How to invest in stocks is a perennial question for new investors. Here, I’ll explain some key principles advocated by legendary investor Warren Buffett and writers here at the Motley Fool.
Buffett’s Berkshire Hathaway investment company has been hugely successful over many decades. And his annual letters to shareholders are full of investing wisdom and wit. Naturally, as the Motley Fool’s purpose is to make the world smarter, happier and richer, our views on investing are much informed by Buffett.
So, here’s how to invest in stocks following key Buffett and Foolish principles.
Cash first
Buffett has said: “I will never risk getting caught short of cash.” He’s pledged always to hold at least $20bn, and that Berkshire “will forever remain a financial fortress.”
Here at the Motley Fool, we regularly caution readers to pay off any high-interest debt, and build up a ‘rainy day’ cash fund, before starting to invest in the stock market. Like Buffett, we believe investing in great businesses, for the long term, is the most effective path to wealth. The last thing you want is to find yourself with short-term cash flow needs during a bear market, and having to sell your stocks to meet them.
How to invest in stocks #1
Stock market indexes, like the UK’s FTSE 100 and the US’s S&P 500, have big down-swings at times. However, they’ve always recovered, and gone on to make new highs. Even if you’ve no interest in individual stocks, you can still profit from putting money into the stock market.
Indeed, as Buffett has said: “By periodically investing in an index fund, the know-nothing investor can actually outperform most investment professionals.” You’ll find plenty of Motley Fool articles discussing the merits of making regular investments in a low-cost index tracker. By simply investing on a monthly plan, you should get close to the index’s long-term return.
How to invest in stocks #2
Of course, Buffett’s great wealth has come from outperforming the market by investing selectively in individual businesses. His selection of such businesses is based on his knowledge of industries, profits, cash flows, and balance sheets. And also his understanding of valuation measures.
This ‘fundamental analysis’ of companies is what we at the Motley Fool also advocate for choosing individual stocks. Like Buffett, we’re interested in identifying great businesses, becoming part-owners of such businesses, and acquiring our shares when they’re trading below the intrinsic value of the business.
Sure, we may not always agree on whether a business is great, or whether its shares are trading below intrinsic value. But we believe that considering a diverse range of insights makes us better investors.
Buffett’s partner Charlie Munger has this advice for investors: “Go to bed smarter than when you woke up.” This is because he puts Buffett’s investing success down to him being “a continuous learning machine.”
Foolish bottom line
If you’ve decided to invest in the stock market, you’ve made a smart move. If you’ve decided on picking individual stocks, aim to keep getting smarter. The more adept you get at identifying great businesses, and figuring their intrinsic value, the more your wealth will likely grow. Fool on!