As mentioned in a prior post, Warren Buffett’s first two rules of investing are “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1”.
These rules are so important, I thought they deserved a bit more discussion. The following two quotes and my comments, sort of, follow from the first two rules. They are from an interview conducted with Charles de Vaulx and Charles de Lardemelle of International Value Advisers:
“One of the most effective ways to compound wealth is to minimize drawdowns” -> Large drawdowns really hamper the long term compounding rate. For instance, if your portfolio falls by 20% in value, it requires a 25% return just to get back to breakeven. If the drawdown is 33%, you need a 50% return to get back to breakeven. If the drawdown is 50%, your portfolio needs to go up 100% just to get to breakeven. So avoiding large drawdowns is important.
“For each stock we arrive at an estimate of intrinsic value, but equally important is defining the worst-case value” -> If you can buy a stock below its intrinsic value, you automatically get a margin of safety. Even if the stock price is higher than the worst-case value (but below the intrinsic value), the worst-case value gives an estimate of the drawdown you might face on that stock. Remember that Mr. Market can get fairly irrational at times. Some of the best investment opportunities are created when a stock goes below the worst-case estimate (provided the analysis is sound).
The full interview is here.