What’s Warren Buffett’s best tip for investing?
I think if I were to ask him, he’d tell me his “rule number one”. This rule – sometimes called his “golden rule” – is like a geiger counter for poor and costly investments.
By following this rule, he’s picked winner after winner. It’s helped his company, Berkshire Hathaway, grow nearly 500 times bigger in the last 40 years and made him a billionaire along the way. Sounds like the rule works then. So, what is it?
Well, in his own words: “Rule number one: never lose money”.
At first glance, that sounds obvious. It even sounds sarcastic. I mean, no one’s trying to lose money in the stock market, Warren!
But if I dig a little deeper, I can see there is a lot of wisdom here that can help me avoid the most costly investing mistakes.
Take options trading, for instance. This is a type of investing where I can pay a small fee for a contract that might let me sell a share in the future for £5. If the shares go up to £10, then I wouldn’t use it. If the shares go to £3, I can take up the option and pocket the difference.
Don’t lose money
These options are very popular, but Buffett wouldn’t dream of buying one. They’re speculative, almost like gambling. And worse, every single option costs a fee. So to even invest like this I’d start off by losing money.
Instead, Buffett sees the stock market as a place to buy and own part a company. When I do this, I’m not losing money, I’m simply transferring my cash into shares with the same value.
And I can take this one step further. With the right research, I can find companies that have little downside and a wide margin of safety. This means I can further protect myself from losing money.
One way to do this is with the price-to-book (P/B) ratio. This tells us the price of a company compared to the assets it owns. If a firm has a P/B of 0.7, then it’s like I’m paying 70p for £1 in assets. As you can imagine, it’s harder to lose money with these asset-rich firms.
On the other hand, a stock like Wise has a P/B of over 12. So the fintech – known for its low-fee money transfers – has little in the way of assets compared to its price. That’s not to say it’s a bad stock, but it does have a lower margin of safety.
This rule can help me build wealth. If I was starting with no savings at 30, investing in stocks with this advice in mind would be a great starting point. I mentioned that Buffett achieved a near 500-times return over 40 years. Well, I’d only need to achieve a fraction of that to target a large net worth or a big second income.
And if this is Buffet’s first rule, you might wonder what the second is. Well, here’s the quote: “Rule number one: never lose money. Rule number two: never forget rule number one”.