There’s much to learn from the investor, but not all ‘Buffettisms’ are golden rules

Warren Buffett: a lifetime of investment genius from the Oracle of Omaha

Billionaire businessman Warren Buffett at Berkshire Hathaway’s 2013 shareholders’ meeting in Omaha, Nebraska, last May. Berkshire is Buffett’s investment vehicle and runs a multi-billion dollar insurance operation. photograph: daniel acker/bloomberg

Billionaire businessman Warren Buffett at Berkshire Hathaway’s 2013 shareholders’ meeting in Omaha, Nebraska, last May. Berkshire is Buffett’s investment vehicle and runs a multi-billion dollar insurance operation. photograph: daniel acker/bloomberg

Tue, Mar 18, 2014, 01:08

Warren Buffett’s latest annual letter to shareholders is another gem, full of the folksy wisdom and quotable tidbits that encapsulate his genius for condensing complex investment concepts into pithy, jargon-free language.

Investors can learn a lot by studying Buffett’s shareholder letters over the years. Here are five investing lessons from the Oracle of Omaha – and a few cautionary examples of how sometimes, it’s better to be wary of the Buffett mystique.

No knowledge needed
The “know-nothing investor can actually outperform most investment professionals”, Buffett rightly argues, by diversifying into cheap index funds, which invariably beat expensive managed funds.

“The unsophisticated investor, who is realistic about his shortcomings, is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.” So-called dumb money, as he once quipped, ceases to be dumb when it acknowledges its limitations.

Advising people to track the markets may seem ironic, given that Buffett amassed his $63 billion (€45 billion) fortune by continually beating the indices, but he has long been sceptical of the claims of active managers.

In 2008, he made a 10-year $1 million wager with a US hedge fund, betting it would be trailing the S&P 500 by the end of 2017 (the index is currently well ahead).

In the latest annual shareholder letter, Buffett revealed that he wants 90 per cent of his inheritance to be invested in the S&P 500.

Fear is your friend
Excitement and expenses are an investor’s enemy; better “to be fearful when others are greedy and greedy only when others are fearful”.

One such an example was in 1974, at the tail end of an unnerving bear market, when undervalued equities prompted Buffett to say he felt “like an oversexed guy in a harem”, adding: “Now is the time to invest and get rich.”

Consequently, Buffett advises investors to see falling stock prices as an opportunity.

“When hamburgers go down in price, we sing the Hallelujah Chorus in the Buffett household. When hamburgers go up, we weep. For most people, it’s the same way with everything in life they will be buying – except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”

Psychology is key
You don’t need to be a rocket scientist to do well in stocks, says Buffett, who says investing is “not a game where the guy with the 160 IQ beats the guy with 130 IQ”. If you do have an IQ of 150 or 160, “sell 30 points to someone else”.

An “emotional stability” and an “inner peace about your decisions” is more important.

Ignore the pundits
Forming macro opinions or listening to the market predictions of others is a “waste of time”, Buffett said in his latest shareholder letter.

“Indeed, it is dangerous because it may blur your vision of the facts that are truly important . . . we have never forgone an attractive purchase because of the macro or political environment.”

This is a point Buffett has stressed in the past. In 1994, he said his best purchases tended to be made “when apprehensions about some macro event were at a peak”. More recently, at the peak of the financial crisis in October 2008, he reminded spooked investors that the US had endured two world wars, expensive military conflicts, the Great Depression, “a dozen or so recessions and financial panics”, oil shocks and much more besides in the 20th century.

During that time, the Dow rose from 66 to 11,497.

Be long-term
Buffett has always advised investors to view themselves as part owners of a business, to invest in stocks as they would a farm.

Investors, he says, should act as if they had a punch card with 20 slots in it, with each stock purchase using up one of those slots. Doing so would guard against making ill-considered investment decisions.

Instead, the system is like an unlimited punch card, where you can change your mind a minute after your purchase. “That very availability, that huge liquidity which people prize so much, is, for most people, a curse, because it tends to make them want to do more things than they can intelligently do.”

According the name “investors” to institutions that trade actively “is like calling someone who repeatedly engages in one-night stands a romantic”, says Buffett. In short, “if you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes”.

Not gospel
But not all Buffett advice should be taken as gospel.

He is often quoted as saying that “wide diversification is only required when investors do not understand what they are doing”, while his investing partner, Charlie Munger, has said that diversification “necessarily includes investment in mediocre businesses”, guaranteeing “ordinary results”.

Buffett likes to wait for high-probability investments, and then bet big.

One paper found that his biggest position has risen to as much as 50 per cent of his portfolio, and only rarely dropped below 20 per cent.

This approach may work for an investing genius like Warren Buffett, but it represents investment suicide for almost everyone else.

The problem with Buffett is that he can make investing seem too easy, and naive souls often cough up good money to so-called educators who promise to teach them how to invest like the Omaha legend.

This ignores the fact that Buffett does a lot more than pick stocks – Berkshire Hathaway, his investment vehicle, runs a multi-billion insurance operation.

It also ignores the unique opportunities that get presented to Buffett, such as his $5 billion investment in Goldman Sachs at the peak of the 2008 financial crisis, when the desperate bank agreed to pay an eye-popping 10 per cent annual dividend in return for Buffett’s public seal of approval (Goldman’s offer was so good, it took Buffett just 20 minutes to accept).

And it ignores the secret to his success – leverage. A 2013 study found Buffett buys steady, low-risk stocks but juices his returns through borrowed money, on average using leverage of about 1.6 to 1.

Buffett gets to borrow money at rock-bottom rates as Berkshire is a massive AAA-rated conglomerate – another option denied to Joe Soap.

And one last point, that will appeal to true investment nerds.

You know that old Buffett line about how it’s “far better to buy a wonderful company at a fair price than a fair company at a wonderful price”? It encapsulates Buffett’s move away from the classic value investing approach pioneered by his mentor, Benjamin Graham.

However, it’s not actually true, according to a new white paper by quantitative investment manager Dr Wesley Gray, who backtested how the value/quality approaches worked between 1974 and 2011.

Graham’s classic value approach not only beat the S&P 500 by more than five percentage points annually, it trumped Buffett’s quality-focused method, and showed “much stronger” risk-reward metrics.

Mind you, Buffett’s approach wasn’t bad either, beating the index by 3.5 percentage points annually. In many ways, that sums him up – even when he’s wrong, he’s impressive.

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