After nearly seven decades of experience, investment legend Warren Buffett has amassed more than $141 billion in personal wealth, and the Oracle of Omaha believes much of his success is based on his ability to avoid losing money.
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“You only have to do a few things right in your life, as long as you don’t do too many things wrong,” he once said.
With this in mind, here are three investment mistakes you should avoid to ensure your long-term fortune.
1. Speculate instead of investing
Some investors do not recognize the difference between a speculative asset and an asset worth investing in. According to Buffett, the difference is in as The asset generates a return.
“All investing is putting money now to get more money back later,” Buffett once explained. “Now, there are two ways to get money back. One is from what the asset itself will produce. That’s investment. (The other) is from what someone else will pay you for it later, regardless of what the asset produces. And I call that speculation.”
Based on this philosophy, assets that produce income organically (such as farmland, profitable businesses, dividend-paying stocks, and real estate investment trusts) are worthy of investment.
On the other hand, speculative assets, such as Bitcoin, fine art, or an unprofitable tech startup, are exposed to unpredictable market sentiments.
Investors looking for exposure to solid earnings might consider the iShares Core Dividend Growth ETF (DGRO).
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2. Try to time the market
Timing the market is deceptively tempting. Investors often convince themselves that they can wait for the right time to buy or sell a stock. However, experienced investors understand that market cycles are unpredictable, so holding on to an investment for longer is often the best strategy.
Data analyzed by RBC Global Asset Management found that an investor who used the perfect timing method only modestly outperformed an investor who used the dollar-cost averaging method.
In other words, investing a fixed dollar amount in the S&P 500 every month from 2004 to 2023 was slightly less profitable than accurately predicting every market peak and trough.
However, one of these strategies is much easier to implement and is probably the one most investors should focus on.
3. Overpaying
During market bubbles and speculative manias, investors risk overpaying for assets, which can be detrimental to profitability.
“No matter how wonderful a company is, there is always a risk that you will pay a price and it will take a few years for the company to catch up with the stock,” Buffett said at a shareholder meeting. In other words, valuation should not be overlooked.
For example, a stock trading at 100 times earnings per share could take 100 years to recoup the initial investment if the price and earnings stay the same. Earnings growth and price appreciation are difficult to predict, so you’re exposed to too much risk when you pay such a premium.
On the other hand, a stock trading at a price-earnings ratio of five might take just five years to recoup your initial investment. Even if there is no growth in earnings or the stock price during this period, you have recouped your initial investment based on organic gains alone. Buffett and other investment professionals prefer these low-risk investments.
Bank of America, Buffett’s second-largest holding, trades at a forward price-to-earnings ratio of about 13%, as of July 2024. Compare that to Tesla, which trades at a forward price-to-earnings ratio of 99%.
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This article is for informational purposes only and should not be construed as advice. It is offered without warranty of any kind.
