The Most Important Rule of Investing

Never Make an Investment if You Couldn't Afford a Total Loss

Never Invest in Something You Don't Understand
You can avoid a lot of misery and misfortune in life if you follow one simple investment rule: Never risk money you can't afford to lose in full. Roy Scott / Ikon Images / Getty Images

There is one golden rule of investing that you should always follow: Never invest money you cannot afford to lose. Investing is not saving. I explained the difference between saving and investing before, but the short version is that saving is money you put aside that is kept in cash for you to access in a few days or less in case of an emergency. In contrast, investing is the process of putting your money to work, making even more money for you.

If you always remember this and never violate it, you shouldn't have to worry about eating cat food during your retirement. But there is a natural human tendency to want to overreach, to put more money in than you can afford, and go for a huge payout. In fact, this trait tends to be magnified the more desperate someone is for money because they hope that hitting the jackpot will make all of their problems go away (you see a lot of people below the poverty line playing the lottery but not very many executives).

You cannot just view your "portfolio" as the stocks you own. It encompasses so much more — your emergency cash reserves, your insurance coverage, your fully funded retirement accounts, your real estate holdings, and even your professional skills that determine the income you earn in the job market. To help you understand some of the things that might make up the entirety of your portfolio, I wrote a step-by-step guide called 10 Steps to Building a Complete Financial Portfolio.

By taking that approach, you can avoid what I called The Refrigerator Problem. It never fails to amaze me that the same folks who spend weeks studying Consumer Reports ratings for a new stove or washer and dryer would put all of their savings into a stock or other investment they don't understand. It just doesn't make any sense.

Your first goal is to avoid major losses. Don't get greedy. Be patient. Seek the advice of qualified, well-regarded advisers. Keep your costs low. The recipe may not seem exciting, but it has proven to work for generations.