Over the last half-century, Warren Buffett has amassed a vast portfolio of businesses in the envelope of his Berkshire Hathaway holding company. Even though he deploys billions of dollars at a time, his basic philosophy and principles can be followed by any regular investor. Here are two pieces of advice from the Oracle of Omaha that I think ordinary investors should follow.
Protect your downside risk at all costs
Buffett’s insistence that the successful investor must never lose money at first glance seems like a truism. Of course investors should avoid losses! Who would argue with that? With any investment, there is a certain amount of risk involved. The whole point of investing is that you are making a prediction about the future value of an asset, and the person selling to you does not agree with that prediction. One of you has to be wrong, and the possibility that that person is you is the risk you are taking on.
However, not all investments are equally risky. Some are boom-or-bust propositions, where you can either lose all of your invested capital, or win big and make your money back many times over. This is the case with venture capital and angel investing, where the majority of bets tend to lose money, and a minority win out.
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Other investments have a very different risk profile. A mature utility company whose share price has been hit by a cyclical downturn is probably not going to double in price over the course of a year. But it is also unlikely to go to zero, and it is these kinds of opportunities that value investors like Buffett like to feast on. Identify good businesses that are going through temporary difficulties, and avoid boom-or-bust companies. It’s a much easier – and less stressful – way of building a retirement pot than trying to find the next Google or Amazon.
Take the bargains offered by Mr. Market
One of Buffett’s favourite metaphors (actually invented by his mentor, Benjamin Graham) is Mr. Market: an imaginary investor who is driven purely by emotion. On some days he is manically optimistic, and will pay any price, no matter how high, to own your stocks. On other days he is terminally depressed and pessimistic, and will accept any price, no matter how low, to sell you his stocks.
Mr. Market is a hyper-realised version of a typical investor – no one is purely driven by their emotions. However, the market as a whole contains enough of this kind of behaviour that it does sometimes act in this way. It used to be thought that markets are perfectly efficient and that stock prices always reflect all available information. Accordingly, it wasn’t possible to buy an undervalued stock, since, by definition, stocks couldn’t be undervalued.
Unsurprisingly, Buffett posted some of his best returns during the period when this theory was most dominant (the 1970s and 1980s). Follow his example, and look to buy stocks when everyone else is desperately trying to sell them.
