This is a multi part article. For the previous article, you can read it here: What we can learn from Warren Buffett? Part 3.
Do not get emotional
Warren Buffett is not perfect. We can learn from his mistakes. Did you know that one of his worse investments turn out to be Berkshire Hathaway? Surprise surprise! Berkshire Hathaway was a textile company that was going downhill. Buffett Partnership first purchased Berkshire Hathaway in 1962 at $7.50 when the working-capital was worth $10.25 and a book price of $20.20. It was a bargain stock despite the business was declining. In 1964, Seabury Stanton, who ran Berkshire, offered to buyback the stock at $11.50. Obviously it was a windfall and Warren Buffett agreed. However, when the actual offer letter came, the price offered was $11 3/8. He was so furious that the offer was 1/8 cents lower than promised that he bought more of Berkshire and ends up controlling the entire company that was going downhill. The textile business of Berkshire eventually collapsed in 1985 after many years of losses. To put it simply, the investment was a total failure. It was a silly mistake because he knew that the business was failing and instead of cashing in on a windfall, he became the controlling shareholder. He mentioned that if he did not make that mistake and poured so much money into maintaining the textile business, Berkshire would be worth TWICE as much which is another $200 billion! See this video:
We can learn from this lesson that it never pays to be emotional. By getting emotional, one can make stupid mistakes.
Among my clients, many of them are emotionally attached to their investments. Although they do not do stupid things but their issue is quite the opposite - the lack of wanting to do anything! Some examples of not wanting to do anything are:
- Refusal to sell a particular investment because recently it made a gain of XX% (they are hoping to make more).
- Refusal to sell a particular investment because recently it made a loss of XX% (they are hoping to recover from losses).
- Refusal to sell because the investment was inherited.
- Refusal to sell because the investment paid good dividends nevermind it made larger capital losses. See Dividend Yield Play turn out to be a disaster.
- Refusal to sell because the investment paid good dividends nevermind it borrowed money to do so. See Paying dividends from borrowings.
- Refusal to diversify because it isn’t cool.
The most common reason why I advise my clients to sell is because of overexposure but their refusal to sell is quite frustrating. At times, their emotional attachment sounds like as if they are married to their investments. Such emotional investors are going to get even more emotional when Mr. Market wakes up one day with a depression. That is when Mr. Market decides to offer a price that is 50% lower (i.e. market crash). Such emotional investors are going to panic and sell their ‘spouse’ whom they had held so dearly for a long time. That is when they give up investing. Such investors are exposed to 100% of the downside risk but nothing on the upside when market recovers. Even if they to hold on to their losses, it is not likely these investments can ever recover simply because of the overexposure and there is no guarantee their particular stocks or unit trusts can ever recover. They will blame everybody – including the financial adviser – but never themselves for the mistakes they did right from the beginning which was never fall in love with their investments.
Frankly speaking, I know which clients fit into the above emotional category. I feel totally helpless since I do not have full control of the portfolio investments and knowing their downfall is almost certain.
Does Warren Buffett has a crystal ball?
I do not think he has a crystal ball to provide a 100% assurance that he is going to make money for individual stocks and businesses. But he is very confidence that on a portfolio basis, he is going to make money. He uses a two prong approach in investing: (1) Identify companies whose earnings are likely to be higher in 5 to 20 years from now and (2) having confidence that the portfolio market value will go up along with the aggregated earnings of a portfolio. Here is the excerpt of his from his 1996 letter to shareholders:
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.”
The following is a summary of why Warren Buffett is so successful. Not surprisingly, these are well known investment principles which few actually heed.
- Invest in a small amount.
- Have a diversified portfolio.
- Do not use leverage and be prepared to lose 50%
- Ignore Mr Market
- View your investments as a business, not a ticker.
- Do not get emotional. Do not get married to your investment.
- No crystal but invest in a portfolio of companies with good earnings potential on aggregated basis.
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