Image source: The Motley Fool
Warren Buffett’s first rule for investors is “never lose money”. That sounds like a joke, right? Nobody sets out to lose cash.
But many other top money managers agree. The general advice is to focus on risk management above all else. Buffett has five habits that help him do that.
Research and analysis
One part of managing risk involves doing careful research and analysis before buying shares.
Buffett’s known for poring over company reports daily. Maybe such dedication’s beyond the stamina of most. But I reckon it’s important to at least read the news flowing from the companies that interest us.
Follow the cash
Company profits are open to interpretation. However, cash flowing in and out of a business can be a reliable guide. Buffett once said he focuses on cash flow when analysing businesses. To me, that means the habit looks like part of his risk management process. So company cash flow statements can be an investor’s friend.
Valuation
A focus on business valuations is a big part of Buffett’s process. Investment outcomes can be poor if the stock’s too expensive. He never intentionally overpays, and the habit helps him to manage risk.
Sensible position sizing
There’s often the temptation to put too much money into one stock. But sizing stock positions correctly can reduce risk.
A bit of diversification between several investments can help manage risk too. Nevertheless, effective diversification requires the Goldilocks approach — not too much and not too little. Buffett always has several investments on the go.
Stop losses
If all else fails, good risk management can mean stopping losses and selling. Many successful investors do it, including Buffett. In recent years he sold his losing Tesco investment and his underwater shares in US airline companies.
The tactic makes sense. If a stock drops by 50% it takes a 100% move to return to breakeven. So it may be a good idea to sell before a loss gets as big as 50%.
For long-term investors, I like UK investor Lord John Lee’s approach. He said he stops losses at 20%. However, different strategies will likely require varying stop-loss levels to make sense of an investor’s particular investment process.
A stock worth a closer look
One company that’s worth investors’ consideration now is Phoenix Group (LSE: PHNX).
The company is the UK’s largest long-term savings and retirement business. Over many years it’s been acquiring and managing life and pension funds when they’ve closed to new business. The strategy has been a nice earner for the company and the success shows in the impressive multi-year dividend record.
However, the business is part of the cyclical financial sector and the share price may be volatile. If that happens, capital losses could neutralise income gains from the dividend.
Nevertheless, with the stock in the ballpark of 500p, the forward-looking dividend yield for 2025 is just over a mighty 11%. So that’s an attention-grabbing reason to undertake deeper research and consideration.
