One of Warren Buffett’s most important pieces of advice is to “never invest in a business you cannot understand.”
Valuing a business and projecting its prospects for growth and success are very important to Warren Buffett when making investment decisions. He is famous for finding undervalued businesses that have room to grow; how can you analyze and evaluate an investment if you don’t understand it?
Investing in businesses that you understand is a sound investing strategy for avoiding losses, and Warren Buffett doesn’t like investment losses because digging out of a hole is harder than avoiding the hole in the first place.
Here is a simple explanation:
If you start with $1,000 and lose 50%, you’ll need the investment to gain more than 50% to get back to your original $1,000. Here’s why. If you lose 50% of $1,000, you only have $500 left to work with. You’re starting from behind, so you’ll need your investment to gain more than 50% to regain all your losses. For example, a 50% gain from $500 only puts you at $750. You will need a 100% gain – double – to get back to $1,000.
If you find yourself in a hole, here is Warren Buffett’s next piece of advice. “The most important thing to do if you find yourself in a hole is to stop digging.” The longer you stay in a losing investment, the harder it will be to climb out of the hole.
While much of the investing public are bandwagon investors who jump on and off investments based on the latest fads, crazes, and memes, Warren Buffett sticks to his guns and invests in only what he understands. And one thing he doesn’t understand is why people invest in things they don’t understand in things that really don’t do anything productive. Warren Buffett’s investing circle can’t run numbers on a potential investment if they can’t run reliable income projections. This is why he doesn’t invest in fad tech investments or Bitcoin. He doesn’t fall under the spell of fad investments or any other investment just because everyone else has fallen in love with them.
At the most recent shareholder’s meeting of his public investment company Berkshire Hathaway, Warren Buffett gave his most thorough explanation for why he doesn’t invest in Bitcoin. You can substitute Bitcoin with any other fad investment, and Warren Buffett explains why he avoids Bitcoin, or any other type of bandwagon investment is spot on. So, while Bitcoin has steadily been gaining acceptance from even traditional finance and investment circles in recent years, Warren Buffett is not buying the hype.
At the Berkshire Hathaway annual shareholders meeting held on Saturday, April 28th, he said that he does not invest in Bitcoin because it’s not a productive asset and doesn’t produce anything tangible. “Whether it goes up or down in the next year, or five or ten years, I don’t know. But the one thing I’m pretty sure of is that it doesn’t produce anything,” Buffett said. “It’s got a magic to it, and people have attached magic to many things.”
Since the beginning of the year, both the stock and crypto markets have seen extreme volatility, with more volatility predicted shortly, with many credible experts predicting a recession.
It’s in this exact environment that investors should give heed to three pieces of Warren Buffett’s most important investment advice:
If you’re experiencing losses, get out.
Stop digging a bigger hole for yourself.
Invest in what you know to properly evaluate the prospects of an investment.
Running numbers and making projections are much easier for businesses and assets that you understand. Do you understand crypto? Does it generate income in any way besides from price appreciations?
Invest in productive businesses and assets.
Productive businesses and assets have a history of performance and lend themselves to being evaluated and projections.
Better to preserve capital.
Like Warren Buffett, the ultra-wealthy understand that it’s better to avoid losses than recover from one. From their experience, the biggest losses occur in the most volatile markets.
They avoid volatility and the resulting losses by avoiding the public markets that are susceptible to this volatility. It’s exactly why they’re drawn to assets that they understand and that produce something in the private market that is insulated from volatility.
No matter what the public is enamored with, the ultra-wealthy stick to these basic principles to avoid losses.
Kyle Jones is a co-founder and Key Principal of TruePoint Capital, LLC. Kyle is responsible for the company’s strategic planning, investment decisions, asset management, and overseeing all aspects of the company’s financial activities, operations, and investor relations.
Kyle obtained a Bachelor of Science degree from Texas State University – San Marcos, where he also played Division 1 Baseball.