Investing Rules the Legendary Warren Buffett Lives By

Longtime Berkshire Hathaway CEO Warren Buffett is inarguably the world's greatest stock investor. He's also a bit of a philosopher and Buffett pares down his investment ideas into simple, memorable sound bites. Here are a few of his most famous rules of investing.

Key Takeaways

• Longtime Berkshire Hathaway CEO Warren Buffett ranks as one of the richest people in the world.
• Buffett is seen by some as the best stock-picker in history and his investment philosophies have influenced countless other investors.
• One of his most famous sayings is "Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1."
• Another is "If the business does well, the stock eventually follows."

Rule 1: Never Lose Money

This might seem like a no-brainer because what investor sets out with the intention of losing their hard-earned cash? But, in fact, events can transpire that can cause an investor to forget this rule. Buffett thereby swears by Rule 2.

Rule 2: Never Forget Rule No. 1

Buffett personally lost about $25 billion in the financial crisis of 2008 and his company, Berkshire Hathaway, lost its revered AAA rating. So how can he tell us to never lose money?

He's referring to the mindset of a sensible investor: Don't be frivolous. Don't gamble. Don't go into an investment with a cavalier attitude that it's OK to lose. Be informed. Do your homework.

Warren Buffett invests only in companies that he thoroughly researches and understands. He doesn't go into an investment prepared to lose and neither should you. He believes that the most important quality for an investor is temperament, not intellect. A successful investor doesn't focus on being with or against the crowd.

The stock market will experience swings but Buffett stays focused on his goals in good times and bad. So should all serious investors.

Warren Buffett rarely changes his long-term investing strategy no matter what the market does.

Rule 3: Pick Businesses, Not Stocks

When a business does well, the stock should eventually follow. Buffett seeks out businesses that exhibit favorable long-term prospects when he's choosing investments. Does the company have a consistent operating history? Does it have a dominant business franchise? Is the business generating high and sustainable profit margins? It's a stock that Buffett might want to own if the company's share price is trading below expectations for its future growth.

One of Buffett's rules for success is that he never buys stock in a company unless he can write down the reasons he's willing to pay a specific price per share. Other investors could benefit from the same exercise.

Rule 4: A Wonderful Company at a Fair Price vs. a Fair Company at a Wonderful Price

Buffett is a value investor who likes to buy quality stocks at reasonable if not rock bottom prices. His goal is to build a portfolio of stocks that will reward him with solid profits and capital appreciation for years to come. When the markets reeled during the 2007-2009 financial crisis, Buffett used the opportunity to stockpile venerable long-term investments by spending billions on names like General Electric and Goldman Sachs.

Disciplined investors establish their criteria and stick to them to pick stocks effectively. You might seek companies that offer a high-quality product or service and also have solid operating earnings and the germ for future profits. You might establish a minimum market capitalization that you're willing to accept and a maximum price-to-earnings (P/E) ratio or debt level. Finding the right company at the right price with a margin for safety against unknown market risk is the ultimate goal.

Remember that the price you pay for a stock isn't the same as the value you get in return. Successful investors know the difference.

$121 billion

Berkshire Hathaway CEO Warren Buffett's net worth as of August 2023 was $121 billion, according to Bloomberg.

Rule 5: Our Favorite Holding Period Is Forever

Warren Buffet is the ultimate exponent of a buy-and-hold philosophy. How long should you hold a stock? Buffett says you shouldn't own it for 10 minutes if you don't feel comfortable owning it for 10 years. He held on to the bulk of his portfolio even during the financial crisis, which he referred to as an "economic Pearl Harbor."

Committing to a long holding period will keep an investor from acting too human unless a company has suffered a sea change in prospects, such as impossible labor problems or product obsolescence. Being overly fearful or greedy can cause investors to sell stocks at the bottom or buy at the peak and destroy portfolio appreciation in the long run.

Rule 6: Be Willing to Be Different

Don't follow the pack, even if the leader of the pack would appear at first glance to be wildly successful. You most definitely want to follow the advice of the masses and popular opinion because you can't know how or from where those opinions derive. They could be and often are without any real basis, in fact.

Buffett has suggested following your own gut instincts if you're going to trust any gut instincts at all. Don't be afraid to swim against the tide. He started out with a "mere" $100,000 in 1955. It wasn't his own money. It was gathered from a handful of investors who trusted him even though he didn't operate on Wall Street.

But Buffett declined to share his plans and tactics with them, and he broke a golden rule in the process: He didn't tell his investors where he was putting their money. He preferred to operate without their approval, trusting his instincts without interference. And he ultimately turned that first $100,000 into more than $100 million.

Read about Investopedia's 10 Rules of Investing by picking up a copy of our special issue print edition.

Rule 7: Avoid Credit Card Debt

You can do far better things with your money than give it to credit card lenders in the form of interest in exchange for purchasing power you might not have had otherwise. The idea behind investing is to earn interest, not to give it away. This is the basis of one of Buffett's rules of life. It's not focused solely on investing.

Buffett told a 1991 audience at the University of Notre Dame, "The two biggest weak links in my experience: I’ve seen more people fail because of liquor and leverage – leverage being
borrowed money." He specifically warned against being infatuated with how much money can borrow and not giving enough thought to how much money you can pay back."

The liquor reference might not need an explanation. It goes without saying that its influence might not always suggest the best ideas in the world.

Rule 8: Invest in What You Understand

Buffett told the media at a press conference after Berkshire Hathaway's annual shareholders meeting in 2019 that they should "invest in what you know." They should confine themselves to businesses they understand. You're effectively taking a shot in the dark when you throw money at an industry that leaves you clueless as to how and why it might succeed or fail.

And Buffett speaks from experience. He's renowned for not investing in high-tech stocks back in their pilgrimage because he admits he didn't fully understand what they were about or what they were trying to achieve. Don't place your money in an area where you're "incompetent," at least until you become competent. Take some time to educate yourself first.

What Is the Essence of Buffett's Investing Principles?

The short answer is to buy undervalued stocks with solid long-term potential. The longer answer is that it requires research and a steady commitment to the companies in which you're invested. Hold them through thick and thin, ignoring market volatility, unless something material changes in the company's outlook, such as product obsolescence.

What Metrics Does Buffett Look at When Analyzing a Particular Stock?

In addition to analyzing the long-term business prospects of a company such as whether it has competent senior management and a solid balance sheet, Buffett is known to focus on market capitalization (not too small), debt levels (not too great), and earnings per share (not too high). He's looking for solid companies with sound balance sheets and positive long-term outlooks, investments that he can hold for a long period of time.

What Is the Ideal Holding Period for an Investment?

Buffett might blithely answer "forever" to that question, and that's not far from the truth. He will maintain his portfolio and may even add to it if certain holdings drop to an attractive price level, even during extreme market volatility. Buffett is a long-term value investor who sees volatility as an opportunity to buy at appealing levels or to take profit and sell some of his holdings if they've overshot what he believes to be a reasonable price.

The Bottom Line

It's safe to say that Warren Buffett is an investor nonpareil and the frequent subject of many books on investing. He's accomplished this by sticking to some very basic rules for buying and holding investments in his portfolio. His methodology for picking stocks involves a great deal of research aimed at establishing a fair price for a particular stock.

The rest of the market may be in a panic-selling mode, but Buffett sees opportunities as prices fall to his predetermined fair valuation. It might be said that he likes Stock XYZ but not at its current market price. He's ready to buy it if the price of that stock drops to his preferred value range. To paraphrase Buffett, the market is there to accommodate your investing strategy but only when the price is right.

Warren Buffett once said, “The first rule of an investment is don’t lose [money]. And the second rule of an investment is don’t forget the first rule. And that’s all the rules there are.”

Of course, your financial adviser isn’t always going to be able to follow that rule — the markets do go down, and nobody beats the market every time, even Buffett himself — but when they do lose you money, how do you know when to pull the plug? (Looking for a new financial adviser? You can use this free tool to get matched with a planner who might meet your needs.)

One good rule of thumb when you see losses in your portfolio: “Comparing the relative returns of your investment portfolio to a similar target portfolio, over the same time period, can help you see if your losses are out of line. If you have a portfolio with 60% in stocks and 40% in bonds, compare it to a similar portfolio,” says Tiffany Lam-Balfour, investing spokesperson for NerdWallet.

You can also consider getting a second opinion from another adviser. “Some brokerage firms may include a target portfolio as part of their statement or a financial adviser can likely include it in a client’s portfolio review,” says Lam-Balfour. Additionally, you can use a benchmark like the S&P 500 but you will likely need to do a weighted average of one or more indices because a diversified portfolio will not be 100% invested in the S&P 500. “If your portfolio happens to be 60% stock and 40% bonds, you might calculate a 60% weight to the S&P 500 and 40% to the Barclays Aggregate bond index or something like that to get a more accurate representation of your actual portfolio,” says Lam-Balfour. 

If you’re consistently underperforming the market, Lam-Balfour recommends asking your adviser why and seeing if the explanation makes sense. “You may also want to seek a second opinion to check if your current investments are appropriate for your goals and whether you should go in a different direction,” says Lam-Balfour. (Looking for a new financial adviser? You can use this tool to get matched with a planner who meets your needs.)

It’s also key that you consider whether your adviser invested according to your goals and expectations. “What’s important is that clients have a clear understanding and expectation so they are not caught off guard. If an adviser inappropriately invests a client in a portfolio with too much risk that does not align with their profile, then I would suggest they think about switching advisers,” says Arielle Jacobs-Bittoni, certified financial planner at Refresh Investments.

Remember, too, that losing money isn’t always a dealbreaker. Luis Strohmeier, certified financial planner at Octavia Wealth Advisors, notes that advisers don’t control market fluctuations, so it’s difficult to judge their performance based solely on losses alone. “If the market is down 30% and your adviser loses you 10%, I might be happy that the adviser didn’t lose me an additional 20%,” says Strohmeier. 

And, he adds, make sure your adviser is an advocate and a fiduciary for you. “They don’t have to judge your lifestyle, but they do have to understand it. If it’s important to you, it should be important to them and they should find ways to help support your goals,” says Strohmeier. (Looking for a new financial adviser? You can use this tool to get matched with a planner who might meet your needs.)