Warren Buffett’s letter to Berkshire Hathaway shareholders reminded investors of this timeless lesson.

Every year, investors travel from far and wide to a city along the Missouri River to hear Warren Buffett speak. Berkshire Hathaway (BRK.A -0.95%) (BRK.B -0.91%) Annual meeting. But in the months since, investors have been looking at the wisdom conveyed through the pages of Buffett’s annual letter to shareholders.

This year’s letter did not disappoint. In it, Buffett shared timeless lessons that are especially relevant in today’s frothy markets. Here are the key lessons, what they mean, and how they can help you achieve your financial goals.

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expecting the unexpected

Berkshire Hathaway is known for maintaining high cash positions and maintaining conservative levels, which is unusual among other funds and money managers. The reasoning is simple. In his 2023 letter to shareholders, Buffett wrote:

Berkshire’s one investment rule has not changed and will not change in the future. Don’t risk permanent capital loss. Thanks to America’s tailwinds and the power of compound interest, the sectors in which we operate have been and will continue to be rewarding if we make a few good decisions and avoid serious mistakes throughout our lives.

Avoiding big mistakes is just as important as choosing a good company. But while avoiding big mistakes is a habit that stays consistent over time, hot stocks aren’t talked about enough because they can catapult you into the spotlight in an instant. cIf you lose half your money, you have to double it to recover. Math is a tricky beast in that regard, but that’s one reason losses are dangerous.

Buffett took more risks in the early days of Berkshire. But as Berkshire’s assets grew and its business became more complex, the company took great care to maintain a cash-rich balance sheet. Therefore, if a recession occurs, Berkshire will be better positioned than its competitors and may even take market share. share. To quote the letter:

Extreme fiscal conservatism is our corporate promise to those who join us for ownership of Berkshire. Most years, perhaps even most decades, our attention will turn out to be an unnecessary action, akin to an insurance policy for a fortress-like building presumed to be arson. However, Berkshire does not want to cause permanent financial harm to Bertie (Buffett’s sister) or to the individuals who have trusted us with their savings. Long-term quotation reductions are unavoidable.

Since markets are generally rising, conservatism is generally out of favor. But when markets are falling and we’re going through a steep bear market, cash is a hot commodity. The same goes for recession-proof, safe stocks with solid brands and wide moats.

It’s no coincidence that Berkshire Hathaway runs a surprisingly stable business filled with insurance companies, America’s largest railroad, a variety of energy and utility assets, consumer brands, and public stocks. apologize, Coca Colaand other solid companies.

A glimpse into diversification

The wisdom of not taking big losses looks great on paper. But how does it work in practice? Although nothing is guaranteed in the markets, there are steps you can take to limit your potential losses and avoid catastrophic losses.

The most useful tool is understanding the importance of assignments and correlations. Investing 5% of your portfolio in 20 fast-growing software stocks may seem like diversification, but those companies are highly correlated and likely to rise and fall together. A better approach is to pick your favorite companies across multiple spaces/themes and allocate your portfolio to suit your risk profile.

Below is a theoretical portfolio for a moderate risk tolerance investor focused on saving for retirement. It was fully made up. However, it focuses on a clear topic and features a predetermined allocation strategy. That is, allocate 10% of your portfolio to your highest-conviction pick in each category and 2% to your fourth pick.

If you look at this portfolio, I would say it is balanced and healthy and you should stick to Buffett’s lessons to avoid big losses. It has investors interested in big tech and the energy transition, rounding out the portfolio with blue chip stocks, growth stocks, and income stocks.

Some companies may fit into multiple categories. Tesla fits into big tech and the energy transition. Microsoft is a huge technology stock, a blue-chip stock, and a growth stock. The key is to avoid over-correlated companies and instead reach out to a variety of industries.

For example, there is only one energy stock on the list: Chevron, a balanced integrated major with a dividend yield of 4.1%. It is also Berkshire’s fifth-largest publicly traded holding. Therefore, it makes sense to include such companies in 10% of the portfolio. It would be much riskier to have Rivian as a top energy transition choice at 10% of your portfolio and Tesla at just 2%.

Again, this sample portfolio assumes a somewhat conservative risk tolerance while mixing in some interesting themes. But it takes this kind of discipline to follow Buffett’s advice to avoid big losses.

Lessons available today

Buffett deserves credit for practicing what he preaches. Apple accounts for 44.3% of Berkshire’s publicly traded stock portfolio. But that’s because the stock has been a big win for Berkshire since it started buying the stock in 2016.

The public stock portfolio is worth $370 billion of Berkshire’s $892 billion market capitalization. A simple calculation shows that Apple’s stake as a percentage of the company’s total value is closer to 18%. This is a reasonable level for a blue-chip growth stock.

Over the past few decades, Berkshire has performed well despite missing some key themes because it undervalued technology, avoided big losses, and invested in what it understood.

Individual investors don’t have to hold cash in the same way Berkshire chose, but they can implement Buffett’s timeless lessons to help them rationally compound their wealth over time.