Buffett Followed This One Rule And Built a Fortune — most investors still miss it!

Warren Buffett built his fortune using a single investing secret that no one else seems to employ. Warren's fortune is over $130 billion. Buffett's Berkshire Hathaway is now a trillion-dollar company and one of the biggest in the world due to the success of his one rule. Instead of running around using tips and tricks to make a quick buck in the stock market, Buffett follows the same rule that he started using in the early seventies and that he is still using today.

Although his one rule is very simple, it does take some time to truly grasp the rule's concept. From an outside perspective, his rule is viewed as boring because it does not involve the use of algorithms or other methods that would expedite the process. However, his investing rule works so well that he is now the most successful stock investor in the world. 

The Majority of Investors Make The Same Mistake: Confusion Instead of Focus

The rule itself is quite simple: concentrate your money on a few businesses you know best and hold them for a long time. 

Warren Buffett says, “You don’t need 20 right decisions to get very rich. Four or five will probably do it over time.” Buffett says, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”

The opposite of this is true for most investors. They call buying 20 to 30 stocks, or worse, dozens of stocks through mutual funds and ETFs, tiny 1–5% stakes in a company, “diversification.” Buffett calls it confusion.  

 

 

When you thin out your portfolio, you stop concentrating on the individual companies, and you stop understanding each business in depth. You own companies about which you know little, and you blindly pay prices you don’t value, and you react emotionally to market swings. This is not a value investing principle; it is speculation disguised as safety.

In contrast, Buffett's method is more opposite than traditional methods. He believes that the potential of businesses can be served better by focusing the rest of his investments on a select few businesses. Buffett's wealth has come from a relatively small number of businesses that he has made a large number of investments in, such as American Express, GEICO, Apple, 

See's Candy, Coca-Cola, and a few others. Buffett studies these businesses in detail, and while some may consider this the first step, when he buys a company, he does not do anything (in terms of running the company).

Alongside research, patience is needed, and that is the secret of holding exceptional businesses for several decades, as that will, without a doubt, be the engine of his long-term investing strategy.

Why This Buffett Investing Rule Crushes Conventional Wisdom

The financial industry loves preaching broad diversification, as more stocks sold means more fees, more transactions, and more rebalancing. More stocks does in fact, lead to a greater number of transactions. In simple terms, true wealth generation comes from a small number of exceptional businesses.

Of course, there are some exceptions to this (for Operational, Financial, and Legal balances), but consider these two investors, inefficient as they may be, to possess pure wealth without other means of growing their wealth (financially).

- A = 10,000,000 shares of 25 businesses (10-12% avg. annual) (30 years = 1.7-2.2 crores, avg. approx. 2.00 crores).

- B = 10,000,000 (Buffett's avg. 10-12%, holding for several decades, = 30 years =  15-25 crores or greater, avg. approx.  20.00 crores or greater) (18-20% avg. annual).

The difference is due to value investing principles, not luck. Buffett is buying something worth a dollar for 50-70 pence, and then he lets time and compounding do the rest.

Buffett embodies this mindset with the saying, “Our favourite holding period is forever.” Buffett is buying businesses, not ticker symbols. For Buffett, once he finds a business with a durable competitive advantage, solid management and cash flow predictability with shareholder-friendly policies, he is happy to own it forever.

The Value Investing Principle That Powers Buffett’s Rule

The Buffett investing rule is centred on the value investing principle with which his mentor Benjamin Graham taught and Buffett refined:

1. Buy wonderful companies at fair prices (not fair companies at wonderful prices).

2. Demand a margin of safety - your stories of potential should not lead to overpaying.

3. Focus on intrinsic value, not on the market price.

Buffett's investing rule focuses on companies with: 

- A durable (brand, cost, network, or regulation) moat.

- High return on capital with minimal reinvestment.

- Honest and capable management

- Investors focused on the long term and know how to identify the businesses they want to invest in.

- The investor has to remain disciplined and wait while the businesses wait for the market to offer them to invest in the businesses at the market’s offer to them.

- Investing in the long term is a business that has to be relaxed and doing nothing to watch the market’s price change.

- Once the investment is made, the long-term investing strategy begins to compound.

- A simple example of an investment made 37 years ago now demonstrates the power of reinvested dividends.

- The investment made in Apple demonstrates the power of the value of the investment.

No Emotion- Learn from history so emotional mistakes can be avoided. 

Where 'No Timing the Market' is a 'No'

 

 

Successful Examples of Buffett's Principles

- Coca Cola (1988) - Buffett purchased Coca Cola's stock when it was irreversibly devalued and held it no matter what. During the course of a few recessions, those few hundred million dollars worth of shares skyrocketed. Buffett was wise; the stock simply had a depressed price and fair-to-excessive underlying value.

- American Express (1960s Scandal) - The unpopular or devalued stock was bought because Buffett believed that the franchise was intact despite the short-term profitability concerns. This was a massive success.

- Apple (2016 and Beyond) - Apple was BUR and the noise was certain, and short-term profitability was questioned. BUR's largest holding was the greatest success.

- GEICO also holds true. 

Intensive Research

Ask yourself, "With what certainty do I hold this stock?" The Buffett investment philosophy can be summed up as, "Diversification is a failure of knowledge." 

1. Focus on your circle of competency- Focus on the companies and the industry or market and the technology or service(s) that fall under it/these.

2. Understand basic metrics- Read the annual reports, do the free cash flow numbers, P/E ratios, P/B ratios, and compare the ROE to peers and history.

3. Create a shortlist- Look for 8-12 companies that you would consider owning for ten years or more.

4. Wait for good pricing- Relatively low pricing happens during corrections, rotations of the sectors, or setbacks due to company-specific reasons.

5. Concentrate where it makes sense- In all probability, 6 – 12 high-conviction individual stocks is a good range. 10-25% of your best ideas should get a bigger allocation.

6. Hold during the ups and downs- Change your mind about 30-50% drawdowns. Those should be buying opportunities for the same businesses and not a reason to liquidate.

7. Let the reinvesting of your dividends do the work.- Compounding is good.

Start small. Even with 3-4 stocks where you know the business inside out, you will be ahead of 95% of the investors who own dozens of names that they can’t explain.

Mistakes that are the most common and destroy the creation of wealth

- Looking at stocks as lottery tickets and not the fractional ownership of real businesses.

- Investing in 30+ stocks to be safe and called over-diversification.

- Selling winners too early to book profits and holding losers for too long.

- Chasing hot sectors without understanding the real economics of things. (e.g. tech in 1999, EVs in 2021).

Using leverage or margin is one of the quickest methods to break Buffett's rule of thumb of never losing money.

 

 

Conclusion

You will follow in the footsteps of a young man from Omaha who became a legend of wealth creation and stock market success if you begin implementing this Buffett investing guideline right now. It's an easy rule. The discipline is uncommon. Because of this, it continues to be effective, and most investors continue to overlook it.

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.