Warren Buffett is everyone’s favorite billionaire. The world’s richest man is in many ways just like you. He drinks Coke and eats hamburgers and french fries, drives a beat up car and lives in a 4 bedroom house. In other ways, he is quite different, he owns a jet and collects quality companies the way people collect shot glasses on vacation.
I think there are 3 lessons from Buffett’s journey from middle class child to avuncular billionaire that we should all learn and immediately apply:
1. Compound Interest is the Most Powerful Force in the World
Buffett’s authorized biography is titled “The Snowball”. And he chose this phrase knowingly as it is an apt metaphor for his own financial assets as they have been accumulating and gathering steam like a snowball rolling downhill. This is like the magic of compound interest.
It is when your money is working for you, and your interest begins to earn interest for you. However to really reap the benefits of compound interest takes time. And this patience is what really separates the financial winners from the losers.
At some point, you have to be willing to delay your gratification and put away some money into savings or investments. It’s simple but not easy or the US and most developed countries would not be facing a looming retirement crisis.
2. Don’t Lose Money
Buffett has famously stated that there are only two rules to investing. One is don’t lose money, and the second is look at Rule #1. This is his way of emphasizing the importance of looking for a margin of safety when making an investment.
Following this rule may have prevented you from participating in the euphoria of the technology driven bull market of the late 90s or the real estate boom of the last decade. However, it also saved you from the tears and heartbreak that followed when these bull markets collapsed.
A corollary to this rule is Buffett’s maxim to only invest in what you understand. Buffett famously does not invest in technology because he does not understand it. Instead, he sticks to what he is comfortable with such as insurance, banks, or those companies with ubiquitous products such as Heinz, Wrigley, or Coke.
Again, this kept him out of trouble during time periods in which many people’s financial lives were destroyed. However, this requires patience and a discipline not to be seduced by the latest fad.
3. Don’t Use Too Much Leverage
Leverage is borrowing excessively to buy stocks, a business, or even a house. It should be avoided at all costs. In fact, excess leverage was the primary reason that small drops in housing value cascaded to an entire economic crisis that almost created another Great Depression in 2008.
By participating in the leverage game, you inevitably turn yourself into a short term speculator whose entire net worth can be destroyed by small fluctuations in the market. As we learned in the previous lessons, one of Buffett’s keys to success has been to be patient and think long term. Leverage will rob you of the ability to make intelligent, rational decisions.