With all due respect to Warren Buffett, the number 1 rule in investing is not anything close to “never lose money.” In fact, the entire notion is absurd. Anyone who has ever invested in the history of the world has lost money at one time or another. Buffett himself lost close to 50% on two separate occasions. Being in a drawdown is the norm, not the exception. That is the price you pay in exchange for a higher return than a risk-free savings account.

So what is the number 1 rule in investing? That’s an impossible question, but if I had to pick just one it would be the Peter Lynch line about “knowing what you own and why you own it.” For if you don’t get that one right, you won’t hold any investment long enough to reap the benefits of time and compounding. You can have the best assets/strategy in the world but if you don’t understand what it is you will abandon it at the first sign of trouble. And believe me when I tell you that there will be many times of trouble.

Most advisors nowadays focus on asset allocation for their clients, typically a diversified mix of stocks and bonds. This is a good start, for asset allocation is the most important determinant of portfolio returns.

While not the “market portfolio” (see my recent post on this here), many advisors consider a 60/40 split between U.S. stocks and bonds to be a sufficient baseline for the average investor. If an investor’s profile allows for more risk, this can be shifted to 70/30 (80/20, etc.), and if an investor’s profile necessitates a more conservative stance, this can be shifted to 50/50 (40/60, etc.).

Advantages of a stock/bond portfolio are that it is 1) low cost (less than .04% using ETFs), 2) simple in execution (as little as two index funds), and 3) easy for investors to understand, at least in theory. You have a growth component (stocks) and an interest/capital preservation component (bonds) to balance out that risk. When things are going well, few advisors are questioned on this approach. It is only when losses rear their ugly head that the calls start coming in. Why are we holding this much in stocks? Did you know that my last statement showed that I lost thousands of dollars? What are you going to do about it?