They say that the number one rule in playing the stock market is never to lose your money. This is reinforced by the second rule of investing which is to see rule number one. If these rules are so important, then why don’t so many investors take heed and invest foolishly on companies they don’t understand? In fact, if more people could control their buying impulses, it would not only save them money but it would allow them to buy shares in better companies if they only did their research.
There is perhaps no other man that exemplifies this iron discipline of investing better than Warren Buffett. As CEO of the investment holding company Berkshire Hathaway, he has more than 40 billion dollars at his disposal to invest. During the darkest days of the credit crunch, it was reported that CEOs of banks would phone Buffett to bail them out. However, these banks did not fit into the profile of Warren Buffett stock picks. In fact, while most people are interested in what Warren Buffett is buying, it is also important to underscore the importance of not making bad deals. You can do so by not investing in complicated investment vehicles that you do not understand.
In real life, most people would not get into a business they do not understand. However, for some reason, people think it is perfectly acceptable to buy shares in a company they do not understand. And don’t think that this mental illness is restricted to everyday folk. It was prevalent on Wall Street – that was how we got into the credit mess with “sophisticated” asset backed commercial papers that no one could unravel. It got lots of banks in trouble which spilled onto main street. The rule of thumb is if you can’t explain what it is, don’t invest in it. Sometimes, it’s not the trades you make but the trades that you don’t make that are important.