How I’ve broken Warren Buffett’s number one investing rule

It’s often quoted that Warren Buffett’s number one investing rule is “never lose money“.

In fact, the legendary investor places so much emphasis on this rule that his second key investing rule is “never forget rule number one”.

Given that if you lose 20% on an investment you need to generate a 25% return to break-even, preservation of capital is paramount. However when it comes to investing in the share market, there’s no doubt it’s easier said than done.

In 15 years of investing I’ve had my fair share of losses and today I look at some of the mistakes I’ve made over the years which have resulted in a loss of capital.

I tried to get rich fast

In my early investing days I invested way too much capital in highly speculative stocks in an attempt to get rich fast. Many of these companies had no revenues, earnings or dividends, yet I was convinced that I might be able to land a 100 bagger’ and achieve instant wealth. 

Needless to say, I learned the hard way, as many of these speculative companies went bust. In hindsight it was not wise to invest so much in the small end of the market.  

I’ve since changed my investing approach and these days I’m focused on building a sizeable portfolio over the long term, mainly through investing in high-quality, dividend-paying companies and putting the power of compounding to work. 

While I still allocate a small portion of my portfolio to smaller companies, I look for ones that are already generating revenues and earnings, as I’ve found that there’s less chance of these companies bombing.  

I didn’t diversify properly

Diversification is one of the fundamental elements of investing, yet it’s surprisingly easy to get wrong.

I recall getting carried away with mining stocks during the mining boom, and stuffing my portfolio to the brim with a selection of highly speculative mining companies. With the mining sector firing on all cylinders, I focused heavily on this one sector and neglected the rest of the market.

I thought I was diversified because I was invested across 15 different stocks, however, when the mining boom ended, the whole sector crumbled, and my portfolio suffered heavily.

The lesson I learned is that diversification is about more than just buying a handful of stocks — it’s important to diversify across asset classes, countries, sectors, companies and market capitalisations, too

I got greedy

Have you ever owned a stock that rose exponentially in a short period of time?

A few years ago, I purchased a stock that gained around 600% in under a year. I had taken some profits off the table when the stock first doubled, but then as the stock kept rising, and euphoria surrounding the stock increased, I became greedy and ploughed more capital into the stock. This one company made up an unhealthy proportion of my portfolio.

When profits at the company failed to materialise, sentiment changed quickly and the stock fell heavily, taking a chunk of my capital with it.

Fear and greed are the dominant emotions in the investing world, and it’s vital to keep these emotions in check. 

Get the fundamentals right with this report 

In summary, I've learned many lessons in 15 years of investing and I've realised that it's important to get the fundamentals right.

Focus on building wealth over the long term, invest in high quality companies and employ sensible risk management processes, and the rest should take care of itself.   

The Motley Fool recently published an informative report entitled The worst mistakes investors make and if you're looking to tighten up your investment process I'd highly recommend reading the report for the vital investing tips it contains. 

To get hold of a FREE copy of the report, click here

Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any 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.