Warren Buffett on the two keys to GUARANTEED investment success
In his introduction to the Intelligent Investor, Warren Buffett wrote that it only takes two things to invest successfully – having a sound plan and sticking to it.
He further said that of those two, it’s the “sticking to it” part that investors struggle with the most.
These themes were tackled in two recent columns in the Globe and Mail Report on Business – these have received an excellent response from investors and may be helpful as something to send clients.
The first column offered advice from Benjamin Graham , the father of value investing and considered the single most influential investor of the past hundred years. Some key lessons from Graham:
Bring discipline and process to investing
More than anyone else, Graham turned investing from an art into a science. Warren Buffett has said about his professor: “Ben Graham taught us to look at stocks as businesses, use the market’s fluctuations to your advantage and seek a margin of safety. A hundred years from now, these will still be the cornerstones of investing.”
Seeking a margin of safety
The margin of safety is the gap between what you can buy a stock for and what Graham called its intrinsic or true underlying value, something that Graham believed was the most important principle of investing. What the margin of safety does is give you a buffer should the company run into unanticipated problems or the market as a whole go into a decline.
The elements of sound investments
Graham wrote that the bigger the gap between a company’s stock price and its intrinsic value, the safer an investment and the greater the likely return.
Graham advocated seeking out companies with strong balance sheets, conservative financing, solid profit margins and strong cash flow; he was an especially strong proponent of companies that paid dividends that regularly rose.
Minimizing the effects of emotion
Graham wrote that in the short term the stock market is a “voting machine, with prices based on the emotional, fickle investors but in the long term is is a weighing machine, measuring the value of stocks’ underlying businesses.”
The full column on lessons from Benjamin Graham can be read here:
The second column focused on the obstacles to investment success, based on new research from the field of behavioural finance.
Some key behavioural traps that sabotage investors:
Overconfidence
Research shows that the biggest obstacle to long term investing success stems from investors’ overconfidence in their investing knowledge and ability.
Many do-it-yourself investors believe that by nimbly jumping in and out of stocks, they can beat the market. Research into the records of heavy traders at a discount brokerage firm discovered that there’s an inverse correlation between the amount of trading and investor returns – the more trading you do, the lower your chances of success.
And even if investors do show a paper profit, often commission costs turns that into a loss.
The researchers’ conclusion: “Excessive trading is dangerous to your wealth.”
Herding
A second trap is “herding”, also known as the “lemming effect”.
It’s hard to stand on the sidelines while everyone around us is making money – or conversely to be in the market losing money while people we talk to are safely on the sidelines. The Globe article pointed to specific examples of this in action.
Anchoring
Anchoring makes us fixate on the price we paid, regardless of whether that price is still relevant We have a tendency to latch on to what we paid or what something was worth at its peak, even after the world has changed; some investors held Nortel all the way down, waiting for it to get back to $60 or $80.
Regret
Another issue is regret. Research shows that investors experience more pain when they lose money than satisfaction when they make it; that’s one of the drivers of risk aversion. That’s why people hang on to investments that are underwater, avoiding the pain of selling them and then when they do finally sell, they often do it all at once to get it over with.
“We have seen the enemy and he is us”
In another Globe article earlier this spring, I talked about investors’ emotional responses to market movements and the resulting tendency to buy at the top and sell at the bottom – and referred to the famous line from the cartoon strip Pogo: “We have seen the enemy and he is us.”
This line is equally true when it comes to behavioural finance traps. The good news is that awareness is the first step to change – and growing understanding of the behaviours that undermine investment success means advisors are better positioned to help client avoid them going forward
You may want to share this column with clients. To read the full column on behavioural traps that undermine investment success click here:
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