9 Lessons In Investing By Warren Buffett

 

9 Lessons In Investing By Warren Buffett

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9 Lessons In Investing By Warren Buffett

If you are into investing, you must have heard of Warren Buffett. He is one of the most successful investors and has a net worth of over US $100 billion, which also makes him the world’s seventh-richest person as of April 2021.

Buffett’s investment track record is outstanding with compounded annual returns of a little over 20% over the last 55 years. In other words, if you had invested 10,000 US dollars in his investment firm Berkshire Hathaway in 1965 that 10,000 US dollars would today be worth over 280 million US dollars.

Over the years, a lot has been written about Buffett’s investing style by others. In fact, Buffett himself has eloquently penned down his thinking framework in his annual letters to Berkshire Hathaway’s shareholders. So, in this blog, we will put together the available information into 9 valuable investing lessons which can help us in becoming better investors.

Lesson 1: Risk Comes From Not Knowing What You Are Doing

Many first-time investors have started trading in stocks and cryptocurrency without really understanding how these asset classes work. Buffett has time and again advised investors to not chase everything that shines and to only focus on the opportunities that they understand.

For instance, Buffett himself did not understand how to value technology stocks for a prolonged period of time. Hence he stayed away from these stocks for many years. In fact, it was only in 2016 that Berkshire Hathaway bought a stake in Apple after really understanding the business.

But keeping away from technology was not a problem for Buffett at all. And this performance chart of Berkshire Hathaway versus Nasdaq really proves it with Berkshire Hathaway staying ahead of the Nasdaq for most of these last two decades.

The point Buffett makes here is that if you know what you are doing then there are enough opportunities everywhere.

“Never invest in a business you cannot understand,” Warren Buffett.

Lesson 2: System Overpowers The Smart

For someone who earned billions using his stock-picking skills, Buffett’s advice for retail investors to use a low-cost index fund may look surprising but has clear reasoning behind it.

After all, investing via index funds gives you the advantage of a system, it allows for a disciplined investing cycle via SIPs and keeps emotions away from corrupting that framework. In other words, Buffett wants retail investors to follow a system over everything else.

And it is this system and a clear investing framework finding great business at good reasonable prices that have powered Berkshire Hathaway for the last five decades to become one of the biggest and most profitable corporations in the world.

“A low-cost index fund is the most sensible equity investment for the great majority of investors,” Warren Buffett.

Lesson 3: Have An Owner’s Mindset

From Buffett’s perspective, buying a stock is nothing short of buying a business and one should follow the same kind of rigorous analysis and due diligence as one would do when buying a business.

For example, say someone offers to sell you his company for Rs. 500 crores. Now, you are not likely to pay him Rs. 500 crores without wanting to know some details like how much profit is this company generating, what are the competitive advantages, what are the growth prospects, the risks, the capital expenditure required, etc.

Buffett’s lesson here is that instead of getting too caught up in the recent movement of the stock price, you should spend more time analyzing the business behind the stock price. And once you have answers to the pertinent questions, invest in a business that you would like to own for the next 10 to 20 years.

A case in point is Berkshire Hathaway which displays an owner’s mindset with their multi-decade holdings in companies like GEICO, Coca-Cola, American Express, and Wells Fargo amongst many more.

“That whole idea that you own a business you know is vital to the investment process,” Warren Buffett.

Lesson 4: Be Fearful When Others Are Greedy And Be Greedy When Others Are Fearful

The stock markets work in cycles of greed and fear. When there is greed, people are ready to pay more than what a business is worth. But when fear sets in, then great businesses are available at huge discounts for anyone who is ready to keep their gloomy emotions aside.

Warren Buffett is one such investor who has perfected this art and encourages other investors to do the same. For instance, when there was a global economic meltdown in 2008, it was fear which was questioning the long-term prosperity of most businesses. Buffett moved swiftly and made large investments in blue-chip companies like GE, Goldman Sachs, Bank of America, Mars, and Dow Chemical which per a 2013 estimate fetched a profit of over 10 billion US dollars.

In his 2018 shareholder letter, Buffett wrote, “Seizing opportunities does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period — or even to look foolish — is also essential.”

In other words, Buffett encourages investors to not follow the herd. And strip away emotions when making investment decisions, which is likely to open up more profitable opportunities.

“What investors need is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals,” Warren Buffett.

Lesson 5: Save For A Golden Rainy Day

Besides being funny, Buffett is also very frugal. In fact, it is said that he never spends more than 3 dollars and 17 cents on breakfast. Warren Buffett goes by the philosophy – hold onto your money when money is cheap and spend aggressively when money is expensive.

This was seen in the year 2000 and again in 2008 when every financial expert was criticizing him for holding onto billions of dollars in cash and not deploying it in stocks. But what they didn’t know is that Buffett was saving all that cash to be used when companies come down from the then astronomical valuations to more reasonable prices.

Here is the investing lesson is when life gives you lemons, don’t just make lemonade, but also make a lemon pie, a lemon jam, a lemon pickle, and sell all the remaining lemons at the bazaar for a big fat profit.

“Every decade or so, dark clouds will fill the economic skies and they will briefly rain gold. When a downpour of that sort occurs. It is imperative that we rush outdoors carrying washtubs and not teaspoons,” Warren Buffett.

Lesson 6: Never Invest Just Because A Company Is Cheap

For someone who was taught by Benjamin Graham, also known as the father of Value Investing, you may expect Buffett to love a company that is available at a few cents to the dollar. However, after some poor acquisitions and investments, he made early on, Buffett came to realize that a cheap business may be cheap but may not be a profitable investment.

In fact, when he bought Berkshire Hathaway, it was in the textile business and was priced at a deep discount to its book value. But while operating the business, Buffett realised that the business was a cash guzzler and all the money earned from the business was going back into it as capital expenditure.

This experience and with a lot of guidance from his investment partner Charlie Munger, Buffett started evolving his investing style from the classical cigar-butt value investing approach to one where you look at a business’s competitive advantage, intangibles like brand value, cost superiority and its strong growth prospects.

“It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” Warren Buffett.

Lesson 7: Time Is The Friend Of The Wonderful Business

Warren Buffett understood the importance of time in investing and has reaped the benefits of compounding.

Imagine two businesses. The first one, company A grows by 20% every year and the other one company B grows at 10%. When we run compounding on these two businesses, company A would double company B’s output by the 8th year. And on an accelerated basis, company A will become five times the size by the 19th year and 10 times B by the 27th year.

This effect of compounding is also visible in how his personal wealth has grown over the years, with him making a lot more money in the last 10 years than what he made in his 50 years.

Buffett extends the “time as a friend” concept to the businesses he buys by looking at them, not over 1, 2, or 3 years but over the next 20 to 30 years. This learning is particularly important presently when most investors work on a daily, weekly, or a few short months horizons and most definitely do not receive any advantages of compounding.

“Time is the friend of the wonderful company, the enemy of the mediocre,” Warren Buffett.

Lesson 8: Never Use Borrowed Money To Buy Stocks

If there is one practice that infuriates Warren Buffett, it is that of taking on debt to finance the buying of stocks.

Buffett is of the view that when ordinary people borrow money to buy stocks, they are putting their livelihoods in the hands of a market whose swings can be random and extremely violent, even when it comes to a reliable stock like Berkshire Hathaway.

For instance, over the last 5 decades, Berkshire shares have suffered four major dips. These happened in the 1970s, 80s, 90s, and 2000s. This means one major dip in every decade. It happened over a period of 6 to 24 months when at least one-third of the company’s value was wiped out.

Taking this volatility in Berkshire as an example, Buffett said, “There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions are not immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

That is why Buffett is not a fan of the kind of debt that can leave consumers broke and helpless, especially when the markets go down.

“It is insane to risk what you have and need in order to obtain what you don’t need,” Warren Buffett.

Lesson 9: Keep It Simple

Everything Warren Buffett does and advises has an element of simplicity to it.

Buffett himself follows a simple to understand investing framework, which can best be defined as buying stakes in a business where the price you pay is far lower than the value you derive.

Of course, this is easier said than done. But the point Buffett continues to drive is that he wants investors to invest in simple and understandable instruments only and using a process that one can easily digest.

For example, if you don’t understand cryptocurrency, don’t invest, trade, or speculate in Bitcoins. The same goes for futures, options, penny stocks, forex, commodities, silver, and the dozens of new, shiny, and glamorous-looking investment vehicles we are exposed to every year.

“If you are uncomfortable with the asset class that you have picked, then chances are you will panic when others panic,” Warren Buffett.

Bottomline

Buffett’s lessons are no rocket science. Keep it simple, improve upon what you know, stay within your comfort zone and there are enough opportunities for one to thrive in investing.

Written By Tinesh Bhasin

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Tinesh Bhasin is the Head of Content for ET Money. He has been a journalist for over 16 years, covering mutual funds, insurance, banking, real estate, taxation and financial planning. He holds a postgraduate diploma in Journalism and an undergraduate degree in mass media from Mumbai University.