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.

4 responses to “A Simple Way to Avoid Losing Money in Stocks

  1. Hail NLO:

    I was not aware of this valuation theory…Would it also be applicable to the S&P 500?

    Thank you most kindly, Sir!

    • Greetings BlueIce,

      Not sure of when it is applicable to the S&P 500, as an investment. However, consider this, the S&P 500 has declined more than -45% twice in the last 14 years. This is a staggering stat that should not be lost on anyone who wishes to participate in the stock market.

      Our studies of investing have been focused on another decline like 1929 to 1932. We have center our investment assumptions on the premise that we will lose close to all that we have put into each stocks that we hold. However, at minimum, a loss of -50% should be expect if nothing else.

      Thanks for the comments.

      Best regards.

  2. As stated above almost every 14 years the global markets decline 50% and when long term socks decline we can sometimes take comfort in the fact that chances are that in the future one may be able to recover their loses. In just the last 5 years the global markets took one 50% dip around late 2008 and early 2009, and since then generally the economy has been on the rise with the Dow Jones and S&P 500 both reaching new highs. But 5 years out and almost roughly a decade until the next big dip, would it be a sound choice to invest in long term stocks at this point or wait out this unsure timing and jump in after the next drop?

    • Greetings Rupam,

      As a clarification, we demonstrated that the portfolios of Warren Buffett and Charlie Munger have declined more than -50% every 14 years. These are exceptional investors with high levels of skill in selecting high quality stocks and putting substantial amounts of their portfolio into a single company.

      Our assumption is that (individually) we’re going to experience significantly more situations where the value of our portfolio declines greater than -50%.

      However, regarding your question, “…would it be a sound choice to invest in long term stocks at this point or wait out this unsure timing and jump in after the next drop?”

      Inherent in the question that is asked is that somehow we could know where the bottom is in the stock market. We don’t know when we’ve hit bottom.

      However, if your primary target is the acquisition of stocks that have a consistent history of dividend payments (ideally increasing) and at or near a new low, you have a high probability of being able to compound your investment income substantially over time.

      One article that is worth reviewing is Jeremy Siegel’s article titled “The Nifty-Fifty Revisited” (PDF here: http://www.jeremysiegel.com/index.cfm?fuseaction=Resources.Download&resourceID=6155 ) This article examines what would happen if a person bought the top 50 stocks with the highest P/E ratios at the peak in the stock market of 1972. The basic theme of the article suggests that, even at the worst possible time, it makes sense to invest in stocks.

      For us, the most essential element is the timing of the purchase and setting parameters for when we sell.

      Regards.