Lessons from my mentor, Warren Buffett

Chances are you have heard of Warren Buffett. You probably know that he’s the founder of Berkshire Hathaway, one of the largest companies in the world. You likely also know that he’s extremely rich. In fact, with a net worth of over $80 billion, he’s currently the third richest in the world behind Jeff Bezos the founder of Amazon and Bill Gates. He is also a philanthropist who has committed to giving away most of his fortune and he’s frugal, choosing to invest the money he makes rather than to live an opulent lifestyle.

In case you’re not familiar with Berkshire Hathaway, it’s basically a holding company that invests in a lot of other companies. Companies like Apple, Bank of America, Coke, Kraft and Visa. There are literally hundreds of public and private companies that it owns. In a sense, Berkshire is like a massive mutual fund. The total value of the company is over $500B US. And if you’re interested in investing, the stock symbol is BRK. But before you run out to by some, you should know that one share trades at over $300,000 US. The good news is there is also a Class B stock. We call them Baby Birkshires and they are basically the same thing but at 1/1500th of the price. Right now it will run you around $220 a share, which is a little more accessible.

Want to know how well it’s performed? Since 1964, the price of Berkshire’s Class A stock has increased by more than 2,400,000%, meaning that a $10,000 investment in 1964 would be worth $240Million today!

Warren Buffett is a patient investor who likes to buy good companies when they’re cheap and hold onto them. Buffett has been investing pretty much his entire life, making his first stock purchase when he was only 11 years old. He bought six shares of an oil service company called Cities Services. Before he bought it, he did a lot of research. At $38 a share, he thought it was undervalued and that he could make profit on it. Unfortunately, the stock lost almost a third of its value within just a few weeks, but Buffett was confident in it so he held on. Sure enough, it rebounded to $40 a share and he sold it, making a profit of $2 a share. After cashing in however, he watched it rise to over $200 a share. I think he learned a lot of lessons from that single trade. The things that he did right, like doing the research, investing in quality and not being spooked by a pullback, and the mistakes he made, like selling simply to take a profit, despite the fact that nothing had really changed in his analysis.

Every year, Buffett writes an open letter to Berkshire Hathaway shareholders. These annual letters provide insight into how Buffett and his team think about everything from investment strategy to stock ownership to company culture and life in general. Here are some of the best lessons I’ve gleaned from the Oracle of Omaha.

The first lesson that applies to pretty much everyone is to be patient and move slowly. Or in Buffett’s words: “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”

What does he mean by this? Investing is a marathon, not a sprint. The way I see it, the journey to success really is a ladder -- you have to take one step at a time. Buffett has achieved his success by focusing on small wins. He worked on one company at a time. I don’t think he would have had the same level of success if he tried to do too many things at once. So if you’re just getting started on your financial journey, pick one area that you want to focus on and stick to that. If you’re finding a lot of gaps in your estate plan, your retirement plan, your budget, or your financial literacy, pick one and dedicate your time and effort to it.

The next lesson I’ve learned from Warren Buffett is to invest in yourself.

Buffett often gives business school students the following thought experiment. Imagine that you can invest in one of your classmates and be entitled to 10% of their future earnings. Who would you choose and what characteristics would they possess? He says that most students wouldn't simply choose the classmate with the highest marks but would be more likely to pick someone who is driven to excel and not satisfied with mediocrity. They’d also have a lot of other positive characteristics, like generosity, patience, integrity, and sociability. The point of the exercise is to show students that the most valuable skills are not innate but rather ones that anyone can build in themselves to become a person worth investing in. What’s the lesson here? If you want to become the kind of person others would want to invest in, build your own skills and traits to realize your full potential. He closes out the exercise by saying that, unlike getting a 10% return when you invest in someone else with those traits, when you invest in yourself, you'll get the full 100%.

The next lesson Buffett taught me is patience.

An analogy I often use is tied to baseball. When you swing for home runs you’re a lot more likely to strike out. When you hit for singles and doubles, you get on base much more often. But investing differs from baseball, says Buffet, because with investing, you don’t get a strike called against you if you miss a perfect pitch. You can stand at the plate all day and not swing if you don't see any pitches you like. The problem is people like to see activity -- even when the best action is to take no action at all. Imagine that you did that with Buffett’s stock in 1964? You bought it and then never did anything at all. 55 years later you’re up 2.4 million percent. The right mentality is to get rich slow, not fast. Too many investors can't wait to reach their financial goals and the industry tends to shine a spotlight on quarterly performance and irrelevant benchmarks. It encourages investors to sell whatever has recently underperformed – in other words sell low, and to buy more of whatever has recently outperformed -- buy high. Even investment professionals feel short-term pressure, justifiably fearing that one bad quarter or year could cause their clients to pull their assets. Buffett’s advice is to be consistent and patient. Wait for your pitch.

Warren Buffett also says that it’s critical to invest unemotionally. In my opinion this is probably one of the hardest but one of the most impactful rules to follow.

It’s human nature to be emotional but when it comes to investing, emotion can actually reduce investment returns and derail the best laid financial plan. There’s a growing focus in the investment industry in an area called behavioural finance which focuses on how emotions impact our decisions. The biggest mistakes people make usually occur because they let their emotions, egos and cognitive biases take control. Here are two of the more common biases we see in investors:

• Confirmation bias: People tend to seek out and place more confidence in evidence to support their position rather than evidence that might refute it. For example, if someone thinks bitcoin is going to go up, they’ll talk at length with the cabbie who just invested in it, but ignore the strategists who say it’s a bubble.
• Anchoring: Let’s say you make an investment for $1,000. If that investment doubles to $2,000 and then pulls back to $1,500 before you sell it, you might feel upset that you lost $500, even though you actually made a 50% return. What if instead, it started at $1,000, went to $1,500 and then no higher. You sell it and make the same 50%. How do you feel now? Probably a lot better. That’s because your performance wasn’t tied to some other arbitrary anchor.

Another important Buffett lesson is to think for yourself.

Investment noise is everywhere. Financial news programs are more about speculation than investing. Their job is to entertain you and keep you watching so they can sell ads. Pundits are always ready with a superficial one-minute analysis of whatever hot stock is in the news that day. If someone is actively trying to sell something to you, you probably shouldn't buy it and the same holds true with negative news. If you don't tune out the noise, you're likely to get swept up in it. Fear and greed are contagious. Think for yourself and ignore the crowd.

His next lesson is one of my favourites. Be selectively contrarian.

Sometimes it's best not to merely ignore the crowd, but to see which way they're going and explore whether it's worth going the other way. Buffett often buys when people are selling, and vice versa. It’s actually hard to do well by buying what's popular because by the time the investment has gone up, it’s because so many have already piled in. This is called recency bias. When the markets are going up, people focus on what they are seeing and tend to believe it will continue, so investors jump on. When markets are dropping, they again think it’ll continue and they run for the exits. They buy high and sell low. Buffett’s quote, “Be fearful when others are greedy and greedy when others are fearful,” rings true here.

How do you avoid this bias? The next time you find yourself following the crowd, stop and ask yourself the following questions: Has your plan has changed? Are your actions aligned with your plan or simply to what the crowd is doing? Think for yourself and stick to your plan.

As a financial advisor the role I often play is to be a voice of reason and to protect clients from themselves. If you hire an advisor, find someone who can act as an intermediary between you and your emotions. If you are going to manage your own investments, you'll need some rules to keep your emotions out of the buy/sell process.

1. You should never react to the market. If the market goes down, ask yourself: Have my financial goals changed? Is my savings strategy in place? Am I continuing to add to my savings? What about my portfolio strategy? Am I buying the great companies of the world? Is my portfolio diversified around the world and covers many different sectors? Is my asset allocation and my investments aligned with my long-term goals? If the answers are yes, then a short-term change in markets shouldn't matter.
2. The other rule to remember is that science works. It’s been academically proven that a disciplined approach to investing delivers higher returns. It’s based on a combination of simple fundamentals, it’s boring; but it works.

If you’re interested in hearing more from Warren Buffet, here is a link to his letters to shareholders dating back to 1977.
http://www.berkshirehathaway.com/letters/letters.html

Mark Shimkovitz is a financial advisor with Raymond James Ltd. The views of the author do not necessarily reflect those of Raymond James. This article is for information only. Raymond James Ltd. is a member of Canadian Investor Protection Fund.