Editor’s note: This article was first published in March 2013. Tip 15 cites Coca-Cola and Wrigley as Buffett investments, but Wrigley has belonged to Mars since 2008.
Warren Buffett has a knack for explaining complicated stock market ideas in a very simple, down-to-earth way. A lot has been said about him (and we have said a lot about him ourselves), but his best advice is usually what he says on TV programmes and in interviews, as well as in his letters to shareholders.
Here is a summary of what we consider his 16 best tips on investing.
Warren Buffett’s rules and commandments of investing
1. Master the basics, but don’t get lost in technicalities
To invest successfully you don’t need to understand modern portfolio theory, option pricing or emerging markets. You might even be better off knowing nothing about them. Business schools turn out students who are not ready to invest, because vision does not come first. On the other hand, give someone who wants to learn about investing two well-taught courses, one on how to value a business and one on how to think about market prices, and with that they can make a lot of money investing.
2. The best time to buy a company is when it’s in trouble
The best thing that can happen to an investor is to find a great company with temporary problems. The best time to buy a company is when it is on the operating table, although you have to make sure the “patient” isn’t going to go straight from the operating theatre to the cemetery. Bear in mind that the market’s reaction to a company’s problems is usually wildly exaggerated because of panic selling, and that is the moment we can take advantage of to buy.
3. Don’t buy a stock just because everyone hates it
Even Benjamin Graham himself was known for buying what every other investor was selling, but the truth is that buying shares simply because everyone is selling is just as foolish a reason as buying a stock because everyone is buying it. That doesn’t rule out a stock being unpopular while we, through our own analysis, have spotted potential in the company.
4. Stocks always come out of a crisis
Even if we are flooded with bad news, in the long run the news in the markets always ends up being good. In the 20th century, the United States went through two world wars, costly conflicts, the Depression, a dozen recessions, flu epidemics and so on, and in the end the stock markets went up. Of course, we have to choose strong stocks that won’t become fatal casualties of the crisis.
5. Beware the Cinderella complex when you’re making big gains
There is a line between investing and speculating, and it gets blurred when investors make a lot of money in the short term by speculating because the market happens to favour it. When speculators make money effortlessly they learn nothing, even though they think they are Cinderella. Once the turbulence arrives, they are left with a pumpkin and a couple of mice.
6. You don’t have to be a genius to be a good investor
(Read: You don’t need a high IQ to get rich.) In investing, someone with an IQ of 160 won’t necessarily get better returns than someone with an IQ of 130.
7. Think long term
Your goal as an investor should simply be to buy, at a reasonable price, part of an understandable business whose earnings will be safe for the next five, ten and twenty years. Over time you will find only a few companies that meet these standards. So when you do see one that does, you should buy a meaningful amount of its shares. If you aren’t willing to own those shares for ten years, don’t even think about owning them for ten minutes.
See also: The 4 books Warren Buffett still recommends for learning to invest
8. The best holding period for a stock portfolio is FOREVER
When we buy shares, we are buying part of a company. When our portfolio holds great businesses, the reasonable holding period for those shares is forever. Why would we sell something that is doing well?
9. Buy shares in companies that even an idiot could run
I try to buy shares in businesses so wonderful, with a product so easy to sell, that even an idiot could run the company. Because sooner or later, some idiot will.
10. Buying a stock is about much more than the price
It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
11. You don’t have to react to every move in the market
Markets never go on strike. They are open every working day, and every day there are changes. We don’t have to spend all day trading in the markets trying to catch every opportunity, nor do we need to swing at everything. The problem comes when you manage portfolios, because then your clients are the ones forcing you to keep moving.
12. If you’ve picked your stocks well, forget about politics and macroeconomics
There have always been conflicts, wars and crises, and there always will be. And Graham still made money. If we have good companies in our portfolio, the best thing that can happen to us is for the portfolio to fall 50% because of a crisis, because that way we can buy more shares at a cheaper price. In the end, if the shares in our portfolio have been well chosen, they will rise again.
13. Price and value are not the same thing
Long ago, Graham taught me that “price is what you pay, and value is what you get”. Whether we’re talking about socks or stocks, I like buying quality merchandise when the price is low.
14. Bad things don’t show when times are good
“After all, you can only find out who is swimming naked when the tide goes out.” People, like many companies, didn’t realise how much debt they were carrying until the crisis arrived.
15. Companies that don’t change can be great investments
Whatever happens over the next 10 years, the internet won’t hurt Coca-Cola or Wrigley chewing gum (two of Buffett’s investments). I like companies that have no need to change their business model as time goes by.
16. And finally: the two most important tips you must never forget
To be a great investor, you only need to follow two simple rules:
Rule number 1: Never lose money.
Rule number 2: Never forget rule number 1.
I think these tips sum up Warren Buffett’s and Benjamin Graham’s investing style perfectly.
Further reading
- 5 steps to building a dividend investing strategy
- Lessons from the few investors who beat the market
Featured image: Unknown author, Public domain, via Wikimedia Commons.
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