Warren Buffett is recognised as one of the greatest investors of all time, and for good reason. He became a self-made billionaire at the age of 53 and, still commands captive audiences wherever he speaks.
I made a lot of mistakes when I first started investing. I watched the market and listened to the news every day because I felt that that was what was important. But instead, it was overwhelming, stressful and, most importantly, expensive. Eventually I realised that, if I want to be successful, I should learn from the master. After devouring all the letters, books and speaking events I could find, these are three of Warren Buffett’s key rules I follow when considering stocks for my portfolio.
1. Know what you’re investing in
Warren Buffett refuses to invest in businesses he doesn’t understand. His reasoning is that you have to understand the business to know if a company is being run well. I agree with this thinking. I know nothing about banking, so now I don’t invest in banks. What I am passionate about is renewable energy. I understand the challenges and opportunities in that sector, which means I can make more informed decisions about the stocks I add to my portfolio. It can be frustrating missing out on big growth stocks, and Warren Buffett received a lot of criticism for not investing in Google (Alphabet) or Facebook. But he didn’t understand how they made money and didn’t want to take that risk.
However, he was one of the only big investors who bought Apple when it was undervalued and has since made $100bn from that investment.
2. Margin of safety
This is the most difficult step when choosing a stock. Warren Buffett only buys a company when it is undervalued, providing a ‘margin of safety’ in case it doesn’t go up by as much as he had hoped. To do this, Buffett waits for the price to go down before buying and continues to buy more as the price falls lower and lower. I found this very scary at first. But, if I’ve chosen a company well, this is how I’ll make the most profit in the long term.
3. Think long term
Warren Buffett is not a trader, he’s an investor. He buys stocks with the aim of holding them ‘forever’. That is where real wealth is built. Thinking long term may be the most important rule I’ve had to learn. It’s not exciting or flashy, and I won’t be rich tomorrow. But investing isn’t a get rich quick scheme, and planning for the long term is how I’ll continue to approach my portfolio. Buffett became a billionaire in his 50s, so I still have many years in which to catch up.
If there’s one theme in all of Buffett’s teachings, it’s patience. Warren Buffett once said that the stock market is a system for transferring wealth from the impatient to the patient. In my early days, I often grew over-excited watching a stock shoot up in value, and would buy in, hoping to make a quick profit. Reacting to the market like that cost me a lot of money. I’ve since learned to ignore the noise and plan for the long term, just like Warren Buffett.
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James Reynolds does not have a position in any of the shares mentioned. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Alphabet (A shares), Alphabet (C shares), Apple, and Facebook. The Motley Fool UK has recommended the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. 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.