What is Warren Buffett’s secret of success? You can find numerous answers to this question. They abound in endless numbers of books, articles and investing seminars. But the world’s greatest living investor has, at core, this credo that has made him a multi-billionaire: He is an optimist.
Some point to his ability to analyze a company’s books and industry outlook. Others laud his strategy of only investing in stocks whose business he understands. Still others credit his steadfastly holding onto prized assets, year in, year out. Most of the time, he manages to pick the right investment.
A talent for evaluating opportunity is important, but Buffett’s optimism about the U.S. economy helps him overcome adversity and panic, things that undermine many investors by pushing them into making foolish moves.
“Though the preachers of pessimism prattle endlessly about America’s problems, I’ve never seen one who wishes to emigrate (though I can think of a few for whom I would happily buy a one-way ticket),” Buffett wrote in this year’s shareholder letter. “The dynamism embedded in our market economy will continue to work its magic. Gains won’t come in a smooth or uninterrupted manner; they never have. And we will regularly grumble about our government. But, most assuredly, America’s best days lie ahead.”
And for him, fortune smiled. What a mind-blowing investment performance he has compiled. His holding company, Berkshire Hathaway (BRK.A), calculates in its shareholder letter that it has enjoyed a 1,826,163% market value gain from 1964 through 2014, compared with 11,196% for the Standard & Poor’s 500. Buffett took over the company, then a declining textile maker, 50 years ago.
Not that Buffett hasn’t made mistakes. He has. But the point is that he learned from them. In this year’s letter, Buffett acknowledges the crossover between business acumen and investment success. Owning companies, as opposed to simply investing in them, gave him experience that “helps me as an investor.”
Indeed, the Berkshire Hathaway name comes from his failed investment experience in the fading New England textile industry. Buffett admits the textile manufacturer was one of many mistakes he’s made. On balance, of course, his record is far more reflective of an extraordinary ability to recognize and execute opportunities to make money.
A promising future aside, Buffett actually looks forward to the “interruption” phase of market cycles. Perhaps his most seminal shareholder letter quote came on this note in 1986:
“We have no idea — and never have had — whether the market is going to go up, down or sideways in the near or intermediate-term future. What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable.”
How he deals with these diseases is telling: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
With today’s U.S. stock market on the high side – despite the March downdraft, the Standard & Poor’s 500 is up 10.4%, in price terms, from 12 months ago as of yesterday’s close – the environment is closer to greedy than fearful. Therefore, the likelihood of exceptional returns for new money invested at this point is seemingly less than say March 2009, when fear dominated – that low point marked the beginning of a roaring bull market. The challenge is to understand that low points are where the easy money is made.
As Buffett wrote in the 1989 letter, “to the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers. The finding may seem unfair but both in business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.”
Sticking with an investment has proven more and more difficult as the average holding period of any position has shrunk consistently for the past 60 years for most investors. Short-termism results in fast-twitch, responsive decision making that can harm long-term success.
Buffett has even proposed limiting individuals to a punch card of 20 investment decisions in their lifetime. Then, you would put a lot more effort into the selection criteria and also commit more money to your best ideas. You couldn’t constantly shift in search of what the market favors.
“A hyperactive stock market is the pickpocket of enterprise,” Buffett wrote in the 1983 shareholder letter. Many investors could benefit simply by not pick-pocketing themselves via excessive transactions and the costs of chasing performance. After all, according to Buffett’s philosophy, things should work out well in the end anyway.
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Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, and a registered investment adviser in Tacoma, Wash. An expanded version of this piece first ran at his blog The Money Architects.
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