Warren Buffett and Charlie Munger are two of the greatest investors ever. But their incredible success came from something other than following the crowd. In fact, they attribute much of their investing excellence to avoiding common errors that trip up most market participants. Buffett and Munger have warned about the pitfalls that cause most investors to fail in the markets long term. By going against conventional wisdom and resisting the mistakes that most investors make, Buffett and Munger have consistently beat the market for decades. This article will dive into the investing principles and contrarian wisdom from these legendary investors that can help you avoid significant errors and become a better investor yourself.
Here are ten common investor mistakes that Buffett and Munger warn against:
- Holding Cash – Keeping excess cash on hand instead of putting it to work in quality investments.
- Market Conditions – Trying to predict market swings rather than focusing on individual companies.
- Diversification – Owning too many stocks and spreading your assets too thin.
- Risk – Defining risk as volatility rather than permanent capital loss.
- Best Investments – Not investing more in improving your skills and mindset.
- High Intelligence – Relying too much on IQ versus having the right temperament.
- Asset Allocation – Following preset allocation models rather than going where the value is.
- Day Trading – Engaging in speculative short-term trading without a systematic edge instead of long-term investing.
- Growth Stocks – Chasing “growth” stocks without analyzing the economics.
- Don’t Wait for a Correction – Waiting for market declines instead of buying quality companies.
Keep reading for a deeper dive into their advice for avoiding these errors.
1. Holding Cash
Buffett says Berkshire Hathaway never wants to have cash sitting around. Still, sometimes money builds up unexpectedly when they can’t find decent businesses to invest in or receive an influx of cash from selling something. Buffett advises putting your money to work in good companies rather than holding cash to have a cash position. As he put it, “We’ll never employ it just to employ it.” Having excess cash goes against Buffett’s philosophy of always having your money working for you. He prefers to have currency working as capital in equity investments as much as possible. However Buffett and Munger will not buy overpriced businesses or stocks.
2. Market Conditions
Buffett and Munger say they never try to time the overall stock market or have an opinion on whether it is going higher or lower. That’s because market predictions wouldn’t help them make good investment decisions in individual companies. Buffett believes you can’t produce better investment returns by trying to gauge market swings. It just introduces an unnecessary variable. As Munger put it, “We don’t know and won’t know” where the market is headed. Their focus in on the current fundamental value of a business and the probability of the business continuing to have growing cash flow in the future.
Buffett believes diversification makes little sense for investors who know what they’re doing. It’s better to put a large portion of your assets into just a few businesses you understand exceptionally well rather than owning small pieces of many companies. Buffett said, “If you know how to analyze businesses… it’s crazy to own 50 stocks or 40 stocks.” He added, “We think the idea of diversification makes very little sense for anyone who knows what they’re doing.” Broad diversification may reduce volatility but dilutes your best investment ideas.
Buffett defines risk as permanently losing money, not volatility. He believes most academics and Wall Street professionals define risk incorrectly by relying on volatility as their risk metric. Buffett says risk comes from needing to understand a business’s economics, competitors, and managers — not from short-term stock price fluctuations. As he put it, “Risk comes from the nature of certain kinds of businesses” and “not knowing what you’re doing.”
5. Best Investments
When asked about the best investment people can make, Buffett said it’s investing in themselves — their skills, knowledge, and communication abilities. He said improving your skills will increase your value by 50%. Buffett said, “The best investment you can make is in yourself.” He encourages reading and self-improvement above all else. If you want to be a successful investor, the first step in investing in your own knowledge about how the stock market and business works.
6. High Intelligence
Buffett warns that brilliant people often do dumb things when investing because they rely too much on complex formulas and academic theories. He thinks having the proper temperament is more important than having a high IQ. Buffett largely attributes much of his own business wins to a steady temperament. Not intelligence. “It’s a temperamental quality, not an intellectual quality, you don’t need tons of IQ in this business,” Investing success requires patience, discipline, and common sense more than sheer brain power.
7. Asset Allocation
Buffett sees no magic in asset allocation models that advise set percentages in stocks, bonds, and other asset classes. He believes you should figure out where you can find investments trading at attractive valuations and put your money there rather than follow some predetermined allocation model. Buffett said allocation strategies are “total nonsense” and “it doesn’t make any sense.”
8. Day Trading
Buffett believes short-term trading often comes close to gambling, as traders speculate on stock price movements rather than intrinsic value. He knows most traders act as gamblers and don’t trade with an edge like a casino. He advises against getting caught up in the action of daily price changes. He said, “If the stock exchange were to close tomorrow for a couple of years, you will find many investment ideas.” Don’t focus on noise.
9. Growth Stocks
Buffett sees growth as an input in determining value, not as a separate category of stocks. He analyzes growth businesses rather than just seeking out “growth stocks.” Buffett looks for companies where today’s investment will produce far greater cash flow and appreciation in the future. But he warns that growth for the sake of growth is only inherently good if returns on an investment are good.
10. Don’t Wait for a Correction
Buffett says it’s better to buy great companies at fair prices than wait indefinitely for major market crashes or corrections. If you’ve identified great long-term winners, it’s time to buy them before they get overvalued. As Buffett said, “It’s better to own them” than trade them. While market declines provide opportunities, Buffett prefers to avoid unpredictable downturns to find bargains. Buffett focuses on the value of a stock at purchase based on future potential regardless of what the overall market is doing.
- Don’t stockpile cash, keep your money actively invested in quality businesses.
- Disregard market predictions and focus solely on individual companies.
- Concentrate your assets on your best ideas rather than diversifying broadly.
- Define risk as permanent loss, not short-term volatility.
- Make self-improvement your top investment priority.
- Seek a steady temperament over raw intellect when investing.
- Avoid preset asset allocation formulas, go where the value is.
- He advises to shun speculative day trading if you have no edge in favor of long-term business ownership.
- Judge growth by the economics and returns it generates.
- Purchase excellent companies at fair prices rather than waiting for crashes.
By avoiding the standard errors of holding excess cash, predictive market timing, over-diversification, misjudging risk, underinvesting in yourself, over-relying on IQ, adhering to allocation models, speculating, chasing “growth,” and waiting for corrections, you can become a successful investor in the mold of Buffett and Munger. Their wisdom shows that investing excellence comes from going against the grain, ignoring short-term noise, focusing on business fundamentals, continuously learning, and developing emotional discipline. With the right mindset and dedication to self-improvement, you too can achieve investing success.
You can vastly improve your investing results by avoiding these common errors and following Buffett and Munger’s contrarian principles. As Buffett said, “We’ve been able to do pretty well” by recognizing that “very smart people do very dumb things.”