Buffett Never Ignores These 4 Rules… Do You?

As one of the most successful investors of all time and one of the richest men on Earth, Warren Buffett has offered a lot of wisdom over the years. And while there’s a lot of wise words to choose from, his timeless principles over the years have made his reputation in the investing community as good as gold.

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And rightfully so. Buffett’s Berkshire Hathaway investment portfolio has averaged staggering annual returns of 20% per year since 1965 — doubling the average annual return of the S&P 500 over the same period. In other words, every $100 invested with Buffett then would be worth $910,000 today.

With a track record like that, it may be worth looking at some of Buffett’s sage investing advice to see how we might improve our own portfolio performance. After polling some of our StreetAuthority experts, I came up with a few of our favorite lines from Buffett over the years:

4 Buffett Principles To Invest By

1. “Our favorite holding period is forever.”
It may not be trendy or sophisticated… but buy-and-hold investing — Buffett’s favorite strategy according to Berkshire Hathaway’s 1988 letter — is one of the few strategies actually proven to consistently make money over the long term. The proof comes from an Oppenheimer study, which found that the S&P 500 never suffered a loss over any 20-year period going all the way back to 1950. The extensive study also showed that short-term investing can be a bad idea, as the S&P 500 lost money 16 times in a one-year-period since 1950.

2. “If a business does well, the stock eventually follows.”
Don’t just buy stock if you want strong returns. Buy shares in a business you’d be proud to own, and be prepared to reap the rewards. Much of Buffett’s investing success has come from buying well-managed companies with solid economic moats (i.e. lasting competitive advantages), consistently high return on equity (ROE), and low debt. He also admires companies with leaders that readily admit mistakes, have the interests of shareholders at heart, and own a large portion of the company themselves. (You can see Buffett’s full criteria on page 23 of his 2014 shareholder letter.)

3. “Investment must be rational; if you don’t understand it, don’t do it.”
Buffett advocates owning established companies with household name brands and understandable business models. One look at Berkshire Hathaway’s portfolio should illustrate this point, as well-known and simple companies like Coca-Cola (NYSE: KO) and American Express (NYSE: AXP) continue to be some of its largest holdings, making the firm ten times (or more) than the original investment.

It doesn’t always work out, though… Buffett famously missed out on the initial big run-up in tech stocks like Apple and Amazon — but that’s because he always admitted that he didn’t quite understand tech. It was only years later after bringing on trusted, experienced money managers into the firm that he later decided to invest in Apple, for example. The point is most investors would be better off knowing when to “stay in their lane” and avoid what they don’t know, too.

4. “Diversification is protection against ignorance. It makes little sense for those who know what they’re doing.”
Yes, it’s true Buffett recommends that non-professional investors buy shares in diversified, low-cost S&P 500 index funds to avoid risk. But how can you beat the broader market when your portfolio is the market?

Buffett compares this to putting Lebron James on the bench during a basketball game: “If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice. It’s the ‘LeBron James’ analogy. If you have basketball phenom LeBron James on your team, don’t take him out of the game just to make room for someone else.”

In other words, if you know an industry well (or work in it), you may have a better-than-average chance of spotting a good company and thus a potentially market-beating stock. And if you’re picking your own stocks, then it’s far more likely you’ve come up with only one or two really good ideas than a dozen. So as long as you’re aware of the risks, it can really pay to be “overweight” on your best ideas.

The Takeaway

We can argue whether Berkshire Hathaway itself is a “buy” today, but there’s no denying that we can all profit from Buffett’s wisdom. Learn from the man himself and try to adapt his principles to form a sound, profitable investing strategy.

In short: Buy well-managed companies with wide moats, understandable business models, and in industries that you know well.

P.S. Our colleague J.R. Butts has been researching the “next investment frontier” in tech for the past few months. And he’s convinced this is the “next big thing”…

You may already know that Elon Musk is busy commercializing outer space with his company, SpaceX. Dozens of other companies are scrambling to win the race, too. But what’s barely getting any attention in the mainstream press is one of Musk’s “secret” projects that could be an absolute game-changer. And J.R. has discovered a unique “backdoor” way we can gain exposure before the crowd catches on…

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