Detect accounting fraud, invest safely.

“Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.” Yes, everyone has heard this famous Buffett quote before. It is regarded by many as the most important rule in investing. Makes sense to me. You invest to make money, not to lose money. It’s a truism or what I would call a “Duh!” statement. That’s great advice coming from the greatest investor ever lived. But it’s like me telling you, “Rule No. 1 in becoming a millionaire is to make a lot of money.” And you’d roll your eyes and mock me, “Yeah, duh! The 64-million-dollar question is how the hell do you make a lot of money?”

Great question. Well, one way to make a lot of money is to invest. Buffett did okay investing. And he laid down two simple rules in investing, which everyone gets. But I bet not many actually abide by Rule No. 1. Why? Because to never lose money is a lot of hard work. What’s more discouraging is, after all this labor, you may end up with nothing to buy. The mere thought of wasting hours reading annual reports with no result in sight is so prohibitive that we have chosen to just look at the pretty graphs. “Gee, it dropped 30% from the peak.” and we conclude “What a great discount!”

Because never losing money is so hard, we tend to ignore the rule even though we know it’s true. It is human nature to avoid the hard stuff. We like easy. It’s in our genes. We would tip a valet $5 to park our car five feet away. We would talk ourselves out of negotiating a ten-thousand-dollar raise because we have to walk into the manager’s office and ask. We would even keep quiet about getting a whole milk Café Latté instead of the non-fat milk we asked for. (Damn it! Just ask! You’re not going to lose anything if you’d just ask. By the way, Starbucks baristas will make you a new cup if you ask, guaranteed.) These reactions are completely normal. Entrepreneur-blogger Ramit would call these barriers. Like Buffett, we are very good at convincing ourselves. We convince ourselves that reading the annual and quarterly reports and the proxy statements are not necessary because it’s too much work. Too bad we usually talk ourselves out of the good stuff. How many of you convinced yourselves to quit smoking? And how many convinced yourselves to run a mile a day?

It’s hard enough accepting the fact that analyzing a stock requires a lot of reading. To add fuel to the fire, even after you have done all this work, you could still be wrong. Nothing is certain in investing. You bet when the odds are in your favor. Nonetheless, even geniuses make mistakes. Successful hedge fund manager, Mohnish Pabrai of the Pabrai Funds, lost $50 million on his Delta Financial bet. Responding to the question of whether he would place the same bet if he could do it all over again, Pabrai replied “It was a good bet.” So, looking at all the barriers to never lose money in investing, I can understand why many could not live by the rule.

Despite its popularity and importance implied by the number, Rule No. 1, I’m afraid to disappoint, is not the best kept secret to successful investing. The secret is to remove all barriers to achieve Rule No. 1. The secret, like all other success stories, involves a lot of hard work. Due diligence is not reading the Yahoo! message board. Due diligence is reading every word in the 156-page annual report. Due diligence is reading the annual reports of competitors. I think the amount of work needed to truly understand a company is a barrier big enough to discourage 95% of the investors. The reluctance to sit and read is what separates the Bruce Berkowitz’s from the rest of us. In fact, Buffett was so generous, he did shed some light on how to never lose money, except we simply dismissed it because it sounded like a lot of work and was downright boring. “We read hundreds and hundreds of annual reports every year.” is Buffett’s answer to successful investing.