Investing Rules the Legendary Warren Buffett Lives By

How any investor can learn—and profit—by heeding the Oracle of Omaha

Reviewed by Robert C. KellyReviewed by Robert C. Kelly

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.”

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.

Important

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.

Note

Berkshire Hathaway CEO Warren Buffett’s net worth as of July 26, 2024, was $137 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.

Note

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 Berkshire Hathaway’s annual shareholders at the 2019 meeting that they should invest in what they know and “expand your circle of competence if you can.”

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 a 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.

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