Warren Buffett is hands down the most famous investor in the world. His record speaks for itself. Yet he’s come under pressure recently, as most great money managers do at some point. A US day trader, Dave Portnoy, claimed to be a better investor than legendary Buffett. This is nonsense as most day traders lose money. Even if Portnoy does make money it would be hard to replicate, so instead I’d follow Buffett’s methods to make money from the stock market.
Buffett’s success isn’t easy to replicate of course, but there are basic principles that make long-term stock picking more likely to help you retire early or become financially independent.
Long-term mindset
If you have money to invest, speculating on day trading seems a sure-fire way to lose it. Buffett’s number one rule is not to lose money. That’s not the same as not taking any risk. Investing isn’t a risk-free pursuit. It’s about taking smart risks.
Also, by investing for the long term, you reduce the risks you face of being stuck with an investment at one particular price. You can average up or down on an investment over the years.
If you invest in company A at 100p and need to make a profit in one month then your only option is to hope it goes up over that short time frame. That’s gambling. If you invest in it for 10 years, assuming it’s a good investment, the odds that it’ll do very well at some point over those years drastically increase. All the while you should be collecting dividends if it’s profitable.
By investing for the long term you can benefit from compounding. This is where you reinvest dividends in buying more shares that then produce more and more income. This phenomenon accounts for a large part of Buffett’s success.
Margin of safety
Like his mentor Benjamin Graham – author of The Intelligent Investor and a leading value-focused investor – Buffett believes in a margin of safety. What this means is in effect buying shares for less than they are calculated to be worth. This is easier to say then to work out or do.
As a starting point though you can use price-to-earnings ratios as a rough guide. You can then layer on top of that PEG ratios as a growth investor like Jim Slater would do.
Be flexible up to a point
You can have a strategy in place but if your criteria for buying shares is too strict you’ll miss out on a lot of opportunities. You need to always be a little flexible. Like the best entrepreneurs, investors also need to be prepared to adapt to the reality of the world as it is, not how they want it to be. If income shares are out of fashion you might want to look more at growth stocks and vice versa.
If you have money to invest, I’d put it into the stock market and follow the principles of Buffett. That way you’re unlikely to go far wrong.
