Warren Buffett Explains the 7 Rules Investors Must Follow in 2023

Warren Buffett, the king of value investing, has definitely built a cult-like following over the years, and well, he's undoubtedly my investing idol too. What I find so interesting about his investment strategy, the one that's made him 20% returns per year since 1965, is that it literally boils down to a short list of rules that anyone can follow. So in this video, I'm going to walk you through Warren's seven rules step by step with examples so that you can apply these to your own investing.

So with that said, let's start with his first rule, which is: Don't hold a stock for 10 minutes unless you're willing to hold it for 10 years. I'm not recommending that people buy stocks today or tomorrow or next week or next month. I think it all depends on your circumstances, but you shouldn't buy stocks unless you expect, in my view, you expect to hold them for a very extended period, and you are prepared financially and psychologically to hold them the same way you would hold a farm. And never look at a quote; you don't need to pay attention to them.

Warren has always described investing as a game of psychology much more than a game of intellectual ability, and a part of forming those successful thought patterns is to focus on the long term. Buffett's famous quote here is: Don't hold a company for 10 minutes unless you're willing to hold it for 10 years. This helps you ward off the gambling mindset; it instead makes you focus on the actual business you're buying and its future. Giving great businesses a long time to compound is exactly how Warren has created his fortune.

American Express, Coca-Cola, Bank of America, Visa, Moody's—they're all large holdings in the Berkshire portfolio, but each stock has also been held for more than 10 years. In fact, Buffett first bought Coca-Cola back in 1988; in total, he spent about $1.3 billion. But today, through the passage of time and the power of long-term compounding, that investment is worth $24.8 billion and pays Buffett $700 million a year just in dividends.

You've got to be prepared when you buy a stock to have it go down 50% or more and be comfortable with it, as long as you're comfortable with the holding. I pointed out three times in Berkshire's history when the price of Berkshire stock went down 50%. There wasn't anything wrong with Berkshire when those three times occurred, but if you're going to look at the price of the stock and think that you have to act because it's doing this or that, or somebody else tells you, well, you know, how can you stay with that when something else is going up? You've got to be in the right psychological position, and frankly, some people are not really careful. Some people are more subject to fear than others.

Long story short, think long term. Don't get caught in that short-term gambling mindset. Don't hold something for 10 minutes unless you're willing to hold it for 10 years. The real test of whether you're investing from a value standpoint or not is whether you care whether the stock market is open tomorrow. If you're making a good investment in a security, it shouldn't bother you if they close down the stock market for five years.

With that, we come to Buffett's next big rule, which is, quite simply, don't lose money. The first rule in investment is: Don't lose. And the second rule of investment is: Don't forget the first rule. And that's all the rules there are. I mean that if you buy things for far below what they're worth, and you buy a group of them, you basically don't lose money. This is Warren Buffett's famous rule number one of investing, which is also made popular by Phil Town in his book "Rule Number One."

This quote might sound obvious or unhelpful, but it's another one that makes you check your mindset in stock market investing. If you pick six good businesses out of ten, you're doing really well. But the real secret is to ensure those four losers don't punish you. Warren Buffett says the most important thing to do if you find yourself in a hole is to stop digging, and that's very important in stock market investing but also very hard to do because when an investor starts losing money, the tendency is to convince themselves that they need to double down. When sometimes, in reality, the best thing to do is just cut their losses and walk away.

But the main thing Buffett notes in that clip that will help you reduce the likelihood of losing money is to watch the valuations. Make sure you buy businesses for below what they're worth and buy a few of them. If you do this, your risk of loss is greatly reduced. A recent example of this is Buffett's investment in Taiwan Semiconductor. Buffett bought in Q3 of 2022 and sold it practically immediately across Q4 and then Q1 after acknowledging that he quite simply got that one wrong. But because he bought the stock after it was already at a very low valuation, his mistake didn't hurt him. In fact, it's reasonably likely he actually made money on it.

So remember Buffett's rule number one of investing: Don't lose money. And in the same vein, that leads us right to his next rule, which is always buy below intrinsic value. The only reason for making an investment and laying out money now is to get more money later on, right? That's what investing is all about. If you buy Coca-Cola today, the company is selling for about $10 to $15 billion in the market. The question is, if you had $10 or $15 billion, you wouldn't be listening to me, but I'd be listening to you, incidentally. But the question is: Would you lay it out today to get what the Coca-Cola company is going to deliver to you over the next two or three hundred years?

The discount rate doesn't make much difference after you get further out. But that is a question: How much cash are they going to give you? It isn't a question of, you know, it is a question of how many analysts are going to recommend it or what the volume in the stock is, or what the chart looks like, or anything. It's a question of how much cash it's going to give you. That's the only reason—it’s true if you're buying a farm; it’s true if you're buying an apartment house, any financial asset, oil in the ground. You're laying out cash now to get more cash back later on, and the question is, is how much are you going to get, when are you going to get it, and how sure are you?

That's what a lot of people miss when they start out stock market investing. It's not about betting that a company will be the next big thing; it's about checking their free cash flows, how well the business is growing, modeling a conservative prediction of their future cash flows, and then from there, discounting those future cash flows to what you'd be comfortable paying for them today to ensure you get a good rate of return, AKA checking your buying below intrinsic value. And this topic is, honestly, a full video on itself, so if you wanted to learn about this process in detail, definitely check out the video coming up on the screen right now.

Long story short, the process Warren uses to calculate intrinsic value is called a discounted cash flow analysis if you wanted to look it up, but honestly, that's what that video goes into. But a great example of this point is Buffett's purchase of Apple in Q1 of 2016. I mean, at the time, Apple had a market cap of around $600 billion, which gave it a PE ratio of 12. Now, Buffett saw a really strong moat company that was likely to keep printing more and more cash over time, and, you know, it was trading at 12 times ear. So, he bought it. Today, the company sits at a market cap of around $3 trillion and has grown its free cash flow from $53 billion to $11 billion per year.

So the important thing, as Buffett says, is to ensure the business you're buying can distribute enough cash to you, the owner, fast enough that it makes their current market cap look like an attractive buying price. But the real question is: Is Berkshire selling for, we'll say, $105 billion now? If you're going to buy the whole company for $105 billion now, can it distribute enough cash to you soon enough to make it sensible at present interest rates to lay out that cash now? And that’s what it gets down to. If you can't answer that question, you can't buy the stock. You know, you can gamble in the stock if you want to or your neighbors can buy it, but if you don't answer that question—and I can’t answer that for internet companies, for example—there are a lot of companies, all kinds of companies, I can't answer it for, but I just stay away from those.

So make sure you're buying well below intrinsic value, and if you're not sure, stay away. And that leads us perfectly into Buffett's next big lesson, which is to stick to businesses that you understand. I have an old-fashioned belief that I can only expect to make money in things that I understand. When I say understand, I don't mean understand, you know, what the product does or anything like that. I mean understanding what the economics of the business are likely to look like 10 years from now or 20 years from now.

I know, in general, what the economics will say Wrigley chewing gum will look like 10 years from now. The Internet isn't going to change the way people chew gum; it isn't going to change which gum they chew. You know, if you own the chewing gum market in a big way and you've got Double Mint and Spearmint and Juicy Fruit, those brands will be there 10 years from now. So I can't pinpoint exactly what the numbers are going to look like on regular, but I'm not going to be way off if I try to look forward on something like that.

Evaluating that company is within what I call my circle of confidence. I understand what they do, I understand the economics of it, I understand the competitive aspects of the business. And this is where a lot of investors go wrong, particularly when they're first starting out. They maybe use a stock screener and can find some cheap looking stocks, but they don't actually do enough research to understand the business they're buying. And this is a problem because when the stock starts inevitably being around, they just don't know what to do.

I mean, imagine you bought just a random company and the stock price fell 30% tomorrow after you'd bought it. You know, did a good deal just get better, or did something fundamentally change meaning that you should actually get rid of the company? You just won't know unless you've done the digging on that business and it sits firmly inside your circle of competence. Defining your circle of competence is the most important aspect of investing. It's not how important or how large your circle is; you don't have to be an expert on everything, but knowing where the perimeter of that circle of what you know and what you don't know is, and staying inside of it is all important.

If I don't understand something but I get all excited about it because my neighbors are talking about stocks going up and everything, they start fooling around someplace else. Eventually, I'll get creamed. And, as Buffett says, it doesn't matter how big your circle is, just that you're staying inside of it. If you start drifting into businesses you don't understand, it's only a matter of time before you get creamed.

With that said, let's get on to Buffett's next rule, which is something he's changed his mind on over the years, and that is: Don't buy cigar butts. I've been taught by Ben Graham to buy things on a quantitative basis, look around for things that are cheap, and that I was taught that we say in 1949 or 50 made a big impression on me. So I went around looking for what I call cigar butts of stocks, and the cigar butt approach to buying stocks is that you walk down the street and you're looking around for cigar butts, and you find this utterly terrible-looking, soggy ugly-looking cigar with one puff left in it. But you pick it up, and you get your one puff, disgusting, you throw it away, but it's free; I mean, it's cheap.

Then you look around for another soggy, you know, one puff cigarette. Well, that's what I did for years. It's a mistake, although you can make money doing it, but you can't make it with big money. It's so much easier just to buy wonderful businesses. So now, would rather buy a wonderful business at a fair price than a fair business at a wonderful price. But in those and, in all honesty, that change of thinking that Buffett learned in part from Charlie Munger has probably been the biggest thing that has skyrocketed Berkshire's wealth.

Buffett, from the teachings of Ben Graham, used to look for ultra-cheap companies that may have been terrible, but they gave you that one last puff. Ben Graham's thinking was always that if you applied this approach and bought a big diversified basket of these businesses, then on the whole you would come out with fairly strong returns. However, Buffett then learned that this really was not the best way of going about things. It's, in fact, far better and far easier to instead buy really high quality businesses and hold on to them for a very long period of time.

You may not get them at a PE of, say, three or four, but if you can identify a high-quality compounder that's fairly priced and you can hold it for a long time, that's really the ticket. We've already discussed one obvious example of this, and that's Apple. You know, it's a high-quality business; I don't think anyone would argue with that, and Buffett bought it at a fair price, a PE of around 12. Sure, there were probably some rubbish businesses out there in some fire-out country selling for two times earnings, but Buffett understood Apple's quality and future runway and instead decided to back that.

As we already discussed, it worked out very, very well for him. So wonderful businesses at fair prices, not fair businesses at wonderful prices—that's the next big lesson. But next up, I have two more investing lessons to round out the Buffett-Munger philosophy, both to do with psychology. This one is one of Buffett's most classic quotes, which is: To be greedy when others are fearful and fearful when others are greedy.

People behave very peculiarly, in terms of the reactions because they’re human beings. They get excited when others get excited; they get greedy when others get greedy; they get fearful when others get fearful. And they'll continue to do so, and you will see things you won't believe in your lifetime in securities markets. I wrote an article for Forbes in 1979. I just said, how can this be? Pension funds in the 1970s put a percentage of their new money in stocks because they were wild about stocks. Then they got a lot cheaper, and they put a record low in 9% of their net new money in in 1978 when stocks were way cheaper.

Investors behave in very human ways, which is they get very excited during bull markets, and when they look in the rearview mirror and they see a lot of money having been made in the last few years, they plow in and they just push and push and push on prices. And when they look in the rearview mirror and they see no money having been made, they just say: This is a lousy place to be. So they don't care what's going on in the underlying business, and it's astounding, but that makes for a huge opportunity, just huge opportunity.

This has been a consistent talking point for Buffett throughout his whole investing career. The vast majority of investors are, unfortunately, sheep. They all get greedy together; they all get fearful together. They tend to do the same things over and over again. But them acting together really does move the stock market, but it mostly just boils down to fear and short-term thinking. So if you can break that and invest in high-quality businesses during the big panics, well, that tends to lead to the returns that Buffett has achieved because that's exactly what he does.

For example, in 2008, as the banking system was falling apart, Buffett made some big investments in, say, Goldman Sachs, and in 2011, he bought into Bank of America. He understood the businesses, so he knew that his risks were low. And because of this, he was able to get greedy when everybody else was panicking. It doesn't take brains; it takes temperament. It takes the ability to sit there and look at something. When I started out in 1950, I would go through and find things at two times earnings, and they were perfectly decent businesses, and people wanted jobs at those companies.

And everybody knew they were going to be around, and they wouldn’t buy them at two times earnings, and that's when interest rates were 22%. So it's about waiting for those smack bang home runs when everyone else is convinced that the sun won't come up tomorrow. But the trick is you have to show up. The golden opportunities are very infrequent; you won't get that many in your lifetime. So when they do come along, you have to follow Buffett's last investing rule, which is to seize your golden opportunities.

Big opportunities in life have to be seized. We don't do very many things, but when we get the chance to do something that's right and big, we've got to do it. Even to do it on a small scale is just as big a mistake almost as not doing it at all. I mean, you've really got to grab them when they come because you're not going to get 500 great opportunities. Even in my lifetime of 28 years, there's really only been three amazing stock market opportunities: the dot-com crash, the global financial crisis, and the 2020 stock market crash.

So roughly once every 10 years or so, you know, you're not going to get that many opportunities. So you have to stay vigilant and prepare yourself psychologically to act when those opportunities present themselves. I think that's the big thing; you really do have to prepare yourself to act. I mean, the reality is that most people will let these opportunities go right on by. They'll be watching TikToks instead of researching the stock market. Even now, watching this video, you're essentially being given the blueprint, but most people still won't do anything.

So the key is to act, and if you're serious—which I imagine you are because you made it this far into the video—maybe write down some investing goals you're going to do over the next month. Maybe it's to invest your first $500; maybe it's to read a company's annual report; maybe it's to read a famous stock market book. I'll put some of my favorites up on the screen, but whatever it takes, put some sort of plan in place so that you do actually act. Don't listen to the world's best investor telling you the secrets and then do nothing.

The biggest mistakes I've made by far—I've made, not we've made—biggest mistakes I've made by far are mistakes of omission and not commission. I mean, it's the things I knew enough to do; they were within my circle of competence, and I was sucking my thumb. And that is really, those are the ones that hurt. They don't show up anywhere. I probably cost Berkshire at least five billion dollars, for example, by sucking my thumb 20 years ago or close to it when Fannie Mae was having some troubles, and we could have bought the whole company for practically nothing.

And I don't worry about that if it's Microsoft because I don't know it. Microsoft isn't in my circle of competence. And so, I don't have any reason to think I'm entitled to make money out of Microsoft or out of cocoa beans or whatever. But I did know enough to understand Fannie Mae, and I blew it. And that never shows up under conventional accounting, but I know the cost of it. I know; I know—I passed it up. And those are the big, big mistakes. So when you get that pitch right in your hitting zone, make sure you swing. You might not swing for many, many years, but when you do get that perfect pitch, swing hard.

And they, my friends, are Warren Buffett's seven rules of investing. Please like the video if you made it this far and consider subscribing as well. I'm going to check a quick summary up on the screen if you wanted to maybe take down some notes. But thanks for watching, guys, and with that said, I'll see you guys in the next video.