Warren Buffett is widely considered to be one of the best investors of all time. He did not get this position by accident. Over the past seven decades, he has built a vast fortune by following a set of rules, which he continues to use today.
Any investor can follow these rules to improve their investment process. Indeed, I follow some of Buffett’s practices to help me choose investments and reduce the risk of losing money from my choices.
As such, here are the rules I would use from the ‘Oracle of Omaha’ to invest a lump sum of £5,000 today.
Buffett’s rules for success
The billionaire’s first rule of investing is to avoid losing money. This is easier said than done. Even Buffett has bought investments that ended up costing him.
But this advice does not mean we should avoid selling stocks at a loss. Instead, Buffett is trying to get across how important it is to avoid corporations at risk of bankruptcy. These include speculative investments such as early-stage mining or oil exploration companies. Early-stage technology enterprises could also incur losses on investors if they struggle to produce a commercial product.
With this advice in mind, I would avoid investing my lump sum of £5,000 in any companies that may have a chance of running out of cash. This includes small-cap miners, speculative penny stocks and highly-indebted businesses.
When looking for an investment, one of the first questions Buffett asks himself is whether or not he can understand the enterprise. This is something I will follow as well. Some companies are challenging to understand. That includes how they make money and how they will generate returns for investors.
Even if these enterprises are highly sought after investments, I will avoid them because there is no better way to lose money than buying something I do not understand. This approach has helped me avoid several disasters in the past. These companies were market darlings, but their complex business models were designed to obscure fraudulent activity.
Invest for the long term
The third and final Buffett rule I would follow to invest a lump sum of £5,000 today is to focus on the long term. The Oracle of Omaha says investors should only ever consider a stock if they plan to hold it for the next 10 years.
This mentality forces me to complete extra work to understand a company and become entirely comfortable holding it in my portfolio. If I know I cannot sell for the next decade, I want to be sure I bought the right stock.
When I have completed enough research to understand the company inside and out, it is easier to hold the investment. Especially through the peaks and troughs of the market cycle.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.