Warren Buffett is perhaps the most successful investor of all time and when he offers investment advice, people listen. Here are five pieces of advice from the investing legend that could help you become a better investor.
Never lose money
When asked about his most important investment advice, Warren Buffett once replied: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
Capital preservation is vital if you want to be a successful investor. Lose 50% of your capital on a risky small-cap stock and suddenly you need a 100% return just to break even. Lose 90%, and you need a 900% return to break even.
Buffett understands the importance of capital preservation so diversifies his portfolio across a selection of high quality companies that have strong long-term records of generating shareholder wealth. He avoids risky investments in which there’s a higher possibility of a capital loss.
Obviously ‘never losing money’ is easier said than done in the share market, and Buffett himself has made mistakes in which he’s lost capital. But if you can make every effort to avoid big losses in your portfolio, you’ll generate much better returns over the long term.
Take a long-term view
Experts say investing is a long-term game, but there’s no doubt that in the modern world of 24/7 financial news, it’s easy to get caught up in a short-term panic.
Ignore the ‘noise’ and “invest with a multi-decade horizon” says Buffett. Instead of trying to make a quick buck, he says, you should be focused on increasing your purchasing power over your entire lifetime.
Reinvest your profits
It’s a great feeling when you own a stock that rises strongly and suddenly you’re ‘in the money.’ Likewise, when you receive a healthy dividend payment into your account. It can be tempting to take the profits and spend them. However if you want to invest like Buffett, resist the temptation to spend your profits or dividends and reinvest them back into your portfolio.
The greatest tool when it comes to wealth building is the power of compounding. This is where you earn a return on not only your initial capital, but also on your gains. Long term compounding is the secret to really big portfolio gains, so ensure you reinvest your profits for maximum portfolio performance.
Invest in what you understand
Buffett likes to keep things simple when investing and for this reason, avoids investing in anything he doesn’t understand.
It’s an idea backed up by another legendary investor, Peter Lynch, who once said “never invest in an idea that you can’t illustrate with a crayon.”
By concentrating on companies that you understand, it may help you avoid big losses.
Use low cost index funds
Lastly, while Buffett has an incredible track record of picking individual stocks, he’s also a huge advocate of using low cost index funds. In his 2013 letter to Berkshire Hathaway investors, Buffett stated that, upon his passing, the trustee of his wife’s inheritance was instructed to put 90% of her money in a low cost S&P 500 tracker and 10% into short-term government bonds.
Buffett believes this strategy has the potential to outperform most investors, as it’s often shown that the majority of investors, including highly paid ‘expert’ fund managers, fail to beat the market on a consistent basis.