8 Ways to Think Like Warren Buffett

Robert G. Hagstrom wrote a book about the legendary investor Warren Buffett entitled “The Warren Buffett Portfolio” back in 1999. What’s so great about the book and what makes it different from the countless other books and articles written about the “Oracle of Omaha” is that it offers readers valuable insight into how Buffett thinks about investments. It delves into the psychological mindset that has made Buffett so fabulously wealthy.

We’ve selected a sampling of the tips and suggestions regarding the investor mindset and ways to improve stock selection that will help you get inside Buffett’s head.

Key Takeaways

• Warren Buffett has a unique way of thinking about and approaching his investments.
• Diversification is a lauded approach but Buffett states that overly diversifying can be harmful as well.
• He analyzes and pores over the underlying economics of a given business or group of businesses.
• Buffett believes that overcoming emotion can be key when investing.

1. Stocks Are a Business

Many investors think of stocks and the stock market as nothing more than little pieces of paper being traded back and forth among investors. This might help prevent investors from becoming too emotional over a given position but it doesn’t necessarily allow them to make the best possible investment decisions.

Buffett has stated that he believes stockholders should think of themselves as “part owners” of the business in which they’re investing. Both Hagstrom and Buffett argue that investors will tend to avoid making off-the-cuff investment decisions and become more focused on the longer term by thinking that way.

Longer-term “owners” tend to analyze situations in greater detail and then put a great deal of thought into buy and sell decisions.

Important

Hagstrom says this increased thought and analysis tends to lead to improved investment returns.

2. Increase Your Investment

It rarely if ever makes sense for investors to “put all of their eggs in one basket” but putting all your eggs into too many baskets may not be a good thing either. Buffett contends that over-diversification can hamper returns as much as a lack of diversification. He doesn’t invest in mutual funds for this reason. It’s why he prefers to make significant investments in just a handful of companies.

Buffett is a firm believer that investors must first do their homework before investing in any security. Investors should feel comfortable enough to dedicate a sizable portion of assets to that stock, however, after the due diligence process is completed. They should also feel comfortable in winnowing down their overall investment portfolio to a handful of good companies with excellent growth prospects.

Buffett’s stance on taking time to properly allocate your funds is furthered by his comment that it’s not just about the best company but how you feel about the company. Why would you put money into your 20th favorite business instead of adding money to the top choices if the best business you own presents the least financial risk and has the most favorable long-term prospects?

3. Reduce Portfolio Turnover

Rapidly trading in and out of stocks can potentially make an individual a lot of money but this trader is actually hampering their investment returns, according to Buffett. Portfolio turnover increases the amount of taxes that must be paid on capital gains and it boosts the total amount of commission dollars that must be paid in a given year.

The “Oracle” contends that what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.

Investors must think long-term. They can avoid paying huge commission fees and lofty short-term capital gains taxes by having that mindset. They’ll also be more apt to ride out any short-term fluctuations in the business and ultimately reap the rewards of increased earnings and/or dividends over time.

4. Have Alternative Benchmarks

Stock prices may be the ultimate barometer of the success or failure of a given investment choice but Buffett doesn’t focus on this metric. He instead analyzes and pores over the underlying economics of a given business or group of businesses. The share price will ultimately take care of itself if a company is doing what it takes to grow itself on a profitable basis.

Successful investors must look at the companies they own and study their true earnings potential. The share price should reflect it in the long term if the fundamentals are solid and the company is enhancing shareholder value by generating consistent bottom-line growth.

5. Think in Probabilities

Bridge is a card game in which the most successful players can judge mathematical probabilities to beat their opponents. Perhaps not surprisingly, Buffett loves and actively plays bridge and he takes the strategies beyond the game into the investing world.

Buffett suggests that investors focus on the economics of the companies they own and then try to weigh the probability that certain events will or will not transpire. This is much like a bridge player checking the probabilities of his opponents’ hands. He adds that an investor will be more accurate in their ability to judge probability by focusing on the economic aspect of the equation and not the stock price.

Thinking in probabilities has its advantages. An investor who ponders the probability that a company will report a certain earnings growth rate over a five- or 10-year period is much more apt to ride out short-term fluctuations in the share price. Their investment returns are likely to be superior by extension and they will also realize fewer transaction and/or capital gains costs.

6. Understand the Psychology 

Investors tend to have a psychological mindset. A successful investor will focus on probabilities and economic issues while letting decisions be ruled by rational thought rather than emotional thinking.

Investors’ emotions can be their worst enemy. Buffett contends that the key to overcoming emotions is being able to retain your belief in the real fundamentals of the business and not get too concerned about the stock market.

Investors should realize that there’s a certain psychological mindset that they should have if they want to be successful and try to implement that mindset.

7. Ignore Market Forecasts

There’s an old saying that the Dow “climbs a wall of worry.” The markets have fared quite well over time despite the negativity in the marketplace and those who perpetually contend that a recession is “just around the corner.” Doomsayers should be ignored.

Just as many eternal optimists argue that the stock market is headed perpetually higher. They should be ignored as well.

Buffett suggests that investors should focus their efforts on isolating and investing in shares that aren’t currently being accurately valued by the market. The logic here is that the investor will stand to make a lot of money as the stock market begins to realize the company’s intrinsic value through higher prices and greater demand.

8. Wait for the Fat Pitch

Hagstrom’s book uses the model of legendary baseball player Ted Williams as an example of a wise investor. Williams would wait for a specific pitch in an area of the plate where he knew he had a high probability of making contact with the ball before swinging. It’s said that this discipline enabled Williams to have a higher lifetime batting average than the typical player.

Buffett suggests that all investors should act as if they owned a lifetime decision card with only 20 investment choice punches in it. This should prevent them from making mediocre investment choices and hopefully enhance the overall returns of their respective portfolios.

How Did Warren Buffett Get Started?

Buffett bought his first three shares of stock in an oil company at the age of 11. He had a little money on hand with which to do so because he’d begun selling chewing gum and Coca-Cola around his Omaha neighborhood by the age of six. He reportedly sold the shares for a profit of $2 each.

What Is Diversification in Investing?

Diversification involves spreading the assets in your portfolio across different classes. They’re not all the same or even very similar so you’re reasonably protected if one tanks. It’s not a sure thing that the others will perform poorly also. The four classes are typically considered to be domestic stocks, international stocks, bonds, and short-term investments.

What Are the Capital Gains Tax Rates?

The federal capital gains tax is divided into two categories: short-term and long-term. Short-term gains are those that derive from an investment that you’ve held for one year or less. They’re taxed along with your ordinary income at a rate of up to 37% depending on your overall taxable income.

Most long-term capital gains tax rates are 0%, 15%, or 20% but there are a few exceptions for certain business stock, real property, and collectibles. Even these rates peak at only 28%, however. You must hold the asset in question for more than a year to qualify for long-term capital gains tax rates.

The Bottom Line

“The Warren Buffett Portfolio” is a timeless book that offers valuable insight into the psychological mindset of the legendary investor, Warren Buffett. Of course, everyone would be rich if learning how to invest like Warren Buffett was as easy as reading a book! But you could be on your way to better stock selection and greater returns if you take the time and effort to implement some of Buffett’s proven strategies.

Disclosure: This article is not intended to provide investment advice. Investing in securities entails varying degrees of risk and can result in partial or total loss of principal. The trading strategies discussed in this article are complex and should not be undertaken by novice investors. Readers seeking to engage in such trading strategies should seek extensive education on the topic.