The Motley Fool

Why Following This Warren Buffett Rule Could Make You a Millionaire

close-up photo of investor Warren Buffett
Image source: The Motley Fool

Warren Buffett is famous for being one of the most successful investors of all time. Luckily for private investors, he has always been happy to share the secrets of his success.

Overall, Buffett’s investment style is relatively simple. He only invests in businesses that he understands, keeps a sizeable amount of cash spare in case he needs it, and makes logical decisions on how long he holds stocks for. Following this overall focus of simplicity could therefore lead to improved returns for any private investor, with Buffett’s track record showing that investing does not always need to be complicated.

Understanding

All investors have their strengths and weaknesses. Some are able to understand and fully compute the investment potential of some sectors, while other investors may be better-suited because of their character or working background to other industries. Whatever sectors an individual feels they understand, according to Buffett they are the areas where they should focus. Doing so provides an investor with a competitive advantage versus peers, which could lead to relatively high returns in the long run.

Moreover, by focusing on sectors and companies that an investor fully understands, they may be able to reduce their overall risk. Investing in something that remains a mystery throughout the holding period could be dangerous, and may lead to unexpected declines and losses for the investor concerned.

Cash

While many investors may feel that they need to invest every last penny that they have in the stock market, Buffett takes a very different view. He believes that cash serves two main purposes. First, it provides peace of mind for an investor, so that if money is required for a non-investment related event then it is readily available. Second, it allows an investor to capitalise on short-term movements in the stock market, through which they can buy high-quality stocks trading on low valuations.

Clearly, the amount of cash to be kept on hand at all times is open to debate. In this regard, though, a simple method of keeping a specific number of months of living expenses readily available, plus a percentage of a total portfolio value, seems sensible and simple to put into practice.

Holding period

Buffett always comes across as a kind and helpful individual who wants to aid private investors as much as he reasonably can. However, he also has a ruthless side when it comes to underperforming stocks in his portfolio. If he believes they are no longer worth buying, then he is quick to sell. Likewise, he is happy to hold his better performers for as long as they require to deliver on their potential.

As with most of the things he does, deciding whether to hold or sell seems to be a simple decision for Buffett. He doesn’t worry about the optimum holding period, nor does he try to time economic cycles or the stock market. He just holds the companies he believes in, and sells the stocks he doesn’t. In other words, his holding strategy is remarkably simple. Following it and the aforementioned ideas on cash and understanding stocks could help to improve an investor’s portfolio performance in the long run.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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