Lessons From What I Learned Losing a Million Dollars

Monday, March 11, 2019

Part 1: The One Secret That All Successful Money Makers Know and Use

Delray Beach, FL.- It was the only one left in my audiobook library. I didn’t remember buying it. I’d never heard of it or its authors (Jim Paul and Brendan Moynihan). And the title wasn’t a turn on: What I Learned Losing a Million Dollars.

I mean, really. There are probably millions of businesspeople and investors that could make such a claim. You lost a mere million? Don’t bore me. I want to hear from someone that’s lost a hundred million!

But it was, as I said, the only audiobook in my library. So I began listening to it… and was drawn in.

The first third was a breezy memoir of Jim Paul’s early life, education, and how he rather accidentally became a commodities trader, earning big bucks and living large. Then there was the downfall – a pretty exciting account of going broke and into debt fast.

I almost shut it off there, thinking I’d heard the best part, but I’m glad I didn’t. What followed was an analysis of not just Paul’s pride-bound bad thinking but of the mistakes all investors make sometimes (and some investors make all the time), as well as other insights that rang true.

Paul’s account of his experience is, in part, the story of a smart person that cared more about being right than making money. It is also a portrait of the mortal sins of wealth building: arrogance, ignorance, and greed.

In reviewing the mistakes that led to his million-dollar loss, Paul first examines his trading strategy. Was the strategy wrong? Should he have been using another one?

Then he takes you through a quick review of the strategies of some of the most successful investors of modern times. He demonstrates that each of those strategies was different, and all of them had rules that forbade practices that were followed in the others.

The rules that worked for George Soros, for example, are very different than the rules that worked for Warren Buffett. John Templeton’s strategy worked well for him, but would have not worked for Peter Lynch, and vice versa.

Paul concludes, convincingly, that there is no such thing as a successful trading strategy, and that the search for a winning strategy is a waste of time and money. Instead, he argues that if there is a secret behind the fortunes of Buffett and Soros and the like, it must be something they all did. And when he looked for it, he found it.

The single protocol followed by all of them, regardless of their profit strategies – was about limiting losses.

Paul doesn’t argue that any profit strategy can work. His point is that any profit strategy that isn’t coupled with a loss-prevention strategy is doomed to fail.

I thought about this. And it is true of my experience. Nearly every time I put money into an enterprise without some sort of stop-loss mechanism, I ended up losing most or all of it. And if I look at how I acquired and built wealth over the last 40 years, the strategies that worked all had serious downside protection.

When I consider an investment these days, I spend no more than a moment thinking about the upside potential. I’ve been doing business and investing long enough to know that dwelling on how much money you can make reduces your investment intelligence by about 98%. So when someone pitches an idea to me, I focus my thinking almost entirely on how I can limit my losses if things don’t work out.

There are three ways that I limit my losses:

  1. I use stoplosses– actual stop losses for stocks or equivalencies for other assets – to close out my position at a predetermined point if the investment goes south and hits my “get-out-now” number.
  2. I use positionsizing to determine how much I will invest in any given project. This is very powerful, perhaps the most powerful technique for safeguarding and developing wealth. I have a predetermined dollar figure that I will invest in businesses about which I know little, and another for investments about which I know a lot. When you have a modest net worth, that figure might be 5% of it. As your wealth grows, you reduce the percentage. These days, I never invest more than 1% of my net worth in any single investment or business deal.
  3. I diversify. My investment portfolio consists of real estate (mostly income-producing but some land banking), “Legacy” stocks (large, well-capitalized, dividend-bearing stocks), super-secure bonds (if the yields are decent), private lending (for secured assets), business ventures, options (selling puts on Legacy stocks), and cash.

Most people I know are not willing to invest this way. That’s because most people are interested in how much money they can make, not what they can do to limit their possible losses. But as Paul discovered from his own million-dollar-plus loss, when you care more about making big money than avoiding big losses, you aren’t really investing at all. You are gambling.

To invest the way I do, you must be willing to give up something. And that something is the big wins and the ego charge and the bragging rights that go with investing for above-average profits.

I have a very unusual approach to investing in terms of ROI. In fact, I’ve never run into an investment “expert” who thinks this way. When I invest, my goal is to get the natural, historic return on the asset class I’m buying into. If it’s ordinary stocks, that return is 9% to 10%. With Legacy stocks or selling puts, it is 12% to 14%. With cash-based, income-producing real estate, it is 6% to 8%.  With leveraged real estate, it is 10% to 15%. I don’t try to make 50% to 1000% on stocks. And I don’t try to double my money by flipping real estate.

Ego makes it difficult for most people to resist the siren call of huge ROIs. They want the 10-baggers and they will “settle” for doubles and triples. This is a sure strategy for getting poorer. Why do they do it? Because they are either thrill seekers (gamblers) or they want to prove themselves right (bettors). If those are your motives, you have to be willing to take the sort of risks that make it possible to suffer big losses. And when you make it possible to lose big, you eventually will.

In What I Learned Losing a Million Dollars, Paul promotes the only wealth-accumulation protocol that works regardless of the asset class or profit strategy you choose: loss prevention. Using stop-losses, position sizing, and diversifying puts me – and it will put you – in the company of the most successful investors of all time.

So that is one reason I would recommend this book.

But there’s another big takeaway. It’s about terminology – i.e., the difference between investing, trading, speculating, gambling, and investing. Understanding these differences is critical to acquiring wealth steadily and safely. I’ll talk about it in Part 2 of this essay.