How Warren Buffett Invests: Part 1

By Dale Gillham | Published 21 May 2018

Warren Buffett, also known as the Oracle from Omaha, is arguably the greatest investor of all time. 

Buffett is the CEO and largest shareholder of Berkshire Hathaway and has amassed an astonishing 482.9 billion USD in personal wealth making him the third wealthiest person in the world. So how did he do it?

One thing my mentor said to me when I was young was to find someone who is successful and in a position where you want to be, and essentially copy them. 

Warren Buffett has had incredible success sticking to his principles in the stock market, and yes, he had a mentor in his early days. 

There is no surprise as to why his philosophy to investing is so popular. So how does Warren Buffet invest and why is he so successful at it?

What follows are 8 investment insights from Warren Buffett that I break up into a three part series. 

This week, I will discuss the first few insights and the remaining will be discussed over the next two weeks.

1. Long term value investing

Warren Buffett's strategy is a long term value investing approach passed down from his mentor Benjamin Graham and his school of value. 

Benjamin Graham taught the long term value investing strategy of purchasing stocks at a price below their intrinsic value and then holding them until their price reflects the real value of the company.

According to Buffett, the secret to getting a better return on your investment is to buy a stock and forget about it. He believes in having a buy and hold mentality and insists on holding stocks for decades.

He is quoted as saying: "If you aren't willing to own a stock for 10 years, don't even think about owning it for ten minutes."

Further, he states that if you constantly buy and sell stocks, it will take away a significant percentage of your returns in the form of trading commissions and taxes. 

So, it is better to buy great stocks and hold them for a long time. 

While I agree with Buffett on most things, as a trader I have some slightly different views on this, as modern day technology has made brokerage very cheap and pretty much insignificant in the big scheme of things.

Further, the ease and speed with which transactions can be achieved in today’s market means that holding stocks for long periods does not allow you to compound returns like you can with buying low and selling high. 

Even after factoring in capital gain tax, I have found that there is great value to be had in actively managing your portfolio rather than having a passive buy and hold approach.

Remember, Buffett has been investing for over 76 years and times have changed. It also takes time to build a fortune and even Buffett did not amass 99 per cent of his wealth until after his 50th birthday.

I totally agree that you should stick to investing in good stocks. I also agree with Buffett when he talks about not letting fear and greed change your investing criteria and values. 

This means you need to avoid being overwhelmed by outside forces that affect your emotions. Most importantly never, sell into panic. 

These are all great pieces of advice, which sadly most investors do not adhere to.

2. Diversification is not always a good idea

Many good investors stress the importance of diversification, in fact, it is an industry mantra. But Warren Buffett tends to disagree with the idea and so do I. 

Buffett says that diversification is for people who do not know much about investing. An experienced investor should choose stocks on a long term basis and should have faith in their investments. Investors diversify their portfolios because they are afraid that any one stock might sink their entire portfolio. 

So by diversifying, they attempt to reduce the volatility of their portfolio, but at the same time they also reduce their focus on their individual investments. 

What I have found in my research is that over-diversification has the effect of reducing portfolio returns, so I agree with Buffett.

He waits for opportunities to buy good stocks and when those opportunities come his way, he takes full advantage. According to Buffett, "When it's raining gold, put out the bucket not the thimble", which I totally agree with.

That brings us to the end of the first part.

Next week I will continue with the more of Buffets insights.

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