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Warren Buffett: the 3 vital investing rules the world’s best investor follows

James Reynolds — Thu, 23 Dec 2021 08:41:50 +0000

Warren Buffett is widely regarded as the greatest investor of all time. In the 1980s, he became a billionaire, and his tenure at Berkshire Hathaway has seen its A shares grow in value to almost $400,000. What lessons can we take from him? Actually, quite a few. Throughout the years, Warren Buffett has offered a thorough overview of how he makes the types of investments that yield double- or triple-digit returns in interviews, books, and letters. Here are some of the most vital rules he follows to help ensure success.

Warren Buffett says “be patient“

Buffett believes that patience is the most important value an investor can have. There may be a fantastic firm out there, but if the stock price is too high, it’s best to wait for it to fall. There may be a market crash, and your assets may lose value, but if you wait long enough, the price may rise again.

Even if it doesn’t appear so, the stock market is continually presenting fresh chances. All we really have to do is wait for them.

Focus on your circle of competence

It is vitally important that I understand the business I’m investing in. Warren Buffett has been criticised for losing out on the boom in tech companies over recent decades. However, he has always stated that he does not understand how those firms create money and hence does not invest in them. That’s not to imply Facebook or Google are untrustworthy firms; it’s just that he wouldn’t know the difference between a good and a bad investment. For the same reason, I avoid investing in banks, but I do invest in renewable energy.

As we gain confidence in our investing, it is always a good idea to attempt to learn more about other companies and sectors. But Buffett encourages us to focus on what we currently know well. In an interview with CNN, another well-known investor, Peter Lynch, reiterated a similar stance, “I know restaurant managers who invest in IBM, but I always ask why they don’t invest in restaurants. They know how the business works. They know if a restaurant is profitable and what sorts of challenges they face”.

Ignore the share price. What’s its value?

Warren Buffett is a firm believer in the necessity of sound business principles. Observing a stock’s rise and fall is, for the most part, frustrating, draining, and unproductive. Many inexperienced investors make the mistake of purchasing when the price rises and selling when the price falls. However, there are a multitude of other factors that influence share prices. Not only is it hard to forecast these fluctuations, but they typically reveal next to nothing about a company’s health.

If, on the other hand, an investor learns how much debt a firm has, how much cash it has on hand, and whether it makes a consistent profit, they will be in a much better position to determine whether the company is healthy or not.

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James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Investing basics: 3 rules that helped me become a better investor

James Reynolds — Wed, 15 Dec 2021 11:32:27 +0000

Investing basics may seem simple, but they are the foundation on which all successful investors base their decisions. Many of my best decisions were made when remembering these rules. And many of my biggest mistakes were made ignoring them.

No one’s making you swing

Warren Buffett once compared choosing investments to batting in a game of baseball, save for one key difference. There’s no rule that says you have to swing. This means I can take the time to really think over every opportunity that comes my way, and if I’m not 100% certain it’s a good bet, I don’t have to take it. This has meant I’ve missed some great investments, but there’s nothing wrong with that. There will always be more opportunities, more chances to swing. And when it comes to my hard-earned money, it’s better to play it safe.

Don’t be lazy. Do your research

It really doesn’t take much effort to learn a little about a company, and that research can be the difference between making a great investment and losing lots of money. Of course, I need to know what I’m looking for, so I ask myself:

Does the company offer a product or a service?
Is it expensive to run?
Does it have a lot of competition and if so, does the company have an edge over similar companies?
Does it have a lot of debt or large profit margins?

Most of these questions can be answered by looking at a company’s financial statements and by using a bit of common sense.

Don’t buy the news

It’s important to keep up with the news and know what’s going on in the wider world. The problem with following the news too closely is that it can cause us to invest reactively rather than proactively, leaving us always one step behind the market.

One of the biggest mistakes I ever made was buying shares in a company that had just made the news because the stock price had gone through the roof. Shortly after, the price crashed. Because I was a novice investor, I panicked and sold. The entire process just cost me money and caused me stress.

Now I do my research first and never buy a company I hear about in the news.

Investing is a marathon, not a sprint

Every single person on the planet is susceptible to the influence of two key emotions. Fear and greed.

It’s fear that makes us sell our shares when the market goes down, and greed that pushes us to buy when prices are at all-time highs. If I don’t keep these emotions in check, I might as well just burn my money.

The trick is to remember that investing is not about making money today. It’s about building wealth over the long term.

The best thing I ever did was buy shares and forget about them. Prices will fluctuate up and down in completely unpredictable ways for years, and I realised that if I spent my days watching them, I would only lose the strength of my convictions.

All investing brings with it risks but our job as investors is to manage those risks and try to stack the odds in our favour.

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Don’t know how to start investing? These 4 rules helped me

James Reynolds — Thu, 04 Nov 2021 14:30:33 +0000

Trying to start investing can be daunting, especially if no one you know has any experience. This was true for me. With no one to turn to, I poured over as many books, blogs, and videos as I could to work out what to do

These are some of the key rules that I learned and that have helped me on my journey.

Rule 1: don’t lose money

Warren Buffett famously said, “Rule one of investing: don’t lose money. Rule two: follow Rule one”. While the quote is humorous on the surface, it’s worth bearing in mind whenever making an investment decision. Sure, investing is about building wealth, but we can’t do that by throwing cash away on thoughtless ventures. The first thing I learned was that I could lose everything if I wasn’t careful. So, I needed to think a lot before making any decisions.

Rule 2: understand the business

How can I be sure if I’m making a good investment? By knowing what I’m talking about. So, when considering a stock, I ask myself:

What does this company do?
How much does it cost to run?
How much debt does it have?
What’s its year-on-year revenue growth?
Does the company have brand recognition and a stable history of profitability?
Does the company have a new product coming out, or a continuing service?

All this information is easily available with a few good Internet searches. Some of it can be tough to grasp at first, but with time and focus it can be understood. There is no way to know if stock will do well in the future. But if I understand the business then I can have assess how well the company can weather any financial storms.

Rule 3: be patient

When I decided I wanted to become an investor, I saw the gains being made by some stocks and felt like I needed to invest as soon as possible. I didn’t do my research and bought Tesla shares because of how much they were going up. Then, when the price came down, I panicked and sold. I needed the patience to learn what I was investing in.

Conversely, if I had held on to those shares, I would have made a profit by now. I also needed the patience to wait for investments to bear fruit.

Rule 4: invest in myself first

The vast majority of people will not become rich just from investing. And that’s okay. Investing is about compounding wealth over time, not becoming a millionaire overnight. Once I realised this, I stopped worrying about how much a stock would go up in a day, and turned my attention to my career. Now I focus on earning enough to invest, instead of how much I can earn from investing.

Conclusion

Investing is a risky business that requires time, patience, careful planning, and as much help as one can get. The whole process definitely felt daunting from the outside, but I learned that it could be understood and used to my advantage.

No one can predict the future. A stock might go up, down, or nowhere, or a global pandemic could crash the market. What I can do is follow some simple rules to keep a clear head and stack the deck in my favour.

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Smash profit warning paralysis with this three-step guide

Zach Coffell — Sat, 14 Oct 2017 07:44:06 +0000

It’s a morning like any other. You awaken gently, throw open the curtains, stick the kettle on and settle in to catch up on the morning news.

But this peaceful routine is just the calm before the storm. Just a few clicks away it lurks, ready to pounce. When it hits you – and hit you it will – you freeze as your retirement drifts further into the future.

I’m talking, of course, about profit warning paralysis. I’m being more than a little dramatic too, but I’m sure every investor out there has felt uncertain in the face of bad news. Deciding whether or not to sell, or perhaps even buy, more shares can feel like an insurmountable task.

If you find yourself panicking after a profit warning, fear not. We’ve designed a pragmatic methodology to help you separate the irrelevant from the irreversible. The next time you find your critical faculties overwhelmed by sudden negative news (and it happens to the best of us) simply work through this three-step survival guide.

1. Is the investment thesis still intact?

Every time I make an investment, I create an investment thesis – a small paragraph that explains exactly why I’m buying the share. For example:

“I bought company x because I believe its superior product can prosper overseas.”

If you’re investing for the long term, having a thesis for each stock you buy is incredibly important, because it helps you focus on what is important. If the reasons behind the profit warning scupper your investment thesis, it is probably time to move on and sell the shares.

If you haven’t already, perhaps you should clarify the investment thesis behind each of your investments.

2. Quantify a worst-case scenario

If step one didn’t help, I’d advise you try to quantify the profit warning. If the announcement uses vague terminology such as “significantly behind expectations” you should try to put a number on what a worst-case scenario might look like.

For example, a company I follow recently warned on profits because one of its major clients had declared bankruptcy. After sifting through the annual report, it seemed clear that no single client accounted for more than 10% of revenues, so that became my worst-case scenario. As a result, I’m considering buying up some of the shares.

Putting a number on the downside will remove that fear of the unknown and help you make a considered decision.

3. Go for a walk.

If step one and two haven’t banished the nerves, I’d recommend getting away from the computer screen. Go outside, play some sport or read a book. Just get your mind away from the news for a while. Perhaps sleep on it. Decisions made in a panic are almost always poor, so ensure you regain control of your critical faculties before doing anything at all.

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There Are No Rules In Investing!

Alan Oscroft — Fri, 08 Apr 2016 17:01:20 +0000

Wherever you look in the investing world, you’ll find countless experts all with their own rules. My own favourites are Warren Buffett’s top two:

Don’t Lose Money
Don’t Forget Rule 1

But other than general good advice like that, which really just amounts to common-sense, there actually aren’t any hard and fast rules.

I’ve often had newcomers to investing ask me how you can tell when a share is good value, and how to tell if a share is going to go up or down. But if there were any objective rules for deciding such questions, everyone would be winning all of the time.

In fact, for any share price at any given moment when the markets are open, the balance between people thinking it’s a buy and people thinking its a sell is precisely equal. It has to be, because as soon as the balance changes even slightly, the market price adjusts upwards or downwards to re-establish that balance between buying and selling.

Economics? Pah!

What about those who tell you the markets are heading for a new golden era based on a positive outlook for economic recovery? Or those predicting a crash because the economic portents from the East look foreboding? Well, it’s a common suggestion that if all the world’s economists were laid end to end they wouldn’t reach a conclusion. The fact is, there are no rules in economics either; there are just attempts at modeling and predicting. And those models and predictions get it right, except when they don’t.

What we need to do as investors is abandon all reliance on rules, forget trying to outguess the next person in the price-movement stakes, and stop looking for the next get-rich-quick indication. What should we do instead?

Strategy is everything

The key thing is to work out an investing strategy that you are personally comfortable with. It’s no use chasing super-high-risk oil explorers, for example, unless you have money you can comfortably afford to lose and you have steely nerves that can handle a volatile roll-coaster share-price ride. But if you do have those things, and you veer more towards the gambling end of the investment spectrum, then go ahead.

Similarly, while I’d strongly recommend investing in solid blue-chip companies that pay decent dividends, and then reinvesting the dividend cash and leaving it there for decades, if you’re young and potentially have many decades ahead of you and you want to take a higher-risk punt on some hot growth candidates, then why not?

In fact, your strategy may well change with age. When I started out investing in shares around 25 years ago, I used to like smaller cap growth candidates — and some did nicely for me, while others crashed and burned. Today I prefer shares that look to be highly cash-generative and should provide steady dividend income, especially when I can find them at prices that look undervalued — my two prime holdings with that approach are Lloyds Banking Group and Aviva (but even in my advancing years, I still find room for the occasional higher-risk and higher-excitement investment, albeit only with small sums).

It’s your business

In the end, my favourite bit of investing advice is independent of which kind of investments you favour. It’s to invest in companies, not in shares. What that means is you should focus on the business and its future potential, not on the share price and where it might be going — the former is the horse, the latter the cart.

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Alan Oscroft owns shares in Lloyds Banking Group and Aviva. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Five Great Investing Rules

Alan Oscroft — Thu, 25 Feb 2016 18:05:36 +0000

I was thinking what my top five rules for investing might be, but there have been so many good ones from so many great investors over the years it’s very hard to select the best. So here, instead, are just five rules that I think everyone should follow (and next time you ask me I might pick a completely different five).

Rule 1: Never lose money

This might sound obvious, but it’s Warren Buffett’s rule number 1 (and his rule number 2 is, famously, “Never forget rule 1“).

Most people who start out investing in shares are focused on how much they can possibly gain. They look at past successes and want some of it, and they go seeking the shares they think will have the biggest upsides. But the shares with the best growth potential are usually also the riskiest, and if you get the wrong ones then you could be exposed to some nasty downside too.

If you’re investing your hard-earned cash, your first focus should be on how to preserve it — and the companies that are best at preserving cash, strangely enough, usually turn out to be the best at growing it too.

Rule 2: Keep Your Costs Down

If you invest £1,000 in shares it’s likely to cost you around £15 in broker charges and stamp duty, then you’d have to pay around another £10 to sell. The spread between the buying and selling price has to be considered too, and that can vary a lot — a FTSE 100 company will have a very small spread, but smaller AIM shares can carry spreads of 10% or more.

In all, you could easily be looking at a 5% hit for every buy/sell cycle, and that will quickly kill any profits if you trade too often — so don’t over-trade, and keep the costs down.

Rule 3: Don’t try to time the market

Do you watch share price charts and try to guess where the price is going next and try to get in at the low point? Does it upset you if a share falls after you’ve bought it or rises after you’ve sold it? You’re making a big mistake.

Trying to time the market is a mug’s game, and none of the investment greats place any store in it — if it was easy to do then they’d certainly be doing it.

Rule 4: Invest on fundamentals alone

This is the flip side of Rule 3 really, and says that the only thing that counts when making an investment decision is a company’s fundamentals. Is it in a safe business? Does it have a good track record? Is it growing its profits? Does it pay healthy dividends supported by strong earnings?

If you can buy shares that satisfy these criteria and can get them at a favourable share price valuation, you’ll almost certainly beat the chart-watchers.

Rule 5: Investing is forever

This is one of the best rules of all. When you look at a share, don’t buy it for a quick profit, don’t buy if you think you might sell after a year. In fact, don’t buy with any time horizon at all — buy with a view of holding forever.

Of course, fundamentals can turn bad and selling might become a good idea, and this rule doesn’t mean you should actually never sell — just only buy shares that, at the time, look good enough to keep for ever.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.