Warren Buffett Said This 1 Mistake Cost Berkshire About $10 Billion. Here’s How Investors Can Avoid It.

Warren Buffett never hid from his investment mistakes. Instead, he wanted to learn from them. One of his most expensive blunders wasn't a bad purchase, but one he never completed.

At Berkshire Hathaway's (NYSE:BRKA)(NYSE:BRKB) 2004 annual meeting, Buffett confessed that his worst mistake was Walmart (NASDAQ:WMT). While he initially wanted to buy 100 million shares of the retail giant, Berkshire bought only a small amount because, as the price went up, Buffett waited for it to come back down, which never happened. His reluctance to pay a little more turned out to be a $10 billion mistake.

The mistake wasn't buying a bad stock. It was getting too anchored to a price on a good one. That's a trap almost every investor falls into, and it's easy to avoid once you know what to look for.

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What actually went wrong

Walmart was exactly the kind of business Buffett wanted to own. It was a dominant low-cost leader. He set his sights on buying 100 million shares at a pre-split price of $23. Buffett bought some shares, but then the price rose slightly. He thought it might come back down, so he waited. That pullback never came. In hindsight, he said paying a little more would have been inconsequential compared to the gains the stock would go on to deliver.

Buffett did try to fix this mistake. Berkshire built a new Walmart stake starting in 2005, which was worth nearly $6 billion by 2016, the year it sold most of it.

The math of waiting

Berkshire's missed gains on Walmart show why anchoring can be so costly. If you think a $50 stock has the potential to gain 50% over the next few years, paying 5% more ($52.50) than your desired price would yield a 43% return. That's not a bad return. Waiting for the price to come back down to your target, on the other hand, risks the entire upside if it never does. A small premium costs you a little in the long run, while a missed position costs you the whole gain.

3 ways to avoid the same mistake

1. Decide what it's worth before you look at the price. Calculate the estimated future value for a stock you'd be happy to own before you start buying. The target price then becomes a comparison point rather than an anchor.
2. Set your purchases in advance. Consider splitting the position into thirds: buy one third now, another on a pullback, and the final third on a date you pick regardless of price. That way you won't freeze in the face of a rising price like Buffett.
3. Compare the extra cost to the upside you expect. Before you pass on a stock because it has risen, run the math. If you expected it to gain 50% from your target price and it now costs 5% more than when you first looked, you would still earn about 43% on this purchase. If that's not a worthwhile return, you might not have as much conviction in the stock as you think.

The risk on the other side

The lesson here isn't to pay any price for a stock. Buffett's Walmart mistake served as a valuable lesson because Walmart's an exceptional business, so paying a few percentage-point premium was small relative to its upside. However, chasing a stock that has already run up, or paying a premium for an average business, are different mistakes. It's fine to pay a little bit more than you'd like for a high-quality business, but don't go overboard.

Don't let your discipline cost you

Patience and price discipline are good habits, but Buffett's Walmart miss shows how they can backfire when a small price gap keeps you out of a great business. Decide what a stock is worth before you buy, set your purchases in advance, and weigh any premium against the upside you expect. That way, your discipline protects you from overpaying without costing you the opportunity.

Matt DiLallo has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway and Walmart. The Motley Fool has a disclosure policy.