If I wanted to learn karate, I would look for a teacher who had been practising the martial art for years. If I was keen to take up beekeeping, I would contact my local club and speak to some old hands. Tapping into other people’s wisdom and experience seems logical to me. That is why I find it surprising that some investors reckon they can start buying shares successfully without even considering what they can learn for free from proven masters of the art like Warren Buffett.
Buying shares and turning a profit can be challenging. In a bull market, it may seem easier to do well. But as a long-term investor, I am bound to experience both bull and bear markets over the course of my investing career. I need to be able to make the most of both. Here are five practical lessons I have learnt from Buffett that I think can help me improve my own investment returns, even as a private investor putting just a very small sum of money into the market.
1. Stick to areas of expertise
A bricklayer may know nothing about electric vehicles or space exploration. But bricklayers probably have a wealth of knowledge about building. They may be in a better position than some City analysts to look at housebuilding businesses such as Persimmon, Taylor Wimpey, Barratt or Bellway and decide whether they could make a good investment.
Yet oddly, rather than focusing on areas in which they have deep personal understanding, a lot of private investors seem to put money into businesses they do not understand at all. To me that is not investment, but merely speculation.
One’s circle of competence is not necessarily limited to professional expertise. The bricklayer in my example may also know about supermarkets, energy companies and healthcare providers from personal experience. They may be a ham radio enthusiast and so are likely to understand the electronics industry well too. Whatever one’s own circle of competence happens to be, Buffett firmly advocates staying inside it when investing. The logic for that is simple: it makes it easier to assess the prospects for a business. That sort of assessment is critical to thoughtful investment.
2. Focus on the long term
Buffett has said that the stock market could close for years at a time and it would not bother him.
That is because his way of viewing the stock market is not the same as a lot of people. They see it as a place to buy and sell shares frequently based on movements in their prices. By contrast, the Oracle of Omaha sees himself as investing in businesses whose long-term outlooks excite him. So, for example, his stake in Coca-Cola is not simply valuable to him because of the price at which he could sell it today. Instead, he reckons the company’s portfolio of drinks brands can help it make profits for decades.
If the stock market closed for years, the company would likely still be churning out its drinks and making profits. Buffett’s stake would quite possibly be increasing in value even if he could not immediately sell it. By focusing on the long term, Buffett is trying to invest in businesses that can endure and thrive. I try to do the same with my own portfolio.
3. Keep things mixed up
Buffett could have made far more money than he has done by just sticking to some of his most successful investments, like Apple.
Why didn’t he? The answer is that, like everyone else, even he never knows what will happen next in the stock market. He has made some very successful investments – but he has also made big, costly mistakes. Buying only two or three shares concentrates the positive impact of successful choices compared to using the same money to buy a dozen. But crucially, it also concentrates the impact of mistakes.
That matters hugely to Buffett, who says about investing: “Rule number one: never lose money. Rule number two: don’t forget rule number one.” So he always makes sure his portfolio is diversified across a number of companies and business areas. I think that is a prudent risk management strategy for a portfolio of any size.
4. Warren Buffett reads and learns
The biggest part of his working day is spent reading. Even in his nineties, with decades of investment experience under his belt, Buffett reads hundreds of pages a day to improve the quality of his decision-making.
Reading a lot is something I can also do as an investor. It helps me learn how the stock market works, find new opportunities I could invest in and assess possible moves for my portfolio. Actually, I think the more reading and learning I do, the better an investor I am likely to become.
5. Doing less but at scale
Buffett is well-known as an investor, yet often his name appears in the press precisely because he is not investing. He shuns large parts of the stock market that he reckons fall outside of his circle of competence. Buffett also has dry spells where he goes years at a time without buying any businesses.
I think most Olympic athletes would rather have three gold medals than six bronze medals. Buffett feels the same when it comes to choosing shares to own. He wants to invest in a small number of businesses he reckons may perform brilliantly rather than a larger number of companies he believes could do quite well.
That is why he invests only rarely. But when a company strikes him as having the sort of prospects he is looking for, he wants to make the most of it. So he tends to buy a lot of shares, although of course he maintains a diversified portfolio overall.
I think that approach can work well for me too. That is why I am looking for great companies I can add to my portfolio.
