"The first rule of an investment is don't lose [money]. And the second rule of an investment is don’t forget the first rule. And that's all the rules there are."
This quote from legendary billionaire investor Warren Buffett has become one of his most well-known aphorisms. It highlights his fundamental investment philosophy with both wit and clarity.
Buffett's investment strategy stands out because of his aversion to losses. Instead of accepting losses, he tends to double down on his positions or even increase his investments when they go against him. He believes that if you like a stock at a certain price, you should like it even more when the price goes down.
Following Buffett’s rules of not losing money in investments can be easier said than done at times. No one wants to experience financial losses. But by taking calculated risks and investing in promising companies, people have the potential to reap significant rewards.
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Even Berkshire Hathaway Inc. was initially a losing bet. Buffett purchased a textile company, thinking it was a bargain.
During a taped interview with CNBC's Becky Quick, Buffett openly discussed his regrettable decision in 1964 to acquire Berkshire Hathaway, a declining textile company based in Massachusetts. Buffett candidly referred to this move as a $200 billion blunder and one of the ‘worst investments he ever made.’
Despite recognizing the unfavorable circumstances early on, Buffett held on for about 20 years, driven by his determination not to give up easily.
Buffett justified the decision to shut down the textile operations by considering the costs involved. The struggling business would have required substantial investment to remain competitive, but the returns would have been weak compared to Berkshire's other growing business lines at the time. Buffett believed that choosing to invest would have led to terrible returns while refusing to invest would make the company noncompetitive.
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In a letter to shareholders in 1985, he referred to the difficult decision as a "miserable choice."
Berkshire Hathaway was transformed from a losing textile business to a diversified holding company worth $755 billion today.
Buffett's focus on longevity is evident in his investment decisions. When evaluating potential investments, he and his partners consider the company's competitive advantage and its ability to sustain that advantage over the long term. They look for businesses they believe will maintain their strength and profitability for five, 10 or 20 years.
Buffett didn’t invent this strategy, but he has certainly mastered it. This strategy has been popular in recent times with the recent market downturn and the growth of investing in private businesses and startups on platforms like StartEngine and Wefunder. The recent bear market saw a number of billion-dollar brands hit new lows on some of the companies like Meta Platforms, Inc. and Netflix Inc. These companies saw declines in excess of 70% before rebounding to near all-time highs. Similarly, the rise of equity crowdfunding platforms like StartEngine allows investors to invest in startups and early-stage growth companies at the earliest stages. These types of investments see investors holding for several years in earlier-stage companies they believe in. Then once they IPO, investors often see substantial gains.
His investment philosophy, often referred to as value investing, has been successfully applied in various instances. For instance, he acquired See's Candies in 1972 and invested over $1 billion in The Coca-Cola Co. stock in 1988, both of which turned out to be lucrative decisions. He holds the stock to this day.
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This article Warren Buffett's No. 1 Investing Rule: Don't Lose Money — Practical Advice For A Billionaire, But Can Regular Investors Apply It Successfully? originally appeared on Benzinga.com
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Longtime Berkshire Hathaway CEO Warren Buffett is inarguably the world's greatest stock investor. He's also a bit of a philosopher and Buffett pares down his investment ideas into simple, memorable sound bites. Here are a few of his most famous rules of investing.
Alison Czinkota / Investopedia
Rule 1: Never Lose Money
This might seem like a no-brainer because what investor sets out with the intention of losing their hard-earned cash? But, in fact, events can transpire that can cause an investor to forget this rule. Buffett thereby swears by Rule 2.
Rule 2: Never Forget Rule No. 1
Buffett personally lost about $25 billion in the financial crisis of 2008 and his company, Berkshire Hathaway, lost its revered AAA rating. So how can he tell us to never lose money?
He's referring to the mindset of a sensible investor: Don't be frivolous. Don't gamble. Don't go into an investment with a cavalier attitude that it's OK to lose. Be informed. Do your homework.
Warren Buffett invests only in companies that he thoroughly researches and understands. He doesn't go into an investment prepared to lose and neither should you. He believes that the most important quality for an investor is temperament, not intellect. A successful investor doesn't focus on being with or against the crowd.
The stock market will experience swings but Buffett stays focused on his goals in good times and bad. So should all serious investors.
Warren Buffett rarely changes his long-term investing strategy no matter what the market does.
Rule 3: Pick Businesses, Not Stocks
When a business does well, the stock should eventually follow. Buffett seeks out businesses that exhibit favorable long-term prospects when he's choosing investments. Does the company have a consistent operating history? Does it have a dominant business franchise? Is the business generating high and sustainable profit margins? It's a stock that Buffett might want to own if the company's share price is trading below expectations for its future growth.
One of Buffett's rules for success is that he never buys stock in a company unless he can write down the reasons he's willing to pay a specific price per share. Other investors could benefit from the same exercise.
Rule 4: A Wonderful Company at a Fair Price vs. a Fair Company at a Wonderful Price
Buffett is a value investor who likes to buy quality stocks at reasonable if not rock bottom prices. His goal is to build a portfolio of stocks that will reward him with solid profits and capital appreciation for years to come. When the markets reeled during the 2007-2009 financial crisis, Buffett used the opportunity to stockpile venerable long-term investments by spending billions on names like General Electric and Goldman Sachs.
Disciplined investors establish their criteria and stick to them to pick stocks effectively. You might seek companies that offer a high-quality product or service and also have solid operating earnings and the germ for future profits. You might establish a minimum market capitalization that you're willing to accept and a maximum price-to-earnings (P/E) ratio or debt level. Finding the right company at the right price with a margin for safety against unknown market risk is the ultimate goal.
Remember that the price you pay for a stock isn't the same as the value you get in return. Successful investors know the difference.
Berkshire Hathaway CEO Warren Buffett's net worth as of August 2023 was $121 billion, according to Bloomberg.
Rule 5: Our Favorite Holding Period Is Forever
Warren Buffet is the ultimate exponent of a buy-and-hold philosophy. How long should you hold a stock? Buffett says you shouldn't own it for 10 minutes if you don't feel comfortable owning it for 10 years. He held on to the bulk of his portfolio even during the financial crisis, which he referred to as an "economic Pearl Harbor."
Committing to a long holding period will keep an investor from acting too human unless a company has suffered a sea change in prospects, such as impossible labor problems or product obsolescence. Being overly fearful or greedy can cause investors to sell stocks at the bottom or buy at the peak and destroy portfolio appreciation in the long run.
Rule 6: Be Willing to Be Different
Don't follow the pack, even if the leader of the pack would appear at first glance to be wildly successful. You most definitely want to follow the advice of the masses and popular opinion because you can't know how or from where those opinions derive. They could be and often are without any real basis, in fact.
Buffett has suggested following your own gut instincts if you're going to trust any gut instincts at all. Don't be afraid to swim against the tide. He started out with a "mere" $100,000 in 1955. It wasn't his own money. It was gathered from a handful of investors who trusted him even though he didn't operate on Wall Street.
But Buffett declined to share his plans and tactics with them, and he broke a golden rule in the process: He didn't tell his investors where he was putting their money. He preferred to operate without their approval, trusting his instincts without interference. And he ultimately turned that first $100,000 into more than $100 million.
Read about Investopedia's 10 Rules of Investing by picking up a copy of our special issue print edition.
Rule 7: Avoid Credit Card Debt
You can do far better things with your money than give it to credit card lenders in the form of interest in exchange for purchasing power you might not have had otherwise. The idea behind investing is to earn interest, not to give it away. This is the basis of one of Buffett's rules of life. It's not focused solely on investing.
Buffett told a 1991 audience at the University of Notre Dame, "The two biggest weak links in my experience: I’ve seen more people fail because of liquor and leverage – leverage being
borrowed money." He specifically warned against being infatuated with how much money can borrow and not giving enough thought to how much money you can pay back."
The liquor reference might not need an explanation. It goes without saying that its influence might not always suggest the best ideas in the world.
Rule 8: Invest in What You Understand
Buffett told the media at a press conference after Berkshire Hathaway's annual shareholders meeting in 2019 that they should "invest in what you know." They should confine themselves to businesses they understand. You're effectively taking a shot in the dark when you throw money at an industry that leaves you clueless as to how and why it might succeed or fail.
And Buffett speaks from experience. He's renowned for not investing in high-tech stocks back in their pilgrimage because he admits he didn't fully understand what they were about or what they were trying to achieve. Don't place your money in an area where you're "incompetent," at least until you become competent. Take some time to educate yourself first.
The short answer is to buy undervalued stocks with solid long-term potential. The longer answer is that it requires research and a steady commitment to the companies in which you're invested. Hold them through thick and thin, ignoring market volatility, unless something material changes in the company's outlook, such as product obsolescence.
In addition to analyzing the long-term business prospects of a company such as whether it has competent senior management and a solid balance sheet, Buffett is known to focus on market capitalization (not too small), debt levels (not too great), and earnings per share (not too high). He's looking for solid companies with sound balance sheets and positive long-term outlooks, investments that he can hold for a long period of time.
Buffett might blithely answer "forever" to that question, and that's not far from the truth. He will maintain his portfolio and may even add to it if certain holdings drop to an attractive price level, even during extreme market volatility. Buffett is a long-term value investor who sees volatility as an opportunity to buy at appealing levels or to take profit and sell some of his holdings if they've overshot what he believes to be a reasonable price.
The Bottom Line
It's safe to say that Warren Buffett is an investor nonpareil and the frequent subject of many books on investing. He's accomplished this by sticking to some very basic rules for buying and holding investments in his portfolio. His methodology for picking stocks involves a great deal of research aimed at establishing a fair price for a particular stock.
The rest of the market may be in a panic-selling mode, but Buffett sees opportunities as prices fall to his predetermined fair valuation. It might be said that he likes Stock XYZ but not at its current market price. He's ready to buy it if the price of that stock drops to his preferred value range. To paraphrase Buffett, the market is there to accommodate your investing strategy but only when the price is right.
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