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Warren Buffet's Three Golden Rules of Investing

Updated on May 30, 2017

Warren Buffet has consistently hogged a place in top three of Forbe's list of billionaires for nearly two decades. Considered the most successful investor in history, he has consistently given his investment firm, Berkshire Hathaway, an annual return of over 22 percent for over forty years. In so doing, he has not only made himself rich, he had made many people who invested in his firm rich beyond their dreams. What is the secret of his success?

Here are his three golden rules of investing:

Rule No. 1: "Do not lose your money"

The first rule of investing, according to the legendary investor, is not to lose money. "How is that possible?" you may ask. Every investment has inherent risks associated with it. Regardless of how good you are, you can't avoid making losses. That's not entirely true, according to Mr. Buffet. He says that if you plan your investment portfolio well, you will not lose your money no matter what happens to individual investments.

Buffet's advice: Hold on to the winners for the long run and cut your losses while they are still small. This is exactly what most investors fail to do. Let's say out of every ten investments you have made, four turn out to be winners each giving you a return of 50 percent. You will make a total gain of 200 percent, but only if you let the winner run their course and cut the losers before they turn into huge losses.

Rule No. 2: "Do not analyze stocks, analyze business"

Once a reporter asked Buffet for tips on analyzing stocks. He promptly replied, "I do not analyze stocks, I analyze business." This is the secret of his success. While the majority of investors analyze stocks, he analyzes business, because business drives stocks and not the other way round. According to Mr. Buffet, every stock is a business in operation and the long-term value of the stock is determined by the performance of the business.

In the 1980s, Japan Airlines was one of the biggest airlines in the world and its stocks were soaring high. A lot of investors looked the JAL stocks and put their money in it hoping to make a killing. But Buffet knew better. He knew that the airline was overextended and its operating costs were becoming untenable. When global airfares fell in the 1990s, the airline came crashing down. The investors who had put money in its stocks lost a lot of money.

Rule No. 3: "Be greedy when others are fearful; be fearful when others are greedy"

Greed is integral to human nature. But greed is not always bad. If used positively and at the right time, it can make you very, very rich. The trouble is most investors become greedy at the wrong time. They buy stocks just when they are rising rapidly, hoping to make a huge profit in a very short time. But when the market takes a reverse turn, they panic and end up losing a lot of money.

Buffet advocates the contrarian approach. When the market is rapidly rising is not the right time to become greedy. The right time to be greedy is when the market goes for a deep correction, according to him. When the global stock markets went down in 2008 after the collapse of Lehman Brothers, most investors panicked and pulled their money out as fast as they could. Buffet, on the other hand, bought Goldman Sachs and other stocks worth $5 billion and made a several billion more when the market recovered.

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    • Johan Smulders profile image

      Johan Smulders 2 years ago from East London, South Africa

      He should know so good advice!