Who hasn’t heard of Warren Buffett—one of the world’s richest people, consistently ranking high on Forbes’ list of billionaires? His net worth was listed at $80 billion as of Oct. 2020. Buffett is probably best known for being one of the world’s most successful investors. This is why it’s not surprising that Warren Buffett’s investment strategy has reached mythical proportions.
By keeping Buffett’s stock trading advice in mind, you can sidestep some of the common traps that damage returns and jeopardize financial goals. So just what are the secrets to his success in stock trading? Read on to find out more about Buffett’s strategy
Warren Buffett’s Investment Advice on stock Trading
#1 When you buy a stock, plan to hold it forever
Once a high-quality business has been purchased at a reasonable price, how long should it be held?
“If you aren’t thinking about owning a stock for ten years, don’t even think about owning it for ten minutes.” – Warren Buffett.
“Our favorite holding period is forever.” – Warren Buffett
“If the job has been correctly done when a common stock is purchased, the time to sell is rarely.” – Phil Fisher
Warren Buffett clearly embraces a buy-and-hold mentality. He has held some of his positions for several decades.
Why? For one thing, it’s hard to find excellent businesses that continue to have a bright long-term future (Buffett runs a concentrated portfolio for this reason).
Furthermore, quality businesses earn high returns and increase in value over time. Just like Warren Buffett said, time is the friend of the wonderful business. Fundamentals can take years to impact a stock’s price, and only patient investors are rewarded.
Finally, trading activity is the enemy of investment returns. Constantly buying and selling stocks eats away at returns in the form of taxes and trading commissions. Instead, we are generally better off to “buy right and sit tight.”
“The stock market is designed to transfer money from the impatient to the patient.” – Warren Buffett.
Know the difference between price and value
Stock prices are pushed at us nonstop. For some reason, investors love to fixate on ticker quotes running across the screen.
“The stock market is filled with individuals who know the price of everything but the value of nothing.” – Phil Fisher.
However, stock prices are inherently more volatile than underlying business fundamentals (in most cases).
In other words, there can be periods of time in the market where stock prices have zero correlation with the longer-term outlook for a company.
Many bargains were available during the financial crisis because investors were quick to sell off all companies – regardless of their business quality and long-term earnings potential.
Many firms continued to strengthen their competitive advantages during the downturn and emerged from the crisis with even brighter futures.
read more: Is investing in the stock market good or bad
In other words, a company’s stock price was (temporarily) separated from its underlying business value.
“During the extraordinary financial panic that occurred late in 2008, I never gave a thought to selling my farm or New York real estate, even though a severe recession was clearly brewing. And, if I had owned 100% of a solid business with good long-term prospects, it would have been foolish for me even to consider dumping it. So why would I have sold my stocks that were small participations in wonderful businesses? True, any one of them might eventually disappoint, but as a group, they were certain to do well.” – Warren Buffett.
As long-term investors, we need to heed Warren Buffett’s investment advice to buy quality when marked down in price.
“Price is what you pay. Value is what you get.” – Warren Buffett
Stock prices will swing with investor emotions, but that doesn’t mean a company’s future cash flow stream has changed.
While there is always some debate surrounding a company’s future earnings stream, the margin of disagreement is usually far lower than the stock’s price volatility.
Investors need to distinguish between price and value, concentrating their efforts on high-quality companies trading at the most reasonable prices today.
To protect your money, buy stocks in different companies and spread your purchase out over time.
The best thing with stock is to buy them consistently over time. Buffet told Squawk Box In 2017. “You want to spread the risk as far as the specific companies you’re in by owning a diversified group, and you diversify over time by buying this month, next month, year after year after.
Stocks are now generally better than bonds.
“If you save money, you can buy bonds, you can buy a farm, you can buy an apartment/house — or you can buy a part of an American business,” Buffett said in February. “And if you buy a 10-year bond now, you’re paying over 40 times earnings for something whose earnings can’t grow. You compare that to buying equities, good businesses. I don’t think there’s any comparison.”
A 10-year government bond opened the day at a 2.32 percent interest rate and closed at 2.49 percent on Feb. 27, 2017, when Buffett commented. As of Dec. 17, 2018, the 10-year government bond had an interest rate of 2.87 percent.
Meanwhile, according to FactSet, the benchmark S&P 500 Index has averaged an annual return of 10.2 percent over the past 30 years.
Clearly, even as Buffett himself has said, anything can happen in markets. If bond interest rates overtake stock market returns, then this advice no longer holds. “But I would say this: If the 10-year stays at 2.30 [percent interest rate] and it would stay there for 10 years, you would regret very much not having bought stocks now,” Buffett said in February.
“The one thing I’m sure of is that over time, stocks from this level will beat bonds from this level,” Buffett told “Squawk Box” October 2017. “Stocks [have] been so much more attractive than bonds for a long time now.”
The best moves are usually boring.
Investing in the stock market is not a path to get rich quickly.
If anything, I believe the stock market is best meant to moderately growing our existing capital over long periods of time.
Investing is not meant to be exciting, and dividend growth investing, in particular, is a conservative strategy.
Rather than finding the next major winner in an emerging industry, it is often better to invest in companies that have already proven their worth.
“We do not attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We’re not smart enough to do that, and we know it.” – Warren Buffett
After all, the goal is to find quality businesses that will compound in value over the course of many years. If we get this right, our portfolio’s return will take care of itself.
Many companies that boast long and successful corporate lives provide basic products and services – snacks, beverages, toothpaste, medicine, convenience stores, etc.
While not the most exciting businesses, a slow pace of industry change often protects industry leaders. Many companies in the Dividend Aristocrats Index and Dividend Kings list have benefited from this phenomenon.
“Beware the investment activity that produces applause; the great moves are usually greeted by yawns.” – Warren Buffett.
There is no need to try and be a hero or impress anyone with our investments. Boring can be beautiful.
You can’t time the market.
“You’re making a terrible mistake if you stay out of a game that you think is going to be very good over time because you think you can pick a better time to enter it,” he told “Squawk Box” in February 2017.
There’s no room to be emotional.
“Some people should not own stocks at all because they get too upset with price fluctuations. If you’re going to do dumb things because your stock goes down, you shouldn’t own stock at all,” said Buffett told “Squawk Box” in February 2018.
By comparison, “If you buy your house at $20,000 and somebody comes along the next day and says, ‘I’ll pay you $15,000, you don’t sell it because the quote’s [$15,000],” added. “Some people are not actually emotionally or psychologically fit to own stocks, but I think that more of them would be,” Buffett said if they were more educated on what they were really buying, which is part of a business.
Closing Thoughts on Warren Buffett’s Investment Advice
We often make investing harder than it needs to be. Warren Buffett follows a simple approach rooted in common sense. I can certainly relate to his investing tips from my experience working as an equity research analyst, but that doesn’t mean they are always easy to follow!
By embracing some of Warren Buffett’s stock trading tips– focusing on the longer term, sticking to blue-chip dividend stocks, remaining within your circle of competence – you can better manage your portfolios to reduce the number of costly errors you make and continuously move closer to achieving your goals.