Warren Buffett on retirement: reflecting on his investing rules

As discussion grows around Warren Buffett on retirement, investors are revisiting his famous philosophy. He’s the Chairman of Berkshire Hathaway, and for decades, its Chief Executive. He’s probably the most recognisable figure in investing, with his net worth currently estimated to be around $150bn. That wealth has come from applying a relatively consistent Warren Buffett investment strategy over and over again.

Since taking control of Berkshire in 1965, the company’s share price has compounded at roughly 20% per year, far ahead of the US market which is closer to 10% per year. In the 1950s-1960s, returns were extraordinarily high (40-50% per year). Moreover, the consistent rules that Buffett champions make investing sound surprisingly easy if you have the right mindset and temperament. 

The Buffett way is as follows: 

1. buy businesses you understand
2. with favourable long-term economics and trustworthy management
3. at a price that gives you a margin of safety
4. let compound interest do the heavy lifting
5. try not to sell, unless something fundamental changes

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Buffett rule 1: Stay inside your circle of competence

Berkshire has long said it looks for businesses it can understand before anything else. If Warren Buffett looks at something new and after 20 minutes his head is spinning, he puts it in the “too hard” pile and moves on. 

This is an overlooked piece of Warren Buffett investment advice because investors often feel they must have a view on everything – like they can’t say “I don’t know.” In reality, to use a use a baseball analogy, you don’t have to swing at every pitch. Noone’s forcing you to invest in AI, biotech, crypto, luxury goods or anything else you don’t understand. You can stand there all day letting balls fly past you. If they’re not at the right height to swing at, just wait for something better.

The late Charlie Munger, Warren Buffett’s right-hand man and co-leader of Berkshire Hathaway, once joked to shareholders that they’d “lost hundreds of billions of dollars” by missing opportunities. “If you counted the amount of money we could have made in investments we chose not to make, you’d chase me and Warren out of town”. What he was saying was that if they’d just lowered their bar slightly, they’d have been swinging their bat far more and surely caught more winners. But obviously, he and everyone else in that room knew that by lowering the bar, they’d also have let in some ruinous mistakes. 

An example of this is the Dot Com Boom of the late 1990s and early 2000s. There were all kinds of alluring claims about internet stocks. And investors were desperate to load up on them. Buffett stayed out of it because as a 70-year-old, he just didn’t understand what many of these companies did. When the bubble burst, Buffett avoided the fallout.

Charles Stanley Direct gives access to a wide range of investments including UK and international shares, and ETFs. Choice is great, but so is education. For readers still building their knowledge, resources like Charles Stanley’s guide to investing basics can help you expand your circle of competence and feel more confident.

See here: Guide to Investing Basics | Charles Stanley 

Buffett rule 2: Always invest with a margin of safety

This is one of the core ideas Buffett took from his mentor and the father of value investing, Ben Graham. Warren Buffett was a classic value investor in his earlier years, meaning his approach is centred around finding opportunities to buy businesses for less than their true worth, rather than chasing trends. The idea of a margin of safety is intrinsic to this. 

Price is what you pay and value is what you get. So, a margin of safety is about making sure that before you buy a share, your estimate of value is comfortably above the price. That way, if there are bumps in the road or your assumptions were wrong, you have a buffer.

Imagine you think a business is worth £10 a share. If you pay £9.80, you need to be almost exactly right. If earnings disappoint or the company comes up against unexpected headwinds, you’re underwater on that investment pretty fast. But if you pay £6.50 for something you reasonably believe is worth £10, you have more room for error (and by virtue of this, higher upside to the company’s intrinsic value). 

Another way of getting a margin of safety is to focus on buying very good quality companies and to hold them for a long time. That’s the style Buffett migrated to over the years. In the fullness of time, short-term volatility smooths out and becomes a distant memory. Good quality companies invariably march higher. 

Of course, Buffett has lost money on investments. But he avoids the worst losses by sticking to this rule. This is important because a 25% fall needs a 33% gain just to recover. A 50% fall needs 100%. Avoiding serious damage may not feel as fun as looking for opportunities, but it’s one of the great engines of long-term compounding. 

Buffett rule 3: Think like an owner

Buffett has always encouraged investors to think about shares as pieces of real businesses. 

This sounds obvious but it’s easy to forget when trading shares on an app is so easy, with flashing lights on the screen potentially making it feel like a game. 

You can check your stocks 24/7, but if you think about it – you wouldn’t check the value of your home every single day, glued to the upticks and downticks. And if you owned a business outright, you wouldn’t call in investment bankers weekly to put a price tag on it. So, as a business owner through the stock market, it’s not logical in theory for you to check the market value of your holdings every five minutes. That’s Buffett’s view.

He believes the owner mindset focuses the mind on more important fundamentals like revenue, margins, profit, customers, competitors, and whether the business itself is becoming stronger or weaker, regardless of the share price.

Buffett rule 4: Competitive advantages are essential

So, what companies should you be looking for, according to Buffett?

Berkshire has repeatedly said it wants businesses with excellent economics, able and honest management, and enough durability to keep generating strong returns well into the future. These are the companies that can compound wealth for years and years and years.

He loves competitive advantages, which he refers to as moats around a business. A moat can come from a brand, a distribution network, a cost advantage, customer habits, patents, government protection, scale, or network effects. 

Buffett wants these to translate into something called ‘pricing power,’ which is the ability for companies to pass on costs to the customer without losing much in the way of sales. Ideally, companies don’t even lose sales during recessions because their competitive advantages are so strong. That’s a way of keeping the compounding machine consistent in tough times, which is where most people come undone in wealth building. He calls these businesses ‘franchises’ and this is, if anything, the secret to his amazing success.

For more on how compounding works, read this: The power of compounding for future wealth | Charles Stanley

Franchise examples in the Berkshire portfolio include Coca-Cola with their worldwide brand, Apple with their product ecosystem, and Visa and Mastercard for their network effects.

Buffett rule 5: Once you’ve got them, let them run

You may be thinking, “okay, and when do I sell them?” 

Warren Buffett believes that your wealth comes from – and is – your investments growing over time. If you think of yourself as a business owner, then you trust the value in the companies you own and don’t feel the need to crystalise paper gains into cash.

In practice, Buffett would say that within his portfolio, different investments jockey and compete for the incremental dollar he has to invest. If nothing supplants his franchise picks, he’ll actually top up his shareholdings whenever he gets the chance. He believes that unless you’re selling to free up funds to meet an important expense in your life, selling only gives you the job of having to find somewhere better to put the money. If there’s no better fundamental business, don’t move.  And if he can’t or doesn’t want to top even more, Buffett has shown he’s happy to run up cash until the right opportunity comes along.

To illustrate this point, one of Buffett’s first ever investments was See’s Candy, the premium confectionery business. Buffett loved the family who ran it and the brand was special, so he acquired it in 1972. He still owns the sweet shop today (talk about ride or die!). 

What Buffett will do with his wealth when he dies

Warren Buffett has pledged to give away more than 99% of his wealth. And he’ll follow the same principles to do this as he has for his whole career as an investor. He’ll look at where he can allocate money in the charitable space for the most productive and positive return. For investors, there is another lesson in this. 

There has to be a higher purpose than building wealth for its own sake. For some investors, the end goal is a comfortable retirement. For others, it’s family security and helping children. This is where investing connects with financial planning. A Charles Stanley Direct account can hold your compounding investments, but a personal journey with professionals who know your mission can be important too.

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