Warren Buffett likes to say, “there seems to be some perverse human characteristic that likes to make easy things difficult,” and when it comes to investing, he’s absolutely correct. Granted Buffett is a stock market genius, but his methods can be distilled into a simple set of steps that just about anyone can follow.
But who is Warren Buffett, really? And why should anyone listen to him?
Buffett grew up in Omaha, Nebraska and at an early age had a knack for numbers. He could keep track of complex calculations in his head and liked to think things through in a logical manner.
So it came as no surprise that he took an immediate liking to Benjamin Graham’s classic book, “The Intelligent Investor,” when he first read it in University. The premise of value investing, with its focus on numbers and logic, appealed to the young Buffett on a number of different levels.
He was so drawn to the ideas in the book that he left Omaha to study under Graham in New York, eventually going to work for him in 1954.
After his stint with Graham, at the ripe old age of 25, Buffett returned to Omaha and started his, now fabled, limited investment partnership. He ran it mainly using the value techniques he learned from his mentor Graham. It succeeded spectacularly, exceeding even Buffett’s own expectations.
Over a thirteen-year period, Buffett’s annual compounded returns were 29.5% and he never had a losing year.
Today, Buffett is still going strong. His annual Berkshire Hathaway reports are as entertaining as they are informative and provide a unique insight into the mind of the man they call the Oracle of Omaha.
Some of those insights can teach us how to invest like Warren Buffett while others are interesting to read, but not very useful in a practical sense because they are either unique to Buffett or depend upon his vast resources to which the average investor does not have access.
Even so, there is enough pragmatic wisdom in Buffett’s teachings to keep the Oracle’s acolytes reading and learning for many long years.
Three Things You Must Have…
When it comes to investing, there are three basic things that you must possess and master if you’re to be successful. They are, in order, Control of your Emotions, Knowledge and the ability to apply that Knowledge.
On the emotional front, Buffett learned from, who else but, Benjamin Graham.
Graham considered a stock’s price to be made up of two parts: an underlying intrinsic value part and a speculative component. The underlying value could be determined using accurate numbers and logic. The speculative component (which could be positive or negative) depended mainly on human emotions, such as fear and greed, and could not be calculated in advance.
Knowing this, Buffett was able to constantly exploit investors who invested illogically because of their emotions.
He used Graham’s euphemism of Mr. Market to describe how sometimes Mr. Market offers to purchase your stocks at very high prices because he’s in a cheery mood. Everything looks good to him and he’s highly optimistic about the future.
At other times Mr. Market is downright gloomy. He thinks the bottom is about to fall out of the economy and just wants to get rid of his stocks. Thus he offers them to you at very low prices.
The main thing to remember is that the actual stock’s intrinsic value hasn’t changed; the only thing that’s changed is Mr. Market’s emotions and thus his mood.
At any given time you can sell your shares to Mr. Market, buy his shares or simply ignore his offers and repeat the entire process the next day.
What Graham is saying, in effect, is that when someone acts stupidly because of his emotions, dive in and exploit the situation. Sounds harsh right? That’s because it is harsh. Unfortunately that’s the world of investing.
If you want your investments to outperform the markets, you will be taking advantage of people with less knowledge, or of those who don’t control their emotions well.
When you unload your overpriced shares, another human being is on the other side of the trade buying them. When that stock plummets, that human being loses money, perhaps lots of money. Perhaps even his house and other assets. That’s not what most people think about when they trade stocks, but it is the reality. The trick is to ensure that you aren’t the person buying overpriced stocks and losing money — and that entails only purchasing stocks when they are undervalued.
Of course exploiting other people’s emotions is one thing, but keeping a lid on your own emotions is quite another matter altogether. Yet Buffett excels here too. He knows how to effectively deal with his emotions.
Keep Control of Your Emotions
That’s not to say he’s a Vulcan. He’s still human. And rest assured he has the same urges and emotional needs all humans do, but his strength is in how he deals with those urges and needs.
Most people aren’t disciplined enough to always do the right thing when their emotions are running high.
That’s why they need a mechanical system to execute their investment plans for them. That way, emotions are kept out and logic is preserved.
Unfortunately the majority of investors don’t use such systems. They continue to rely on their emotions, losing money and exposing themselves to much more risk than they need to.
To Buffett, emotions are like a double-edged sword. They can hurt you if you let them or they can enrich you if you view them as an opportunity to profit from others who don’t keep such a tight handle on theirs.
He loves the fact he can buy great companies at huge discounts because others are blinded by fear.
And he regularly quotes Benjamin Graham’s quintessential line, “you are neither right or wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”
That’s classic Buffett, breaking the market down into numbers and logic. And that’s one of the key elements to his success: keeping his emotions out of his investing decisions.
If you’re interested in doing well in the stock market, then it’s essential to take a page from Buffett’s book and keep your emotions out of your investing decisions and only invest based on numbers and facts.
That’s the best way to position yourself to achieve life-altering wealth in the long run.