What are Warren Buffet's best pieces of financial advice?(Read article summary)
Warren Buffet has had a lot of success in finance. Over the years, he has shared these five key pieces of advice that could lead you toward financial prosperity. Do any of them surprise you?
The "Oracle of Omaha" truly lives up to his name.
Between 1964 and 2014, the S&P 500 increased by a whopping 2,300%. On the other hand, the stock price of Berkshire Hathaway, the company of which Warren Buffett is chairman, president, and CEO, grew an even more mind-blowing 1,800,000% over the same period.
This performance cements Buffett's reputation as the most successful investor of the 20th century. Here are his five best pieces of financial wisdom that you should take note of.
1. Invest in Stocks
In his 2012 letter to shareholders of Berkshire Hathaway Inc., Buffett wrote "American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance."
Buffett's optimism in the American economy is backed up by strong facts. Remember that stocks still managed to return 2,300% from 1964 and 2014 — despite wars and recessions. The takeaway is that the average investor shouldn't be discouraged by the normal ups and downs of the U.S. stock market. Invest in stocks and do so for the long run. In Buffett's own words, "if you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."
2. Don't Chase "Winners"
Everybody is looking to buy low and sell high.
For example, if you had purchased AOL stock at a rock bottom price of $12 per share on September 1, 2011, you would be jumping with joy at AOL's May 2015 price (now over $50 per share due to Verizon's acquisition of AOL). (See also: The 4 Greatest Stock Reversals in the Last Decade)
However, Buffett recommends that the average investor not play stock picker. Instead, he recommends that the average investor invest in a low-cost S&P 500 index fund.
Keeping true to his own advice, Buffet laid out in his will that his trustee puts 10% of the cash left to his wife in short-term government bonds and the remaining 90% in Vanguard's S&P 500 index fund. That's as simple as it gets.
In simple terms, you already have a day job, so stick to it. You'll save a lot of money in trading fees, too.
3. Avoid Get-Rich-Quick Schemes
In the book The Tao of Warren Buffett, you can find many inspiring sayings from The Oracle of Omaha. Here is a great baseball analogy from Buffett about the stock market:
"The stock market is a no-called-strike game. You don't have to swing at everything — you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'"
Past stock picking performance is not a guarantee of future success. Take any five-year period and only 20% to 35% of actively managed funds beat the benchmark for their category. Resist the temptation of jumping on any "hot investment," particularly when you don't understand what the investment is about. (See also: 5 Investors With Better Returns Than Warren Buffett)
"When promised quick profits, respond with a quick 'no'", Buffett suggests.
4. Pay Yourself First
Roughly half of Americans are saving 5% or less of their incomes. Even worse, 18% of us are not saving at all.
The main problem is that most people are going the wrong way about saving. Most of us first pay rent or mortgage, then take care of bills and debt payments, and after that spend on dining out and shopping. With such a strategy, it's no wonder that 18% of us aren't saving.
"Don't save what is left after spending; spend what is left after saving," recommends Buffett. Just like you budget based on your net paycheck after federal and state taxes have been applied, you need to start planning on your net paycheck after savings.
There are three key ways to pay yourself:
- Retirement account: Participate in your employer's retirement plan or set up your own, such as a Solo 401(k), to build up your nest egg and postpone your tax bill until retirement.
- Savings account: Set up an automatic monthly deposit into your savings account. Take advantage of high-yield online savings accounts, such as Ally Bank and Capital One 360.
- Emergency fund: 26% of Americans have no emergency savings.
Pay yourself first by automatically funding your retirement, savings, and emergency fund accounts. Only start paying bills and spending on necessities after you have taken care of these three key items.
5. Pay Down Debt
Of course, to be able to save, you must first take care of debt.
In another letter to shareholders of Berkshire Hathaway Inc., Buffett warned, "Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks."
The "chronically leaking boat" that Buffett is referring to is living paycheck-to-paycheck, which 76% of Americans are doing. On the other hand, the "patches" are expensive forms of financing, such as car and payday loans, and withdrawals from retirement accounts. (See also: 25 Dumb Habits That Are Keeping You in Debt)
Robbing Peter to pay Paul will catch up with you. For example, the more you treat your 401(k) as an ATM, the bigger the financial hole that you'll build. A study of borrowers from 401(k) plans shows that 25% of them took out a third or fourth loan, and 20% of them took out five or more loans. Borrowing from your nest egg too often turns into a vicious and expensive cycle.
If you think that paying down that huge credit card balance is near to impossible, think again. One couple was able to pay off $48,000 in debt over 2.5 years and a young entrepreneur paid off $40,000 in student loans by age 24. Any debt monster can be slayed no matter how scary it may appear. All it takes is consistency and time.