Doing your homework may be the most important step you take as an investor.
The best laid plans tend to be simple, and there's nothing complex about Warren Buffett's five rules of investing. Apart from being a business magnate and philanthropist, Buffett is known for living a simple life and dispensing simple advice to others. Here's Buffett's take on the five basic rules of investing.
1. Never lose money
Given that Buffett lost billions during the financial crisis of 2008, his first rule of investing may strike you as odd. However, Buffett isn't suggesting you can't ever lose money; he's underscoring the mindset an investor should have.
Takeaway: Do your homework (really do your homework) before investing. Don't make a financial decision without knowing what you're getting into, and never say to yourself that it's okay to lose money. If you're going with a new brokerage, learn everything you can about that firm. Know the pros and cons of working with them before signing up. If you're interested in a particular asset, spend time learning about the risks and the odds of success.
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Bonus rule: Never forget rule No. 1
Obviously, Buffett has experienced far more financial wins than losses, but losses teach us something. In Buffett's case, it's to slow down and make careful investment choices.
Buffett is also famous for his "everyday man" approach to living. After becoming one of the richest people in the world, he didn't move into a McMansion or begin having all his meals prepared by a world-class chef. Instead, Buffett remained in the same house he's lived in since 1958 and regularly picks up McDonald's for breakfast. While some may call him a spendthrift, Buffett remains mindful of the best ways to put his money to work.
Takeaway: Investing is serious business. It's tough to keep your eye on the ball while showing off to friends.
2. Never invest in businesses you cannot understand
According to Buffett, "Risk comes from not knowing what you are doing." His advice is to only put your money into things you fully understand and can explain.
Takeaway: Doing your homework should lead to understanding a potential investment. If you study an investment but still don't understand how it works or what it's supposed to do, walk away.
3. Our favorite holding period is forever
Investing is a long-term endeavor. Once you've studied what you're getting into and made an investment, considering it long term allows you to tune out the natural ups and downs it will experience. When you think of an investment as a long-term commitment, you're far less likely to panic and sell at the wrong time.
Takeaway: Do your homework, trust what you've learned, and let your investment ride.
4. Never invest with borrowed money
Buffett calls it "insane" to risk what you have by borrowing money to make an investment. Although a stock may be taking off like a rocket today, it could crash to the ground tomorrow. If you borrowed money to get in on the hot investment, you'll end up with worthless stock and additional debt.
Takeaway: There's no such thing as a sure thing. All investments have built-in risks. If you can afford to invest with your own money, your best move is to wait.
5. Be fearful when others are greedy
Buffett's full quote is, "Be fearful when others are greedy and be greedy when others are fearful."
The right time to buy is when others are running around like characters from Chicken Little, convinced the sky is falling. That's when bargain basem*nt prices are to be had. And if history has shown us anything, it's that those who invest when prices are low are positioned to make the greatest profit when prices begin to rise.
On the other hand, when others are gobbling up stock they're sure will make them rich, it's your turn to be cautious.
Takeaway: You may not be able to time the market, but you can make it a goal to buy low and sell high. Don't get caught up in the hype.
Warren Buffett has made and lost billions. If anyone is in a position to share useful investing tips, it's the Oracle of Omaha.
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