Can we set limits on the stock exchange?

How to Put Warren Buffett's # 1 Investment Rule into Practice

Warren Buffett has achieved an average return of 20.3% with his holding company Berkshire Hathaway since 1965 (06/17/2020). This is an extraordinary achievement that has not been achieved a second time by almost any other investor.

He was not always right, which is completely impossible in the stock market. Still, many investors try to be 100% right and make one big mistake when it comes to investing in individual stocks.

Warren Buffett's number one investment rule is, "Don't lose money." But how can we implement this rule?

1. Set limits to your investments

Let's stick with the example given that we always want to be right. This would mean never encountering a company that does not fail in the end. There are many good long-term investments that have been listed on the stock exchange for many decades and are constantly increasing, but even they might one day not survive a crisis.

So whatever our investment style, we need to set limits on which we can sell stocks if they don't perform as we want them to. Warren Buffett focuses on fundamentals. So when, as recently, the prospects of the airlines become so uncertain that they could even slide into bankruptcy, it means selling, not hoping.

On the other hand, those who always try to be right will not be able to avoid total losses in the long run. It is very likely that these will only occur sporadically, but what is possible in individual cases may one day also apply to the entire portfolio.

Warren Buffett also uses the following methods to avoid losing money in the long run.

2. Only invest in companies that you understand

Actually, this translation is wrong. It suggests that Warren Buffett only invests in stable companies because he doesn't understand other companies. This, of course, is not correct. He penetrates all industries better than any other investor, but he only invests in those companies whose future cash flows he can predict.

This is what it's all about: Only invest in companies whose cash flows you can forecast for ten to twenty years. Suddenly you will find out how many companies you are unsure about because their future is difficult to predict. This is Warren Buffett's number one test. He considers everything else to be short-term speculation, not investing.

Then the next step follows.

3. Invest at the beginning of development, not at the end

Stocks move in cycles. They fall, begin to rise, and finally begin their final ascent before collapsing again. This cycle repeats itself over and over again. Warren Buffett buys when valuations are low and the purchase candidates described above have fallen significantly. This reduces his risk of losing money and increases the hit rate. On the other hand, stocks that have risen far and steep can only fall in the longer term.

4. Form your own opinion

Buffett advises never making your own investment decisions based on advice from third parties just because they recommend a value. Instead, create your own index card on which you write down why you find a share attractive and the conditions under which you would sell it again.

5. Focus on the fundamental development

Warren Buffett is focused on the fundamentals, prospects and valuation of his holdings. He considers everything else to be speculation, which is not his business. Speculators can push prices very far, but as valuations rise, the likelihood of a sharp fall increases.

Those who concentrate on these points will certainly be able to reduce their investment risks significantly.

The post How to Put Warren Buffett's # 1 Investment Rule into Practice appeared first on The Motley Fool Germany.

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Christof Welzel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway B shares and recommends the following options: long January 2021 $ 200 call on Berkshire Hathaway (B shares), short January 2021 $ 200 put on Berkshire Hathaway (B shares), and short June 2020 $ 205 call on Berkshire Hathaway (B shares).

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