MENU

1 crucial investing lesson Warren Buffett learned … at 11 years old

In June 1942, an 11-year-old Warren Buffett bought his very first stock.

The target of the future Berkshire Hathaway  (NYSE: BRK-B )  (NYSE: BRK-A)  CEO’s inaugural buy? Three shares of Cities Service Preferred at US$38 apiece, good for a total investment of US$114.

That was a hefty sum back then for any kid. Adjusted for inflation, Buffett’s US$114 would have had the same buying power as roughly US$1,633 today.

Then again, Buffett did have a bit of a head start, considering his father was himself a stockbroker, so young Warren was already somewhat familiar with the idea of buying and selling small pieces of businesses through the stock market.

But that didn’t make him feel any better when the price of Cities Service Preferred quickly plunged 29% to US$27 per share later that month.

Even still, that drop was largely thanks to a broader market decline that year, and nothing in particular had happened to negatively change Buffett’s investing thesis for the company. As a result, when the stock recovered shortly thereafter, Buffett sold at US$40 per share to net a tidy 5.3% gain on his investment.

Not too shabby, right?

Here’s the kicker

Shortly after he sold, however, the stock proceeded to rise to more than US$200 per share.

In the end, had Buffett simply stuck to his guns and trusted his original decision, he would have more than quintupled his US$114 investment to more than US$600.

Or, if you prefer the illustration in today’s dollars, Buffett would have quickly turned his US$1,633 into a whopping US$8,595.

Now most folks would probably cut the young investor some slack for this rookie mistake. After all, he was just a kid, right?

There’s a name for that …

The thing is, I’m sure I wouldn’t be going out on a limb to say thousands upon thousands of adult investors make this same mistake every day.

In fact, in the world of behavioral finance, they call it the “disposition effect” — a term to describe the tendency of investors not only to hold on to stocks that have dropped in value, but also to sell their winners too soon.

And while Buffett was right not to panic and held on to a stock for which the underlying fundamentals hadn’t changed, his itchy trigger finger to sell obviously got the better of him when that stock edged into positive territory.

In the end, though, it’s safe to say this lesson paid huge dividends down the road, as Buffett was able to use it as a starting point to hone his incredible ability to focus not just on the price of his equities at any given moment, but also on the actual value of the businesses behind the stocks he buys.

In fact, after the S&P 500 dropped more than 50% from the beginning of 2008 through early 2009, Buffett was the one reassuring investors everything would be OK when he released that’s year’s letter to Berkshire Hathaway shareholders on Feb. 28, 2009:

The market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie [Munger] and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

Foolish takeaway Those of you keeping track know the S&P 500 has more than doubled since then and currently sits near all-time highs.

Better yet, truly Foolish investors know all too well there were a significant number of beaten-down stocks around that time that have absolutely trounced the broader market’s perfectly respectable return over the same period.

But in the end, those gains were reserved only for those who had managed to learn the lesson Warren Buffett first encountered as a child.

The Australian Financial Review says “good quality Australian shares that have a long history of paying dividends are a real alternative to a term deposit.” Get 3 Stocks for the Great Dividend Boom in our special FREE report. Click here now to find out the names, stock symbols, and full research for our three favourite income ideas, all completely free!

More reading

A version of this article, written by Steve Symington, originally appeared on fool.com.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.