MENU

Beginner Investors: Don’t Break These Top 2 Warren Buffett Rules and You’ll Do Very Well Over the Long Run

It’s an incredibly dumb move to time the markets over the near term, especially if you’re a new investor who’s never been face to face with a bear market. Many beginner investors I’ve spoken to think it’s as easy as “buying low and selling high.” Sure, it’s an easy concept on paper, but it’s impossible to do in real time when you feel the emotion and have no idea of what lies ahead.

While you could certainly look back at the 2007-08 Financial Crisis and tell yourself you would have sold at the peak and bought on the dip before the big bounce back, many beginners are oblivious to the fact that their overconfidence bias is leading them to overestimate their investment skill and risk tolerance.

Every investor has the same goal of buying low and selling high, and through technical analysis, the crowd is going to be making all the seemingly obvious moves based on momentum. And by following such “seemingly obvious” buy/sell actions, investors will simply be following the herd, which is not a way to obtain satisfactory returns over the long term.

Everybody wants to beat the market, but what new investors don’t realize is that their desire to obtain market-beating returns leads them to riskier securities that’ll lead to amplified losses when stocks inevitably head south.

Further, as humans, we hate losses substantially more than we love gains of the same magnitude. This leads new investors to chase absurdly expensive momentum stocks with weak hands, ultimately leading to locked-in losses and abysmal returns that pale in comparison to the market benchmarks they intended to beat.

Steer clear of danger by following Uncle Warren’s simple rules

I don’t want to sound glib, but if you want to be a market beater, you need to be a contrarian. You need to buy when others sell and sell when others buy, as brilliant investor Warren Buffett has been doing throughout decades.

If you follow the herd, you’re setting yourself up to buy high and sell low, leading you to break both Buffett’s first and second rule of investing: “Rule number one: Never lose money … Rule number two: Never forget rule number one.”

We just flirted with a bear market, and if you didn’t sell at a loss after the 20% peak-to-trough plunge in the S&P 500, you’re probably feeling better after the big Boxing Day Bounceback. You may even be back in the green!

While Buffett’s number one rule may seem all too simple, it’s the rule that even the most experienced of investors forget on a regular basis, especially when the markets head south in a hurry.

Assuming you haven’t invested on a margin, you should have no problem sticking with your losers in a market-wide downturn; assuming you’ve done the homework on a name to begin with, the broader market turmoil and macro fears likely have little to no effect in the business behind the stock that’s retreating so violently.

Consider National Bank of Canada  (TSX:NA) stock, which has been clobbered 16% over the last few months. The company recently clocked in a sound Q4, where income jumped 8% to $566 million with all three of the company’s main business segments posting improved earnings as fellow Fool contributor Brian Pacampara pointed out in his previous piece, which highlighted his top TSX value picks for 2019.

Indeed, National Bank of Canada is a regional bank that’s not as pretty as its bigger brothers in the Big Five, but with a TTM P/E of just 9.3, something has got to give! The stock is dirt cheap, and although the recent plunge is indicative of dents in the bank’s armour, there are no real dents to be had, as it’s still operating at a high level, as it did a few months ago, before the plunge in shares.

Foolish takeaway

Everybody has been ditching stocks to the curb because they’re so out right now. It doesn’t matter if the businesses are firing on all cylinders; it’s all about the macro picture, which, while uncertain, is overblown beyond proportion and may be setting the bar low for 2019.

Be a contrarian and buy the stock. National Bank of Canada stock is damaged, but the bank itself is in pretty pristine condition. Although losses may be in the cards over the short term, you’re not going to be negatively affected if you stick with Uncle Warren’s golden rules!

Stay hungry. Stay Foolish.

Motley Fool Canada Announces a FREE Gift for Investors

The financial world is buzzing as Iain Butler and his team of market-beating analysts in Stock Advisor Canada pick their favorite stocks for 2019 and beyond.

As a special gift for investors, they’ve decided to give away one of their top TSX stock picks of 2019 for FREE.

Click here to claim your free TSX stock pick for 2019

Fool contributor Joey Frenette has no position in any of the stocks mentioned.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.