Inspiration from Warren Buffett

There are many reasons why people listen to Warren Buffett.  Besides being the second richest American (right after Bill Gates of Microsoft), Buffett is widely considered the most respected (i.e. best) investor there has ever been.

But there are other compelling reasons for listening to him; simply put, he speaks in a way that anyone can understand.  It’s a Midwestern common sense, seasoned with well-earned and certainly, much deserved, confidence. He’s cheerful, loves what he does, and apparently cares very little about consumption.  He is extremely grateful for the opportunity he has had in the United States and the life that he has lived.  He has already given away billions and plans to give away still more to charitable foundations.

Buffett was a guest on the November 13th episode of the Charlie Rose TV show.  Unfortunately, only excerpts of that show are available for online viewing. Go to the Charlie Rose website and search for Warren Buffett. What you’ll find are his ideas on financial regulation, his reasons why he bought the Burlington Northern Santa Fe Railroad, and his assessment of the global economy. There is also a “Web Exclusive” interview.

A full written transcript is available here.

I’d like to focus on his basic optimism about the future of the United States, because in my opinion, you need three things to be a successful long-term investor.

• Faith in the future.
• Patience.
• Discipline.

Here are some relevant quotes from the November 13th program.

(Regarding consumer demand)  Well, it will come back eventually. … Our system will still work. … We talked last year about the patient, you know, being on the floor with a cardiac arrest … and we’re not out of the hospital yet.   But we will come out of the hospital.  This — the things that made America what it is have not disappeared, and they will — they will assert themselves with time.

The American economy will come back.  It won’t be tomorrow, and, you know, it won’t be exactly the same.  But in the end, we have not — we’ve not changed the American people in their capacity to innovate or their excitement about — about becoming more prosperous, and coming up with new ideas.  Businesses will be formed.  Businesses will expand.  But not much tomorrow.

If you look back a couple of hundred years, we’ve gotten where we are not because we’ve gotten smarter or not because we work harder.  We’ve got it because we found ways to unleash more of the human potential.   And what does that?  Well, a rule of law helps.  A market system helps.   Equality of opportunity helps.  All of these things that are still a fundamental part of the American system. As a matter of fact, the American system is now better than it was a couple of hundred years ago, because until the 19th Amendment, you know, we’ve had half the talent in the United States that wasn’t entitled to do much. So we’ve got a great system.  (Emphasis added.)

Well, I have everything I want in life, so there’s nothing to spend it on.  I mean, I could have 10 houses instead of one, would I be happier?  No way.  I could have 10 cars instead of, you know, two in the house.   I wouldn’t be happier.  You know, it would drive me crazy.  I could have a 400-foot boat, you know, and then I’ve got to have a crew of 50 or 60, and some of them (inaudible), sleeping together — I mean, who knows what would be going on. So I don’t — if I wanted to be a ship’s captain, you know, I’d have gone into a different profession.  I have everything in life I want.

I love working — I love working with the people I work with.   I love just viewing the human scene, but I mean, I have an ideal life.  I get to do what I want to do every day.  So, you know, and money can’t — can’t buy any more than that.

As I said earlier, you need three things to be a successful investor:

Faith in the future. Optimism is the only realistic attitude; you cannot be fearful and succeed as an investor.

Patience. Moving in and out of the market or among various investments does not accomplish anything.

Discipline. Do not be driven by headlines or events.  Ask not, “What’s working now?”  Ask, “What always works?”

I believe Warren Buffett to be instructive and inspirational on all three counts.

Is Buy and Hold Not Working? Part 2

My last post addressed the proper response to a stockbroker’s claim that the “Buy and Hold” approach to investing has not worked. My answer was, “compared to what?” I explained that, in determining when you should and should not invest in stocks, the probability is low that you’ll guess right.

By the way, have you noticed that the question of whether “Buy and Hold”  works only comes up after a steep market decline? Why doesn’t it ever come up when stock prices are hitting new highs?

Since we have covered the issue of when to buy, up next is what to buy, or more specifically, what approach to use in investing for the long term.

Active Investing

A perennial debate (actually, only since the 1970’s, but you get the drift) among investors is which is better, active or passive investing. Wall Street (stockbrokers) must convince you that active investing is superior, or they have little to sell. Their sales pitch is usually that their experts can do better than average. Think about it. All stockbrokers and active money managers say the same thing. How is it possible that they all claim to achieve better than average returns? Do they live in Lake Wobegon?

What they are claiming is that, through superior stock selection, they can outperform the market. The strategy is for an investment manager to buy something that is underpriced and will do well. After it has outperformed, sell it and then buy something better. This approach is certainly good for the stockbroker, who earns a commission on each and every trade, or the mutual fund company, which can charge higher fees for active management.

But there is no evidence that anyone can actually do it profitably on a consistent basis. Let me rephrase that a bit, there is no evidence that a stockbroker can do it consistently and profitably on behalf of an investor. Certainly, the stockbroker consistently profits from the commissions he earns while actively trading on an investor’s behalf.

Regarding mutual funds, remember that active trading has costs; the cost of research, trading, and taxes, for a taxable account. Therefore these mutuial funds have to overcome the higher costs before their investors benefit at all from active management.  That is true in good times and bad. In fact, many actively traded mutual funds have had a really rough time in this bear market, underperforming stock indexes.

For a witty (though somewhat wonkish) take on the active versus passive debate, consider a transcript of Rex Sinquefield’s opening statement in a debate with Donald Yacktman at the Schwab Institutional conference in San Francisco, October 12, 1995.

For a more recent comment on the issue, one professional investment management firm that manages billions of dollars and uses the asset class mutual funds of Dimensional Fund Advisors, summarized it well.

“Let’s be very clear: this bear market has been witness to the spectacular failure of active management. Index funds have handily outperformed active managers in a market where conventional wisdom would have you believe the active approach would add value. When (you) read that now it is more important than ever to be tactical, it begs the question that if active management didn’t help you avoid this bear market, then why would you expect it to outperform going forward?”

Conclusion

When an active investor attempts to identify and buy a stock or bond that is underpriced, what he or she is really saying is that everyone else is wrong. That’s because the current price is the best estimate of what everyone thinks it should be. It’s true that prices can be wrong, and that they can and do eventually change, but the question is whether you, or anyone else for that matter, can identify and take advantage of any mis-pricings in advance of their correction.

The same applies when choosing a successful mutual fund investment manager. It would be wonderful if we could find really good stock pickers, the ones who consistently beat the average, but that is impossible. You may find that sometimes (about 25% of the time) a mutual fund has beat its benchmark. Unfortunately, you cannot identify such winners in advance.

To be continued.

Brawl Street: Jon Stewart vs. Jim Cramer

The Daily Show With Jon Stewart	M – Th 11p / 10c
Jim Cramer Unedited Interview Pt. 1
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I’m not a fan of the financial advice dispensed by CNBC’s talking heads. The “advice” is contradictory, often based on someone’s guess, and certainly not geared to your individual situation.

I find Jim Cramer, of Mad Money, particularly difficult to watch, and it’s not just the bombast. I believe that none of his recommendations make any sense. He is telling viewers which stocks will do well and which will do poorly, which is impossible to do.

Guessing which stocks to buy is not investing; it’s speculating. The public needs to understand that. So I was pleased that Jon Stewart of the Daily Show took Cramer to task. Since I believe that Jim Cramer’s infotainment gives viewers the absolutely wrong framework for successful investing, I think he got off easy.

ABC This Week with George Stephanopoulos had a roundtable discussing, among other things, whether CNBC fell down on the job covering the financial and business world.

Right at the end of the session, George Will nailed the real issue with his general rules in life.

• Don’t play poker with a man named Slim.
• Don’t buy a Rolex from someone who is out of breath.
• Don’t take financial advice from people who are shouting.

Amen.