People often wonder how Berkshire Hathaway head Warren Buffett managed to make billions from his investments. It might just be possible he has been very lucky – doing business in the right place, at the right time, with the right people. Or does he have good advice the average person could follow?
You decide. Here are 10 tips on investing from his annual letter to shareholders, covering the company’s 2016 performance.
1. Investing is unpredictable
Buffett writes: “Years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur: not me, not Charlie [Munger], not economists, not the media.”
As a result, do not rely too heavily on the chance of success when investing; even quality shares in the best companies can be affected by falls in market value.
2. Always consider the risks
Because a degree of risk is unavoidable, this should be thought about and factored in before buying anything. This is something of which Buffett and his team are aware.
For good returns, some risk must be taken – perhaps balanced out by diversification into less risky, more stable purchases.
3. Beware of following the herd
Most years – and this letter was no exception – Buffett includes a warning not to simply copy others. Behavioural science teaches us this mistake is easy to make – and beware: even supposedly knowledgeable people fall into the trap.
Many insurers, notes Buffett, “simply can’t turn their back on business that is being eagerly written by their competitors. That old line, ‘the other guy is doing it, so we must as well’, spells trouble in any business.”
4. Act fast when opportunities appear
Meanwhile, as the crowd is running one way, that’s when bargains can appear – but you have to move swiftly to seize the opportunity.
“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons,” explains Buffett.
5. Always do your research first
Do not simply rely on what you think you know about a market or even a company or an individual: always do due diligence and learn as much as you can before leaping into an investment.
“As is the case in marriage, business acquisitions often deliver surprises after the ‘I do’s’,” warns Buffett.
6. Steady gains can win the race
“Our size precludes a brilliant result: prospective returns fall as assets increase," he says. Fast growth tends to happen off a small base – so the growth of a high-risk start-up will look spectacular when compared with established blue-chip investments but it can fail swiftly too.
Getting decent, reliable results long term can therefore be better for the bottom line than those dramatic highs, suggests Buffett.
7. New isn’t always better
What if an “old-fangled” choice can be more efficient – ultimately saving money – like a railroad?
“BNSF, like other Class 1 railroads, uses only a single gallon of diesel fuel to move a ton of freight almost 500 miles,” says Buffett. “Those economics make railroads four times as fuel-efficient as trucks! Furthermore, railroads alleviate highway congestion – and the taxpayer-funded maintenance expenditures that come with heavy traffic – in a major way.”
Successful investing is not all going to be about the latest trends and innovation. Sometimes, older-style traditional investments can continue to deliver strongly.
8. Accept and admit mistakes
No matter how much you know or what experiences you’ve had, you can be wrong. Buffett freely accepts and admits his own mistakes – ready to move on to a better investment. “In most cases, I was wrong when I originally sized up the economic characteristics of these companies or the industries in which they operate,” he says.
9. Luck often plays a role
“I’m a lucky guy, very fortunate,” Buffett writes. Despite his wealth, the billionaire investor does not appear to suffer from the illusion of control. Like him, many of us would do well to remember the likely role of chance.
Buffett further notes that, fortunately, he is surrounded by talented people, who make significant contributions at many levels to his success. A diverse group can sometimes make better decisions together than on their own – as this eZonomics article outlines.
Luck often plays a larger part in success than we think – as economist Robert Frank explains, in this six-minute video.
10. “Set and forget” passive investing may be best
“Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively financed American businesses will almost certainly do well," writes Buffett.
Meanwhile, the power of compounding can add to long-term rewards. Chris Dillow, writing for eZonomics, explains more.
Is Buffett’s approach a good one – or is he suffering from confirmation bias, like many of us? Are you a conservative or even a contrarian with personal finances, and has it paid off? Send us your views using the contact us form or tweet @eZonomics. We will publish the best responses.