When it comes to investing, "beat the market" is the goal above all. It means to produce a portfolio with returns higher than you would receive by putting your money into a major market index fund (typically the S&P 500). And not just once. Beating the market doesn't refer to a lucky stock pick here and there. It means that your portfolio outperforms the S&P 500 consistently over a long period of time.
This may seem obvious. Given that virtually every investor can access an index fund, putting your money anywhere else means that you expect a higher rate of return. And that's true as far as expectations go for professional and retail investors alike. In fact, this is the sales pitch of every investment adviser on the market. They charge you a commission and promise that their guidance can earn you more.
Almost every single one of them is wrong. In reality, only 5% of financial professionals can actually beat the market. For all but this lucky few, their clients would have made just as much money with fewer fees by going on E-Trade and buying an index fund.
Warren Buffett is one of those few. He has made billions as one of the few investors who can actually produce results above and beyond the stock market's average rate of growth. The Oracle of Omaha is a self-made billionaire who started investing when he was 11 years old. He is generally known as one of the best investors in the world and, while it's unlikely any of us will follow in his footsteps, it's possible (and quite wise) to bring some of his principles into your own portfolio.
Principle 1: Buy Businesses, Not Stocks
Most investors start their process by looking at a stock's price, its long term trends and its volatility history. In fact just about all of the tools that professional investors use are built around formulas that take these quantitative values and spit out a result.
This is important information to Buffett too, but he starts his process somewhere different. First and foremost he looks at the underlying company.
Buffett's approach is to evaluate a company's fundamentals. What does its business model look like? How talented is its management team? What is its position in the market? Does it have a "competitive moat," an advantage it can use to protect itself from potential rivals? All of this is critical information to an investor because, while a stock ticker can tell you the company's price, its fundamentals will tell you the company's value.
Principle 2: Buy What You Know
As a writer, I tend to stay away from social media. This is not because platforms like Twitter (TWTR) - Get Report and Facebook (FB) - Get Report offend me, it's just that I think they're the stupidest inventions since electrified water, Goop and DIY bomb disposal kits. I don't understand what people do on Facebook and, as a result, would be terrible at writing for them.
So I don't.
Take the same approach to your portfolio. According to Buffett, he invests only in companies that he understands. This goes hand in hand with the first rule. You can't get to know a business unless you understand how it works. What does this company do to make its money? How does the industry as a whole work? This doesn't mean that you need to master the details of a business model, but it means you should make sure you know this industry well enough to tell the difference between a good business and one that just looks good on paper.
Principle 3: Buy and Hold
Increasingly, few investors buy for the long term. For many professionals, and even individuals, investing has become more like a video game. You don't sit in one place all day, you move and react with the market. This feels satisfying. You are actively managing your money.
It is also not what Buffett does.
There are many versions of this advice. Buffett warns against speculation, the practice of grabbing a stock and hoping that its price will soar. He warns investors to focus on a business' long term potential, not the jitters of its day-to-day price. And he advises that investors plan their stock purchases for the long term. When looking for an investment, find one that you would like to have for several years, not one that you plan to flip in a few months.
All of this comes down to the core lesson: Buy and hold. Invest for the long term and select your stocks based on businesses that you think will do well years from now. Don't waste your money trying to predict what the market will do in four months. Invest your money in what you think your chosen company will do in four years, or fourteen.
It's less interactive but a whole lot more lucrative.
Principle 4: Don't Invest Emotionally
It is common, surprisingly so, for investors to react emotionally to changes in the market. This is often a trigger behind short-term trading. A stock will unexpectedly dip, perhaps, and spooked investors bail out. Or a sector will look exciting and investors dive in, motivated by a rush of greed and FOMO.
This is not a good idea, according to Buffett.
Make and stick to disciplined plans when it comes to your portfolio. Choose new stocks wisely, not based on what seems trendy or cool but based on solid metrics and performance. Sell a company when you think it has exhausted its value to you, not because it suddenly seems scary. Be willing to change your plans, but do so based on a rational analysis of business fundamentals, not because things "feel" different. Gut calls and instinct are for investors on TV.
And if you don't see anything worth buying right now, then sit still. Don't let yourself get spooked into feeling like you need to add something to your portfolio for the sake of it. Cash is a perfectly fine position until the right investment comes alone.
Principle 5: Buy When They're Selling, Sell When They Buy
Finally, Buffett suggests that you should manage your portfolio against the market.
What this means is that you should move in a counter-cycle to how other investors are acting. When the market is caught up in a rush of sales, that's the right time to start buying. Prices are low and good companies are probably undervalued. During bull markets, when other investors are buying and pushing prices up, that's when you should sell.
This is, in many ways, the capstone of his other advice.
Market trends are often formed by investors behaving emotionally or protecting short-term positions at the expense of long term gains. During a downturn, investors unload stocks quickly, hoping to net some value even if it means taking a loss. That's fine if your goal is to protect your assets tomorrow, but you're investing for three years from now. Plan for the long run and don't worry about what the market is doing right now.
After all, your goal is to beat its results anyway.
It's never too late - or too early - to plan and invest for the retirement you deserve. Get more information and a free trial subscription toTheStreet's Retirement Dailyto learn more about saving for and living in retirement. Got questions about money, retirement and/or investments? EmailRobert.Powell@TheStreet.com.