Billionaire investor Warren Buffett‘s investment record is phenomenal. Between 1965 and 2001, he generated a compounded annual gain of 20.5% from his investments within Berkshire Hathaway. That may not look like much. But the total return for the period is a mind-boggling 3,641,613% — and that really is a lot!
Rule number 1
Buffett has mentioned many times that his number-one rule is to never lose money. And by that I reckon he means investors should put capital preservation above all other priorities.
And there’s a sound mathematical reason behind Buffett’s first vital rule. If I lose 50% on an investment, it takes a 100% gain on the next just to break even. And the numbers get worse the more I lose. For example, selling a stock with an 80% loss needs a gain of 400% to break even.
Therefore, my aim is to approach every investment by considering risk first. And it almost goes without saying that it’s important to research a business before investing.
However, sometimes an investment thesis will go wrong, even for Buffett. And in cases like that he sells his underperforming stocks and moves on. Just as he did with his airline holdings when the pandemic struck.
Rule number 2
I’d consider Buffett’s second vital rule is to never invest in a business he doesn’t understand. He once said: “Risk comes from not knowing what you are doing.”
And one of the things he always wants to understand is whether the business can keep making more money all the time. And if the answer is yes, he said… “then you don’t need to ask any more questions.”
It’s clear Buffett focuses on the potential for a business to increase its earnings over time. And when enterprises can do that, they act like compounding machines while he’s holding their shares.
Rule number 3
Buffett is known for his long-term approach to stock ownership. And he expressed his strategy by saying: “If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes.”
That’s a clear message not to dabble with trading stocks for the short term. And I’m taking Buffett’s third vital rule as to invest for the long term. After all, businesses take time to compound their earnings. And I want to be holdings their stocks while they do — for years rather than just weeks, or months.
However, there’s no guarantee of positive performance for me, even if I follow Buffet’s three vital rules. All shares carry risks as well as positive potential. And enterprises behind stocks can suffer from unexpected operational problems from time to time.
Nevertheless, I reckon these three rules will likely help stop me from making too many investment blunders in the years ahead. So I’m sticking with them as a vital part of my own investment strategy.
