The golden rule that’s helped me avoid losing money

Here’s the one principle that’s helped this Fool avoid total losses over the years.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Investing can be a daunting undertaking. I mean, where do you start? Even for the most experienced investors, crucial decisions such as trying to decide which companies deserve a position in your portfolio, how many businesses to own, what percentage of cash you should hold and whether or not to invest in alternative assets can prove tough to make.

That being said, the core of any investment strategy should be designed around one key desire: the desire to prevent losses.

When I say losses, I don’t mean a 2% portfolio drawdown. I’m talking about a permanent impairment of capital or putting it another way, a total loss. Taking a total loss at any point in your investment career can be hugely damaging to your long-term investing success and wealth creation.

A total loss can be catastrophic 

A capital impairment of just 5% of your total portfolio in the early days can cost you tens of thousands or hundreds of thousands of pounds over the long-term. A total loss then, should be avoided at all costs.

There’s one golden rule that I have, which is designed to protect me and my portfolio from such total losses. I admit this rule won’t guarantee that I will never see any of my positions go to zero, but it will almost certainly help push me in the right direction when it comes to making investment decisions.

So what is this simple yet highly effective rule? Follow the cash.

Cash is king 

It’s said that in business, cash is king and over the years I’ve found this to be not only accurate but also revealing. Cash flows are, compared to profit figures, relatively difficult to manipulate. If a company is reporting profits of say £10m, and claiming income growth of 20% yet only recorded a cash flow from operations of £500,000, it’s a red flag. There may be an entirely valid reason for the discrepancy, but such a wide gap between cash flows and profits can indicate the use of aggressive accounting.

Some of the largest corporate scandals in history were revealed because they ran out of cash despite recording large and ever-increasing profits. These scandals should act as a warning to investors to follow the cash, not the profits.

Damaging debt

Cash on the balance sheet is another important cash metric to consider. Debt isn’t always a bad thing. If used correctly, debt invested in assets that can generate a return in excess of the cost of debt over time can accelerate business growth. However, too much debt can strangle a company and limit its options. 

The economy moves in cycles and has done for hundreds of years. Therefore, it’s highly likely that any business, at some point in its life, will find itself in a tough trading environment. If the firm in question has cash to hand and little debt, coping with the downturn won’t be as difficult as a company that has a queue of creditors waiting for interest and debt payments.

All in all, the conclusion is simple. If you want to be a successful long-term investor, follow the cash.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »