Warren Buffett is famous for saying the number one rule for investing is to never lose money. He went on to say the 2nd rule for investing is to always remember the first rule.

After thinking about Buffett’s rule for several years, I have come to realize he means to try and find investing opportunities where your risk of loss over the long-term is minimized. Buffett isn’t saying your investments shouldn’t go down in value, because they most certainly will at some point in the future. What he is saying is to setup your investments so you really can’t lose if you hold on long-term and continue with your investment plan.

This means we really have to think about “loss” before we invest. This past weekend I was walking through possible investment properties with a client and we had an interesting conversation about this idea with regards to one of the homes. The last home we walked through was a larger 3-bedroom colonial in Lake County. The home was on a slab and didn’t have a basement. It needed paint, carpet, and a few other cosmetic updates.

If this investor acquired the home for cash, he would be making a long-term investment where he really couldn’t lose. Here are the reasons why this investor can’t lose with this home over the long-term:

1. He was buying the home for cash and wouldn’t have a mortgage. His only fixed expenses would be taxes and hazard insurance. If his home were vacant for a few months, he wouldn’t have to write a large check out of pocket to make the mortgage payment. After deducting taxes and insurance expenses, his annual return on investment would be around 13% a year.

2. If the home burned down, he would get his money back from the insurance company after the deductible. This means his investment is protected from a 100% wipe out. This same protection isn’t available in the stock or bond markets.

3. Because the home didn’t have a basement and was structurally sound, most serious possible expenses have been eliminated. Yes, he will have to replace the roof every 15 to 20 years. This is easy to see and can be budgeted for in advance. He will also have to replace the furnace and air conditioner over time. Other than these items, everything else is cosmetic and can be done inexpensively.

4. If inflation spirals out of control, he will be protected as the value of this home will rise along with inflation. In addition, he will have the opportunity to raise his rents annually to adjust for higher inflation levels.

5. He would be buying the home under value. If the real estate market crashes again and the home drops in value, he has a cushion built in with this investment. More importantly, he is investing for the long-term and any short-term value fluctuation will have zero impact because he isn’t buying to resell.

6. He is in 100% control of this investment. He gets to decide who he rents to and who he doesn’t. He doesn’t have to worry about the successful management of his investment buy others.

His only real risk would be problem tenants and related property damage. Over a long period of time, he may have to evict a few tenants. This is part of rental property ownership. He’ll lose a month or two of rent. He’ll also have to clean up the home and get it ready to show. All totaled, this may cost him $4,000 every 4 or 5 years. This problem can be minimized by proper tenant screening, Selecting higher quality tenants that have stable W-2 income will improve his odds for success dramatically as he would be able to have his attorney garnish evicted tenant’s wages recapturing these losses through the evicted tenants future paychecks.

I believe this is what Buffett meant with his number 1 rule of investing. We should look for investment opportunities where you can’t lose over the long-term. These investment opportunities rig the game in your favor setting you up for long-term success. The best part is we’re able to “see” this in advance. We don’t have to buy the home crossing our fingers hoping things works out.  There isn’t a great deal of guess work with this investment opportunity because we’ve eliminated significant loss before we invested.