4 Lessons From Buffett That Every Investor Needs To Know

Thursday, July 19, 2018 - 2:45pm

by Eric Winter

Behind each trade or investment, they are there... lurking, waiting to reveal themselves during a moment of weakness.


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They are the four fears of investing.

I learned about these early into my trading career, and I've been a victim of each one over time. All drama aside, they affect every investor or trader who actively manages his or her own money. 

In no particular order, the four fears are as follows:

1. Fear Of Loss
2. Fear Of Missing Out
3. Fear Of Letting A Profit Turn Into A Loss
4. Fear Of Being Wrong

Despite their prevalence, there are fortunately many methods to help conquer each of these fears. One of these tools comes from the long career and immortalized wisdom of the Oracle of Omaha himself. 

While I can't be 100% sure what Warren Buffett would say in regard to each of these problems, we can use his bank of interview quotes and newsletter excerpts to infer what the billionaire would say about understanding and conquering each problem.

1. Fear Of Loss
I have seen the fear of loss paralyze and end more trading careers than I'd like to recall.  When buying a stock, there's an overwhelming chance you won't pick the exact bottom, which means losing money before hopefully turning a profit. Taking risk and experiencing loss are part of the game. 

This fear keeps many from executing a position in the first place. Alternatively, seeing your recent purchase fall can cause enough anxiety for an investor to exit their position and take quick losses. This is a quick way to nickel and dime your accounts. 

Note that lacking this fear completely could be even more disastrous. Feeling immune to the fear of loss and ignoring stops can see an investment drop to $0 (or worse, if it's a short position).

Buffett's take: "Risk comes from not knowing what you're doing." "Time is the friend of the wonderful business, the enemy of the mediocre."

Solution: Patience is key. Being patient before buying may make for a more comfortable entry and can give your trade enough room to grow -- even if that means a missed opportunity. Always keep a realistic and appropriate stop-loss and commit to it. Keeping the quality of your trades high will limit this fear. 

2. Fear Of Missing Out
It could be said that those who don't have a fear of loss are often afflicted by the fear of missing out instead.

Letting go of a good buying opportunity or being stuck in a losing trade and watching profitable plays seemingly fly by keep these investors constantly checking their monitors or phones for stock prices.   

This is where the shoulda-woulda-coulda investors spend a lot of their time. It keeps many active investors fearful of missing the "next big win," fearful of leaving money on the table. This causes overtrading and a constant shuffling of positions, generating expensive commissions for brokers. 

Buffett's take: "You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing."

Solution:  You will miss good opportunities; it is simply part of the process. Keep tight requirements for potential positions so as not to overload yourself with signals, and set alerts, if possible. Finally, realize when you need to step away from your computer (hint: if you are not a full-time short-term trader, you probably don't need to watch your screen all day).

3. Fear Of Letting A Profit Turn Into A Loss
Ever made a great investment that earned you some cash, only to see it flip and head into negative territory? This is an all-too-common occurrence, but once again, it plays an important place in this game.  Letting your winners run while curtailing losses is often easier said than done, especially when volatility rears its head. 

Those affected by this fear may take profits early before their targets are hit, or dump the position at the first sign of correction. You end up missing longer-term trends and foregoing bigger gains.

Buffett's take: "For investors as a whole, returns decrease as motion increases." "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

Solution:  Keep a risk-adjusted profit target in mind before entering a position. Use tools like analyst estimates, price targets and support/resistance points to help you on your way. Employ trailing stops to capture profits as they grow, but leave enough wiggle room for a position to fully realize itself. More advanced investors may look into averaging down

4. Fear Of Being Wrong
At first glance, this fear seems somewhat redundant. However, its presence on this list highlights an important aspect of one's ego. Investors who are afraid of not being right let their emotions drive their trades, not the market, the probabilities or even plain old common sense. 

Those who can't admit fault with an investment often "marry" the trade, ignoring stop losses and holding longer than they should. It is much more important for them to be proven right than to view a trade as one of many in a vast sea of winners and losers. 

Buffett's take: "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."

Solution:  Investing is not a game of perfection, nor is it one where the smarter player always wins. Letting your pride steer a trade can prove disastrous. Stick to a system and the signs the market is giving you, even if it means admitting defeat. 

Risks To Consider: While these four fears are very real, I did take some literary license in applying some of Buffett's wisdom to each.  Buffett's long career has had its pitfalls. Let's not forget that he's the same man who said "Rule No. 1: never lose money; rule No. 2: don't forget rule No. 1."

Action To Take: These fears apply to money managers of all sizes. Educate yourself so that you can recognize each when they creep into your psyche. Develop a strategy to react to each fear, preferably before risking any money. Plan the trade and trade the plan, and don't let emotion take the wheel. 

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Eric Winter does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.