Thoughts on capital preservation

Warren Buffett famously said (not an exact quote):

Rule #1: Don’t lose money. Rule #2: Don’t forget Rule #1.

I only recently came to understand the wisdom behind these rules, a realization that came with changes in my own life circumstances.

Previously, I had a six-figure salary, with a steady monthly income from a stable, large corporation that was unlikely to go under anytime soon. Now, my situation has drastically changed; my monthly income is no longer guaranteed.

My approach to investing has shifted significantly. In the past, I considered an investment with a potential 50% return and an equal chance of a 50% loss to be viable. Today, I would only consider investments that offer the potential for 3-5x returns in the long term, with a minimal risk of losing up to 10% of the invested amount.

On social media platforms like TikTok or Instagram, we often see “finfluencers” promoting various strategies. However, these recommendations may not align with everyone’s personal circumstances or natural inclinations.

Imagine living paycheck to paycheck with less than $10,000 in assets under management (AUM). You might be tempted to gamble it all on an opportunity that could either quintuple your money or result in a total loss, simply because you could potentially recover from the loss within a few months.

This mindset changes drastically with $100,000 in savings. After working hard to accumulate this amount, you’re less willing to take high risks. Losing even a portion of this amount feels significant, especially if it would take you 12-24 months to save that much again. However, when money is still flowing, you are inclined to think that – it’s okay to lose X because I know I can pay back X in 1-2 months.

Another perspective to consider is this: With $100,000, a 10% gain yields $10,000. However, if you lose $50,000, a 10% return on the remaining $50,000 only adds $5,000. To recover from a 50% loss, you need to double your remaining funds. If doubling your money were easy, everyone would be wealthy—clearly, it’s not.

As an investor, you must assume that there’s no regular cash flow coming in. Investing is your primary focus, and the money you have is all you can work with. Therefore, it’s crucial to avoid losses and not rely on the idea of making up for them in the near future. A commitment of 12-24 months is substantial and should be taken into account when assessing risk.

Consider this: with $100,000, a 10% return yields $10,000. However, if you lose $50,000, you’d need to double your remaining money just to get back to where you started. Doubling your money is far from easy, or everyone would be wealthy by now.

As a full-time investor, your greatest asset is time. You have the time to analyze, research, and identify opportunities. It’s easier to find investments with a 90-10 chance of a 3x return or a 10% loss than those with a 50-50 chance of either a 50% gain or loss. Fewer opportunities meet the former criteria, and finding them requires thorough research, including reading 10-Ks, 10-Qs, and earnings transcripts.

Another advantage of being an investor is the flexibility in holding assets. You can sell at any time—whether it’s tomorrow, immediately after purchase, or hold for several years—assuming you can cover your living expenses. This is different from professional money managers who might be forced out of their positions if their investments underperform relative to benchmarks within a year.

As Jack Ma once said: “Today is hard, tomorrow will be worse, but the day after tomorrow will be sunshine. Most people die tomorrow evening.”