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3 Warren Buffett investing rules that Neil Woodford broke

There was a time when portfolio manager Neil Woodford could do no wrong. Regarded as Britain’s greatest stock picker just a few years ago, some people even referred to him as the UK’s Warren Buffett.

However, in the space of a few years, things have gone badly wrong for Woodford. After he was sacked as manager of his Equity Income fund last week, he may never work in the investment management industry again. With that in mind, here’s a look at three fundamental Buffett investing rules Woodford broke.

Never lose money

Let’s start with Buffett’s number one investing rule: “Never lose money.” Here, Woodford got it badly wrong. By investing a large proportion of his flagship fund in smaller, speculative growth companies, such as Purplebricks, Prothena, and Eve Sleep, he set himself up to fail as these types of companies are notoriously volatile by nature. You wouldn’t see The Sage of Omaha investing in these companies. 

One of the reasons Buffett has been so successful over the years is he’s placed a strong focus on capital preservation and kept losses to a minimum. He’s done this by focusing on high-quality, blue-chip companies with excellent long-term track records when it comes to generating shareholder wealth. If Woodford had adopted a similar strategy and focused more on risk management, he wouldn’t have experienced such dramatic underperformance.

Circle of competence

Another key rule of Buffett’s is that when investing in the stock market, it’s essential to stick to your ‘circle of competence’. In other words, stick to what you know. Woodford broke this rule too.

Woodford made his name investing in large-cap FTSE 100 stocks. For example, he loaded up on the tobacco giants when they were out of favour during the tech bubble, and he avoided the banks in the lead up to the Global Financial Crisis.

Yet, for some strange reason, he began investing in early-stage start-ups a few years ago. Investing in these types of companies is very different to investing in large-caps and it backfired in a big way. He clearly didn’t have the skill set required to be successful in this area of the market. Another Buffett quote comes to mind here: “Risk comes from not knowing what you are doing.”

Long-term investing

Finally, Buffett is known for his ability to hold stocks for a very long time. “If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes,” he’s said in the past. This is another reason he’s been so successful, as long-term investing tends to produce great results.

Woodford broke this rule too. For example, around June/July last year, Woodford bought back into British American Tobacco after selling the stock in 2017. Yet just a few months later, the stock was gone from his fund again. So he was no longer investing for the long term and, as a result, his performance suffered.

Ultimately, investing doesn’t need to be complicated. But if you want to be successful, it’s important to get the basics right. I’d argue that focusing on capital preservation, sticking to what you know, and investing for the long term are three of the most important things you can do.

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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.