, we will act as though it intends to spin on.”
-Nick Fury
Yeah…….”get a grip” is the relevant advice here
Heh, right after MBB_boy’s advice the S&P dropped 12% the following week. Everyone’s crystal ball is cloudier than ever.
What he means is never lose the money permanently on speculative things or scams. As an investor, volatility is a commonplace.
This was a fantastic article.
There is a reason that some investments have a potential return that carry a risk premium. If you want a “risk free” rate, invest in the 10-year Treasury. If you want greater returns, you will take on some degree of uncertainty and you will not always win.
Not all investments work. Reasons for failure or suboptimal performance include: unexpected market changes, lack of operator experience, unethical behavior, or even just plain bad luck.
All result in loss of capital and that is painful. However, each failure produces lessons we can hopefully carry to the next investment, which hopefully, becomes a hedge for the risk we must take to achieve higher returns. Our hope is to outweigh the losses with the wins.
Investors who expect to win all the time just haven’t been in the game long enough to get the lesson. Sadly, that education hurts, but it helps to complete the journey and become a better investor.
Appreciate what you do!
Good to hear from you Tom. I think the last time I saw you was at a PIMDCON in LA.
I’ve always thought the mistake the third servant made was being brutally honest with his master. I also wonder how the master would have responded to the first and second servant had they lost money and the third servant returned his single talent, perhaps while pointing out the excessive risk-taking of the first two.
Thanks for composing this article!
It’s important to understand that not everything that comes/came from the mouths of Warren Buffet and Charlie Munger are gospel:
Warren Buffett famously stated his two rules of investing: “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.”
To create wealth from your own earnings, you must invest in risky assets and diversify!
“Never lose money”?
I wonder how many individuals have felt guilty when the market went down, causing them to shy away from the assets that will almost certainly get them to financial independence over their investing lifetime?
You will lose money investing the way you should! But when the market takes a big hit, you can benefit from a Warren Buffet nugget that is actually helpful:
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
Great article.
Gifts should not be squandered, buried or horded. Replace the word talent (a year’s wages) with faith.
Consider the risk the apostles took by living a life of faith. Most martyred. Their ROI was eternal.
Paul also went all in and experienced beatings, shipwrecks, imprisonment, etc due to investing in his faith and promulgating the Gospel message.
During this time of inward reflection during Lent, focusing on fasting and almsgiving, it’s nice to see an article from WCI reminding us of the responsibilities we have to be good stewards of the gifts received by the Almighty.
Yes, we should strive to be destitute in this life and live under a bridge, and receive our reward in the world to come.
This lecture is hard. Direct to the point. So we need to prepare certain amounts we’re willing to lose to get the profits? Can I really get used to losing money?
Wait until you near retirement. You can see $100,000+ disappear in a day. And if you are winning the game, it doesn’t bug you.
I almost gave up on investing after losing over $600 in 2018. I can see I am not alone.
Thank you for this very long-term perspective ! Eternity will be much longer than our limited lifespan. I always enjoy posts at the intersection of faith and finances.
I very much appreciate and I am grateful for what I have learned from WCI. I have always been a very conservative investor – my company related funds are 100% in guaranteed funds. I just do not trust the stock market and have taken 3% gains for many years when others were making 10-25% or more. It pays off in times like these but i know in the long run Im losing from inflation. I think Wall Street is for insiders and I view Warren Buffet as an insider.
I also wanted to point out that its probably still worth investing in physical gold. I think most advisors recommend 10% of your portfolio- if I could I would invest 50 or more. Silver is also a good investment- although it takes up a good deal of physical space.
I disagree that most advisors recommend gold at all and I think putting 50% of your money into speculative investments like Gold or Silver is usually a mistake.
Your conservative approach requires a higher savings rate (50%ish) than most are willing to stomach. Are you saving that much or are you okay having a much lower retirement standard of living than you’re enjoying now? If neither, I’d suggest a bit more investment risk. Even 20% in stocks is much better than 0%.
Im saving at least 50% but only since my children completed college last year. My expenses are $5000/mo and social security is about $4000. My net part time income is ~$6500/mo and My 401K are about 1.2 million. My income will drop significantly when I retire in a few years at 70 but my expenses are relatively low. I will take your advice of 20% stocks in an indexed fund hopefully when the market has bottomed. Thank you!
Then your approach is fine. As William Bernstein says, when you win the game stop playing. If you truly only need $12K a year, a portfolio, even one that is 100% bonds, of just $400K ought to make you FI. Shoot, you should be able to live on less than the interest on $1.2 million in bonds. That’s like $40K a year and you only need $12K.
I’d still add 20% stocks though.
How will you ascertain “when the market has bottomed”? What are your standards or your methodology for ascertaining this event?
The market and investing are driven by sentiment. Sadly, for those who entered medical school, then residency and fellowship beginning in the 1970’s, it has been difficult to accumulate wealth. Trainees were paid minimum wage for 60-hour work weeks with no 403-B contributions. (403-B’s didn’t exist.) Then, in the 1980’s, an era of high inflation, they had to borrow to launch practices. In the 1990’s, Medicare froze or began to reduce reimbursements while malpractice premiums skyrocketed and inflation never dropped back after soaring in the 80’s. Then along came requirements to install EMR’s, or face a financial penalties. That required buying computers, software and hiring more staff. Shortly thereafter, thanks to the ACA, independent practices, especially cardiologists and oncologists , saw severe reimbursement cuts so that they were essentially bankrupt. Who could have foreseen that the government would intentionally force doctors to become employees to capture their productivity? That private equity firms could buy medical practices and health systems, but doctors could not cover their overhead if they remained independent? In many cases, IRA and 401K contributions stopped. Friends who retired in 2008 saw huge drops in the value of their portfolios while they were forced to take RMDs . Two more sell offs made getting back to even very difficult. It’s not surprising that doctors’ sentiment has been hammered by government intrusion and uncertainty. For those who overcame this adversity and stayed invested, congratulations. John Bogle would be proud of you.
Funny. All the docs who started in the 1990s and 2000s said the ones who started in the 1970s and 1980s had it made. That those were the golden years.
Look, if you came out of residency 45+ years ago and still don’t have enough to retire, you’ve got a spending problem and you’ve had it for a long time. Despite all of the issues you mention, the average physician real income has climbed over the last 45 years, even on an after-inflation basis. Even saving just 10% of your income for 45 years and investing it in any sort of reasonable way ought to have made you a multimillionaire by now.
The statistically worst year to retire in the last 45 years was 2000. And those who retired then, even if spending 4.5% of their 50/50 portfolio, still have 72%+ of their nest egg. 2008 retirees have done much better by comparison.
But yes, you do need to stay invested. No amount of savings and no investment returns are adequate to overcome bad investing behavior. Let’s make Bogle proud!
I didn’t say that folks who started practicing in the 1980s are destitute or lacking in retirement resources. What I meant is that it has been difficult to stay positive and take risks due to circumstances beyond their control. A son, who got his MBA at Tuck, told me a number of his classmates already had $1 million in the bank by age 30 due to stock options, high salaries, etc. Yes, many people think doctors have it made. They have no idea how stressful medicine has become.
There will always be circumstances beyond our control. There are also other pathways to wealth that have various advantages and disadvantages when compared to medicine.
When Warren Buffett says don’t lose money, he is not speaking about the avoidance of risk (a concept he thinks differently about than financial planners and academics). Buffett is speaking specifically of, “permanent impairment of capital”, specifically an investment that has gone to ZERO. I’m sure that Mr. Dahle regrets his investments that have gone to zero and has learned lessons from those painful experiences.
Buffett’s purchase of Waumbec Textile Mills was a good example of this painful experience.
Buffett is quite comfortable with the quoted price of a security declining. As Ben Graham’s best student (and the only gentile who ever got the privilege of working directly for Graham), he has no objection to “Mr. Market” offering him a good company on sale (or even a bad company at the right price, at least before Munger updated his views).
Buffett’s late partner Charlie Munger also stated, “If you can’t stomach 50% declines in your investment you will get the mediocre returns you deserve.”
The two concepts may appear contradictory, but really are not. 50% is more less what was seen in the three worst post-Depression US bear markets (73-74, 00-02, 07-09). A lot of investors sold out after experiencing large losses and failed to participate in the recoveries. If you didn’t sell, your capital wasn’t permanently impaired. On the flip side, if your investments in the preceding bull market were in Nifty 50 Stocks, Dot Coms, or nationwide mortgage banks then you suffered permanent impairment of capital.
The message is therefore to take prudent risks, not to avoid risks.
Mr. Dahle is correct that many investors need to first overcome fear of risk in the first place. The quote by Mr. Demuth and the sad comments by “Greg” reinforce this. When I met my wife she had a large amount of cash in a near zero interest savings account which she considered to be “safe”. Needless to say she subsequently received an education in the miracle of compounding.
All good advice/analysis.
Such a thought-provoking perspective, Dr. Dahle! I appreciate how you challenge the common narrative of avoiding losses at all costs. In reality, embracing the risk of loss seems essential for long-term growth. It’s not about fearing the dip, but learning to weather it. A valuable reminder for any investor willing to truly grow their wealth!
This was an excellent article. I recently lost a large amount of money in 3 investments with the same sponsor, and it was quite devastating. I have learned a lot the hard way. I appreciate this article and the Bible passage to put it into perspective. It is going to take some time to recover from the losses, but I know in time it will get better. Thank you for writing on a topic that is rarely seen.