What Can We Learn from Buffett’s 4 Principles of Investing?
If you’ve been reading our articles for a while, we’ve talked a lot about starting to invest and save young. So if you are interested in that, here are a few investment principles from Warren Buffet, arguably the world’s greatest investor!
Warren Buffett is the billionaire CEO of Berkshire Hathaway. Between 1964 and 2022, Buffett grew Berkshire Hathaway’s market value by 3,787,464%, surpassing the S&P 500’s growth of 24,708%. That means if you invested $100 into Berkshire Hathaway in 1964, you would have almost $3.8 million by 2022 (around 20% per year), compared to only $25,000 if you invested in the S&P 500 (just under 10% per year). Buffett is often praised for his simple yet effective investment strategy. Today, we will be summarizing his investment philosophy into four basic principles.
Principle #1: "The first rule of an investment is don't lose [money]. And the second rule of investment is don’t forget the first rule. And that's all the rules there are."
This first principle highlights the importance of building confidence that an investment will not lose money. After all, since the alternative to investing is keeping your money in the bank, you have to believe that over time, your investments can grow in value and at a higher rate than your savings account interest rate. To achieve this goal, Buffett stresses the importance of investing in strong, growing companies with a margin of safety. If you have reasons to believe a company’s business is worth $20/share while the stock market values the company at $15/share, you have a $5 margin of safety. This margin of safety helps protect you from an unexpected deterioration in the company’s business or any mistakes you made in analyzing the business.
Principle #2: "It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Although a company's market price matters, Buffett explains that the health of the company’s underlying business is far more important. He stresses buying high-quality companies with solid fundamentals, a competent and trustworthy management team, and a sustainable competitive advantage within its industry. As an investor, it is your job to analyze companies based on the underlying strength of the business rather than try to profit from market fluctuations.
Principle #3: "Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble."
Essentially, you shouldn’t fear market crashes or economic downturns. When markets sell off, investors see the value of their accounts go down and often “panic sell,” locking in their losses at the worst time. Buffett argues that you should expect markets to go down occasionally and view market crashes similar to Black Friday sales, i.e., opportunities to buy great companies at discounted prices.
Principle #4: "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."
It’s important to have a long-term and patient approach to investing rather than reaping small gains from short-term fluctuations. If a company's underlying business doesn’t have long-term value, don’t buy it.