A Simple Way to Avoid Losing Money in Stocks

One of the easiest and most sure-fire ways to avoid losing money in stocks is to assume that every investment at some point will lose 50% or more. From this standpoint, all investments will be the most judicious and thoughtful. Transaction will not be entered into lightly.

Throughout my writing on the topic of investing, I have repeatedly stated that I always factor in losing 50% before buying a stock. Some readers have asked me, “Why in the world would you invest in something that you think could decline in value by 50%?” My response is always the same, if you haven’t accounted for the worst-case scenario then you aren’t really investing, instead you’re gambling.

I have found that by accounting for the downside risk of 50%, my mind is capable of assessing market declines with a more objective approach. Additionally, I am able to sleep soundly at night.

Below is a transcription of a BBC News interview of Charlie Munger who addresses the idea of accepting 50% loss in Berkshire Hathaway.

BBC News: How worried are you by the share price decline of Berkshire Hathaway?

Munger: Zero. This is the third time that Warren and I have seen our holdings in Berkshire go down, top tick to bottom tick, by 50%. I think it’s in the nature of long term shareholding with the normal vicissitudes and worldly outcomes and in markets, that the long term holder has his quoted value of his stock go down and then by say 50%. I think you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get, compared to the people who do have the temperament who can be more philosophical about these market fluctuations.

It should be noticed that Munger mentions that he has experienced 3 instances of 50% declines in Berkshire Hathaway in the 42 years of its existence. This means that, on average, a portfolio is going to take a massive hit every 14 years or so. This assumes that you have the investment acumen of Warren Buffett and Charlie Munger. If you don’t have the investment savvy of Buffett and Munger, then the likelihood of losing 50% in your portfolio increases significantly.Now you know how easy it is to adhere to Warren Buffett’s rule number one, “don’t lose money.” After all, if you expect that your investments will lose 50% then you really start losing at 51%. Just be sure that you have the right strategy before you buy.

• Before entering into a trade or investment, ask yourself if you’re willing to lose 50% or more.