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These 3 Warren Buffett Rules Will Make You a Better Investor

By Dan Caplinger - Feb 2, 2020 at 9:07AM

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Taking this legendary investor's advice is a smart move.

Berkshire Hathaway (BRK.A 0.55%) (BRK.B 0.42%) CEO Warren Buffett isn't famous just because he has a monumental track record in producing wealth. He also has a no-nonsense common sense attitude toward investing that makes his vast investment knowledge and wisdom easy for investors of all skill and experience levels to understand.

Even a beginning investor can learn a lot from what Buffett talks about, and using some of the principles the Berkshire CEO has established for shareholders can help you in your own investing as well. In particular, the following three rules that Buffett uses can boost your own long-term results in your investment portfolio.

1. Buy stocks in companies with insider ownership

Buffett proudly states that Berkshire shareholders should have confidence in him because of his ownership in the insurance giant. "We eat our own cooking," Buffett has said, referring both to himself and to longtime vice chairman Charlie Munger and their joint holdings in Berkshire stock.

Warren Buffett with people behind him in a crowded room.

Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.

That doesn't just apply to Berkshire Hathaway. Whenever you see a company with top executives who hold significant stakes in the stock, you can have more assurance that company leaders are working in your best interest -- because it's in their best interest to do so as well. Not all companies without high insider ownership are poor investments, but it requires additional confidence to get the sense that corporate leaders are on your side.

2. Pay attention to your performance

Buffett knows that it doesn't make sense to compare his performance to the overall market's on a daily or monthly basis. Over short periods of time, the market simply can't reflect a stock's true intrinsic value. But that doesn't mean that the Berkshire CEO doesn't pay attention to relative performance. Instead, he compared Berkshire's change in book value against the change in the S&P 500 Index over rolling five-year periods. As he puts it, "Noble intentions should be checked periodically against results."

It's important to hold yourself accountable in your investing as well. In bull markets like the one we've experienced for more than 10 years now, it's easy to think that you're doing fine if your portfolio is going up steadily. But that conclusion might be wrong if your investment growth is lagging the overall market over the long run. Knowing is the key first step to developing an action plan to fix the problem.

3. Avoid stocks that use their shares as currency

Buffett is famous for his acquisitions, and over its long history, Berkshire has made many major purchases that have bulked up the conglomerate's holdings. Yet unlike many companies, Berkshire rarely offers up its own stock as part of a buyout. As Buffett puts it, "We'll issue common stock only when we receive as much in business value as we give."

Many stocks are much more profligate in using stock to pay for acquisitions, or in making secondary offerings of stock to raise cash. Even in the best of times, using stock in this way dilutes the potential increase in value for existing shareholders if the business is successful. Moreover, companies often have bad timing in issuing new stock, getting far less value than investors would want to see.

Be a better investor

Following these three rules won't necessarily let you match the track record that Warren Buffett  has achieved over the course of his long career. Understanding what's behind them, though, could help you avoid mistakes and give you at least a modest boost in your portfolio's performance -- and that's worth a little effort to achieve.

Dan Caplinger owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short March 2020 $225 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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