Billionaire investor Warren Buffett has been far more successful in the stock market than most people can dream of.
Still, by learning from a proven master like Buffett, I think I can improve my own performance even as a small private investor.
Here are seven Buffett lessons I find help me in the stock market.
1. Stick to what you know
Buffett says it is hard enough to invest well inside a circle of competence, let alone trying to step outside it. The key point is not the size of that circle, but staying within it.
Investing in a business you cannot understand is not investing at all. It is speculating.
2. Take the long-term view
Buffett says if you cannot imagine owning a share for 10 years, you should not think about holding it even for 10 minutes. As a long-term investor, I agree.
3. Mix it up
Sticking to what you know does not mean putting everything into one area, however. Buffett diversifies his portfolio across a number of different companies.
I think that is a simple but smart way to reduce risk. It means that, if one company performs worse than I expect, the overall impact on my portfolio is limited.
4. Think about cost of capital
When interest rates are high, money in a bank account might be able to earn an attractive amount with little or no risk to capital.
What about owning shares? There can be an opportunity cost compared to keeping the money in a bank account if the shares perform poorly.
That helps explain why Buffett has a large cash pile as well as share portfolio. When assessing whether to buy, hold, or sell shares, he often considers the opportunity cost of tying money up in those shares for years to come.
5. Cut your losses
Despite his renowned success, Buffett is the first to admit his many investment failures. When his investment thesis changes – for example because his view of a company’s prospects gets worse – he is willing to sell his holding at a loss.
I think that is smarter than what many investors do by blindly holding on for recovery even when the facts are changing.
Indeed, that is one reason I am paying close attention to business performance at boohoo. I am trying to decide whether the company is simply in a rough patch, or if the attractiveness of its business model has likely changed for good.
6. Invest in known quantities
Buffett does not worry about getting into a share early. Many of his holdings are in firms that were already around for many decades before he bought them.
Instead, he likes to put money into proven businesses.
7. Compound, compound, compound
What does Buffett do with the billions of pounds in dividends he earns annually from shares?
He puts it back into buying more shares and businesses! That reinvesting is known as compounding.
