Want Better Investment Returns? Aim For Average


If you study Warren Buffett’s style of investing for any amount of time, you will inevitably come across his two rules of investing: #1. Never lose money and #2. Never forget rule #1. I remember my initial thoughts on reading these rules for the first time – I thought, this can’t be right.

My studies of Buffett’s investing style had really just begun, but I couldn’t help but think there had to be a typo in what I just read. It seemed odd to me that the #1 rule of the world’s greatest investor was not to lose. Shouldn’t it have been “make as much money as possible”, I thought. Where was the drumbeat bravado of capitalism, I wondered.

I played sports growing up (and not particularly well I might add). My school’s football team was the smallest in our division, in both the number and the size of our players. To put it into perspective, at about 125 pounds I was one of the bigger players on the team! To add insult to injury, our team name was the Giants. We got beat. A lot.

While playing sports, I can’t ever recall our coach suggesting we play not to lose. Instead, it was always drilled into our young heads to win. After all, wasn’t it Vince Lombardi who said “winning isn’t everything, it’s the only thing.” Imagine if Coach Lombardi had said “not losing isn’t everything, it’s the only thing.” Doesn’t have quite the same impact does it?

So, what does this have to do with investing and Buffett’s rules? We all want our investments to do better than average, but how to do it remains a major question. Well, I have an interesting suggestion for you: Set your sights on one goal when it comes to your investments and that is this – aim to be average.

That might sound shocking. But it makes sense when you consider that the typical investor earns a pathetic 3% return on capital, while at the same time, their underlying investments grew by 10%. For all that work, and all those trades, the everyday stock investor has given up a decent after-tax and after-inflation return and instead left themselves with only 3 cents for every $1.00. They took the risk. They made use of their money. But they gave up most of the prize.

Why?

By trying to be better than average they do the very things that make them below average. In the quest to get investment returns that are very different and better than the average, some investors do things that are very different from the average and worse.

They buy and sell frequently, which means the pay higher fees and taxes. It also means they rarely let their winners run, which robs them of the above average returns they seek.

They accept as fact, whatever the latest talking head on TV is saying about what the stock market will do today, which means they sell low out of fear and buy high out of greed.

They hunt for the next rock star mutual fund manager and move in and out of funds like a mutual fund tango dancer, which means they are always chasing yesterday’s top performer, who will most likely become tomorrow’s dud (see below).

They follow their brother-in-law’s hot stock tips at the family barbecue without doing any of their own research, which means they usually buy some risky technology stock that has no chance of ever becoming a long-term winner.

And all this back and forth creates a great return for two entities… neither of which is the investor. You see, they pay a high amount of transaction fees to brokers and portfolio managers and they pay a high amount taxes to the government due to short-term capital gains tax. They do this as they buzz from one investment to the next, like a bee in a large field of flowers at spring time.

And this chaotic way of investing is not just limited to the individual investor. If you follow the performance of many top money managers you will see a pattern. Many of the shooting stars in a given year ride a rocket to the moon with their performance that year, only to be the next year’s comet, blazing a losing trail back down to earth. There’s a saying on Wall Street, if you want to be in the top 5% of money managers, you have to be willing to be in the bottom 5%, too. I’m here to tell you this – that’s a recipe for ulcers, not superior investment returns.

Which brings me to the key point of this article: The future starts today. If the past is any indication of the future, investors need to do something different if they want a different result going forward. The hard part of investing isn’t picking the best investment. Instead, it’s sticking with the one you’ve picked. Only then will you have a shot at earning the average and above-average returns earned by the minority of investors.

The best part about this is that once you do the proper research (and you should conduct detailed, thorough research before making any investment), the only thing you have to do after making your investments is this – nothing. Which reminds me of one of my favorite Warren Buffett quotes: “Benign neglect, bordering on sloth, remains the hallmark of our investment process.” As Buffett has demonstrated more than once, investing is the one place where we are rewarded for being lazy.

Think about it this way – If you lose your money on some risky investment, you now have to make a 100% return on the next dollar…just to get back to even! If you frame your investment choices via how much you stand to lose, it will help you to be much more selective in where you put your money.

I feel strongly that attempting to achieve a great long term investment record by stringing together many over-the-top years is highly unlikely to succeed. Rather, striving to do average every year is:

– less likely to produce extreme volatility
– less likely to produce huge losses which can’t be recovered
– more likely to produce above average returns

Simply put, if you can avoid losers the winners will take care of themselves. This has held true for my investing success.

The best foundation for above-average long term performance is an absence of disasters. It is much, much easier to lose wealth than it is to make it — so the single best thing a person can do to achieve above average returns on their investments, is to avoid making stupid decisions.

To not lose money is the objective, as Buffett so astutely advised a long time ago. It is for this reason that a quest for consistency and protection, not any single-year greatness, is a common thread underlying all of my investments.

Being average may be boring, but it can make you rich. Year after year, decade after decade, you add to your surplus and collect more dividends and share price appreciation. And after a while, you check your bank account and guess what – you’re rich!

Be free. Nothing else is worth it.

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  • Ron90

    I think this is especially true of people near or already in retirement. They need to understand that they no longer have the time it takes to make up for a loss in their portfolios. It is because of this restriction on their time that many retirees should choose a more conservative style of investing.

    • https://www.montycampbell.com/ Monty Campbell

      Thanks Ron. Well stated.

  • louis

    Thank you Monty, I do appreciate you taking time out to help me, and others as well. I’m just starting to get into the meat of investing and these types of posts have really help me understand the material.

    • https://www.montycampbell.com/ Monty Campbell

      Thanks Louis. Glad you liked it. More investing articles to come.

  • zin87

    Great article. I think to understand Buffett’s never lose money rule, you have to understand the difference between investment and speculation. It’s all about protecting the downside.

    • https://www.montycampbell.com/ Monty Campbell

      That’s right. As Ben Graham said “If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end.”

  • Will

    I try to keep my investing simple. I know there’s a huge number of businesses that I don’t understand very well. I just try to stay away from the ones I am completely clueless about, otherwise I know I’m just gambling and relying completely on luck.

    • https://www.montycampbell.com/ Monty Campbell

      Thanks for commenting Will. I do the same. I invest within my circle of competence.

  • Kiat

    I think it’s also important to think in terms of long periods of time. Sometimes you may “lose” money on paper in the short-term – such as when Buffet’s company underperformed benchmark indexes in a given year but long-term you can still win. An example of this is how Buffet’s company has outperformed benchmarks long-term.

    • https://www.montycampbell.com/ Monty Campbell

      That’s exactly right Kiat. Unrealized losses can appear in the short term but the market generally gets it right in the long term.

  • Howard

    Great article. I agree. Too much “rabbit chasing” with investments just makes others rich.

    • https://www.montycampbell.com/ Monty Campbell

      Thanks Howard. The reminds me of the quote – “man who chases two rabbits catches neither.”