He bought his first share at 11. He has spent almost his whole life in Omaha, in the same house he bought in 1958. Warren Buffett became one of the most famous investors in history without any complicated formulas. His advice fits into a few rules that he repeated for decades in his annual letters to the shareholders of Berkshire Hathaway, the company he led.
In short: Warren Buffett's advice comes down to five ideas: understand what you buy, tell price from value, prefer excellent businesses, hold them for a long time and stay calm when others panic.
Rule 1: stay inside your circle
"You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence" (1996 letter). You don't need to know everything: you need to know what you don't know.
Rule 2: price isn't value
Buffett quotes his teacher Benjamin Graham: "Price is what you pay; value is what you get" (2008 letter). Something worth CHF 100 bought for CHF 70 leaves a margin of safety: if its price catches up with its value, you gain nearly 43%. Bought for CHF 130, you risk losing 23%. The same thing, two opposite outcomes, depending on the price you paid.
Rule 3: quality first
"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price" (1989 letter). A bargain on a poor business often ends up a poor bargain.
Rule 4: hold for a long time
"When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever" (1988 letter). Time lets the snowball do its work, and every sale costs fees.
Rule 5: stay calm when others lose their heads
"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful" (1986 letter). When everyone is selling in a panic, fine businesses suddenly become cheap.
Luck or skill?
In 1984, Buffett answered those who put his success down to luck. If thousands of people play heads or tails, a few will win twenty times in a row by pure chance. But if a large share of the winners come from the same small village, it's no longer chance. And several successful investors he knew came from the same school of thought: that of Graham and Dodd.
In 2018, researchers took his results apart. Their conclusion: no magic. Buffett consistently bought cheap, safe, high-quality businesses and held firm through the storms. He also invested money borrowed cheaply, notably through his insurance companies – a part of the recipe a family doesn't need to copy.
Try this tonight with your child
Write the 5 rules as questions on five cards: "Do I understand what I'm buying?", "Is it worth the price?", "Is it good quality?", "Will I keep it for a long time?", "Do I only want it because everyone else does?". Before any purchase over CHF 10, your child draws a card and answers out loud.
Read also: The investor's shopping list · The stock market rollercoaster
Further reading
- Buffett, W. E. (1984). The Superinvestors of Graham-and-Doddsville. Hermes, Columbia Business School Magazine, Fall 1984, 4–15.
- Frazzini, A., Kabiller, D. & Pedersen, L. H. (2018). Buffett's Alpha. Financial Analysts Journal, 74(4), 35–55.
Quotations: Warren Buffett's annual letters to Berkshire Hathaway shareholders (1986, 1988, 1989, 1996, 2008), available at berkshirehathaway.com. The 1996 quotation is shortened.
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Educational content, not investment advice. Mangosteen Buddy has no connection with Warren Buffett or Berkshire Hathaway.