Warren Buffett’s Investing Advice: Simple, Not Smart
Written by
Peter Burns
Edited by
Molly Sullivan
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When many invest today, they’re hoping for nearly instant returns. Chasing get-rich schemes by investing money in little-known cryptocurrency coins or meme stocks has become popularized online, and it’s leading many young people to believe this is the best way to invest.
Other, more traditional investors try to beat the market as well. This happens when someone buys specific stocks when they’re priced low and sells them when they’re high to earn a higher return than a stock market benchmark like the S&P 500.
These tactics come with a lot of risk and the potential for significant losses. Warren Buffett, a man often regarded as the most successful investor of the modern era, recommends taking a different approach. Following Buffett’s lead may help you grow your wealth, just like he has.
Why Buffett’s Investing Advice Works
The stock market is constantly in flux, making it difficult to predict. However, zooming out and looking at the stock market over a long period of time shows it has always gone up. The S&P 500, an index of 500 leading companies that account for 80% of the stock market, is an excellent indicator of the market’s health. Over the past 30 years, the S&P 500 has risen by an average annualized return of 9%, equaling 6.3% when adjusted for inflation.
With this data, it’s possible to see how Buffett’s thought process works. He broke down a simple investing strategy in a letter to Berkshire Hathaway shareholders in 1993. By consistently investing in a diversified index fund, such as the S&P 500, and reinvesting the dividends, you can outperform many professional investors. This strategy works for several reasons.
Compound Interest
The longer you continually put money into the S&P 500, the more you’ll make. Not only has the index historically risen over time, but you’ll also make money with compound interest. Compound interest means you earn interest on the interest that you gain over time, as long as you reinvest it. If you invest $1,000 and earn $50 after one year at a 5% return, you’ll earn interest on $1,050 the second year. Your investment continues to compound and grows as the value goes up.
No Knowledge Needed
It can be difficult to decide what stocks to invest in. Simply buying stocks that have dipped in price doesn’t mean they’ll ever rebound. If you want to invest in individual stocks, Buffett suggested building a “Circle of Competence.” Since you can’t deeply understand every single niche and industry, focus on just one specific area at first. Learn everything you can and invest only in companies that fall into your Circle of Competence.
While this can work, investing in the S&P 500 requires no research or active management at all. Even investing in different indexes that track specific industries or foreign countries can be problematic because you likely don’t know enough about them.
Timing Doesn’t Matter
When using Buffett’s strategy, you don’t need to worry about whether the index is up or down. As long as you consistently invest over the long run, your investments will average out to the going rates. Dollar-cost averaging is a strategy wherein you invest a set amount of money at a regular interval, ignoring market conditions. Over time, this negates the highs and lows of the market and guarantees that you’re paying the average price.
Similarly, it eliminates the need to time the market, or buy low and sell high. Buffett explained that timing the market is an impossible feat. He’s never made a decision based on trying to predict the market’s short-term moves. Using a dollar-cost averaging approach eliminates this risk and helps maximize your investments.
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