CODEXCard 2 of 6 · Letters to Shareholders, Six
Buffett rule number one (Rule One, Rule Two)
Don't lose money.
Buffett's rule number one, never lose money, is one of his best known lines. Rule two, never forget rule one, is the punchline. Taken literally it sounds impossible, since every investor loses sometimes. What he means is that avoiding big, permanent losses should come before any ambition for large gains.
The reason is arithmetic. Losses and gains are not symmetrical. If you lose half your money, you need to double what is left just to get back to where you started. Someone who avoids deep losses can keep compounding steadily, while someone who suffers them now and then keeps rebuilding from a lower base. Over long periods, staying out of disasters often matters more than catching every winner.
The mistake is reading the rule as never take a risk. Buffett has made many bold bets. What he avoids is exposure where one bad outcome could ruin him. The skill is shaping your bets so the upside stays open and the downside has a ceiling, for example by sizing positions sensibly and avoiding heavy borrowing.
This rule is closely tied to margin of safety. Paying well below value is one of the main ways Buffett keeps rule one.
Example
A friend urges you to put your entire emergency fund into a new cryptocurrency they are excited about. You decide to invest a small amount you could afford to lose completely and keep the rest in savings. If the coin soars, you gain something. If it collapses, your rent is still covered.
Try it this week
Review one financial or career bet you have open and ask what the worst realistic outcome is, then cap it if you could not survive it.
From Letters to Shareholders, Six (Warren Buffett · 1979).
