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Buffett’s Only Two Rules For Investing…

“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1”

– Warren Buffett

When I first started driving, my mom and dad would always remind me not to drive too fast. They would always tell me that the traveling time is not much different when driving 55-70 mph and that speeding up really is not worth it especially if an accident happens.

Now that I am older and a bit wiser, I realized my parent’s advice is also applicable when it comes to trading. In the long run, it is not in our best interest take short-term risky trades especially for stocks that we are not interested in owning 5-10+ years from now.

Why might you ask?

I have created a downloadable excel sheet [1] with the results displayed below to illustrate why making only a few big losses might actually significantly decrease returns. Below are three hypothetical situations here:

1) A low-risk investment strategy generating 20% per year will take your $1,000 of seed capital and grow it to $38,3337.60 after 20 years.

2) A moderate-risk investment strategy will return 30% per year. However, there will be losing years. I modeled for a 15% loss every 4 years (3 years profit and the 4th year will be at a loss). Starting with $1,000 with turn to $22,711.45 in 20 years.

3) A high-risk investment strategy will generate 50% profit each time of profit however it will also make a 50% loss. I modeled for a 50% loss every 4 years (3 years profit and the 4th year will be at a loss). Starting with $1,000 with turn to $13,684.18 in 20 years.

Year 20% Return
Low Risk
30% Return
Moderate Risk
50% Return
High Risk
0 $1,000.00 $1,000.00 $1,000.00
1 $1,200.00 $1,300.00 $1,500.00
2 $1,440.00 $1,690.00 $2,250.00
3 $1,728.00 $2,197.00 $3,375.00
4 $2,073.60 $1,867.45 $1,687.50
5 $2,488.32 $2,427.69 $2,531.25
6 $2,985.98 $3,155.99 $3,796.88
7 $3,583.18 $4,102.79 $5,695.31
8 $4,299.82 $3,487.37 $2,847.66
9 $5,159.78 $4,533.58 $4,271.48
10 $6,191.74 $5,893.65 $6,407.23
11 $7,430.08 $7,661.75 $9,610.84
12 $8,916.10 $6,512.49 $4,805.42
13 $10,699.32 $8,466.23 $7,208.13
14 $12,839.18 $11,006.11 $10,812.19
15 $15,407.02 $14,307.94 $16,218.29
16 $18,488.43 $12,161.75 $8,109.15
17 $22,186.11 $15,810.27 $12,163.72
18 $26,623.33 $20,553.35 $18,245.58
19 $31,948.00 $26,719.36 $27,368.37
20 $38,337.60 $22,711.45 $13,684.18

As the table depicts that even though a high-return investment strategy yields amazing results it is also a double edge sword, every time you take a loss, it is also equally significant. In the long run, the strategy that generates the least return provides better results with much less stress, time spent on trading, and commissions.

This article sums up the simple investment rules that Warren Buffett suggests: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1” – Warren Buffett

If we don’t take big losses, then we will be able to make consistent compounded returns and accomplish our investment goals.

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Comments Disabled To "Buffett’s Only Two Rules For Investing…"

#1 Comment By ABS On April 11, 2020 @ 12:55 am

superb. very lucid explaination with numbers.
thanks

#2 Comment By Peter Kuchnicki On April 11, 2020 @ 11:32 am

Good illustration of the choices and the results.

#3 Comment By David On April 11, 2020 @ 1:10 pm

Good luck with the 20% IRR

#4 Comment By Louis On April 11, 2020 @ 4:58 pm

How do you get 20% annually without ever having a down year

#5 Comment By JLM On April 11, 2020 @ 7:18 pm

Well put, thank you for your perspective.

#6 Comment By Ken On April 12, 2020 @ 12:41 pm

Please, provide details on achieving 20%/annum with “low risk.”

#7 Comment By Jordan On April 13, 2020 @ 2:06 pm

Nice article. However, very hypothetical in nature. How can we make an annual 20% return? Buffet’s mentor Benjamin Graham said that an 8% YoY market return is expected. Therefore, shouldn’t we expect more like 15% at most?

#8 Comment By Alan On April 15, 2020 @ 5:34 pm

Yeah, give me a 15% return and I’ll pay for your service.

#9 Comment By Maxwell On August 8, 2020 @ 7:36 pm

I would even go with 12% (50% higher than Graham expects)

#10 Comment By alan On April 15, 2020 @ 5:32 pm

Never lose money. How is that possible in the stock market?

#11 Comment By Jorge On November 24, 2020 @ 12:04 am

You only lose when you sell your losing positions… That’s one of the great and solid lessons I have learned.

#12 Comment By dick flamos On April 25, 2020 @ 1:35 pm

no such thing as 20 % return,low risk.

#13 Comment By Mary Kennedy On April 26, 2020 @ 7:19 am

I agree with dick flamos.

#14 Comment By ANER FUST On May 19, 2020 @ 5:45 am

This analysis is somewhat silly.
A 20% return is outstanding, but more importantly the 2 other methods describe also yield a very good return:
30% IRR = 16.9% which is better than 99% of money managers
50% IRR = 14% which is better than, well most money managers by far.

You would be trouncing the S&P500 with ease.

Bottom line: if you can make 30%, 50% and take the losses as describe (sleep ok, etc), then definitely go for those methods!!! You would be considered a star in any rankings, and be a rich person too.

#15 Comment By Pedro Fernando Ferreira Macedo On December 9, 2020 @ 6:26 pm

The link for the excel file is not working. Can anyone share this file with me?
Thanks

#16 Comment By Howard Reisman On December 10, 2020 @ 7:20 am

This has been fixed. Sorry for the inconvenience.