Warren Buffett, 93, is a self-made billionaire role model who bought his first stock at the age of 11 for $38 per share and sold it for a profit of $12. By the time he was 14, he had saved enough money from his $175 per month paper route job to invest $1,200 in real estate.
Buffett’s current net worth exceeds $143 billion, and many people are eager to learn how to replicate his success. Moneywise recently shared his core advice, which includes three fundamental investment rules.
Throughout his career, Buffett has adhered to the same principle: only invest in companies you understand. In a letter to Berkshire Hathaway investors in 1996, he wrote, “It is not necessary to evaluate a range of companies beyond one’s capacity. The size of this circle is not important; understanding its boundaries is critical.”
In other words, only invest in a company if you understand how it makes money.
Today, this advice may be more challenging as many promising companies are engaged in high-tech, specialized work, and few possess Buffett’s business acumen.
Fortunately, there is a simple way to expand investors’ circle of competence by seeking advice from trusted professionals.
People often interpret this advice as “start young,” which is certainly good, but starting at 35, 45, 55, or even later is better than not starting at all.
The earlier you begin, the more time you have for the power of compounding to work, thus earning more.
For instance, if you were to invest $1,000 in an account with an annual return of 9.4% – the average return rate over the past century – by the fifth year, the $1,000 would have grown to about $1,500. Even without adding more money to the account, the money will continue to earn interest, resulting in more earnings. By the 20th year, you would have over $6,000.
Now, if you let this money grow for 40 years, the total assets would exceed six times the amount in 20 years: $36,365.
By consistently adding money to the account, the wealth will grow even further. Assuming a relatively stable market, by depositing just $100 monthly, you could accumulate nearly $500,000 in deposits over 40 years.
When Buffett began investing, he put less money into smaller companies. The stock prices of small companies are usually lower. Furthermore, as Buffett stated at the 1999 Berkshire Hathaway meeting, “In this field, certain things are more likely to be overlooked.”
The investment community refers to these smaller stocks as “small caps,” but they have enormous potential. In fact, according to MSCI Research, “Historically, small-cap companies have outperformed large-cap companies, especially after an economic downturn and with long-term holding.”
Investing always involves risks, and if the small company you choose is also a new company with no track record, the risks may be higher. However, there is also a chance to become a big winner from the start.
Buffett warns that this is not a get-rich-quick scheme; returns take time, and markets may fluctuate.
At the 2020 Berkshire Hathaway annual meeting, he told investors, “When you buy a stock, you ought to be fully prepared from day one for it to go down 50% or more and be calm about it.”
If you choose small companies, make confident selections, and wait as long as possible, you are strictly following Buffett’s rules.