The cover story in the August 6, 2007, issue of U.S. News & World Report featured Warren Buffett, the second-wealthiest person in the United States and perhaps the world’s most famous investor. The headline read “How to Make Money the Buffett Way.”
A more appropriate headline might have been, “Don’t Try This at Home.”
According to the magazine, someone who had invested $1,000 with Buffett in 1956 would have $27 million today. That’s an annual return in excess of 22%, impressive by anybody’s standards. It’s certainly more than I or any other reputable financial advisor would lead our clients to expect over the next 51 years. Most prudent investment analysts are expecting total returns from a diversified portfolio of large company stocks in the range of 8% to 12%.
Does that mean we are all misleading our clients or missing some simple secret to building wealth? Not at all. Investing in individual companies rather than building a diversified portfolio through mutual funds is simply not a wise option for ordinary investors.
Suggesting you try to make money “the Buffett way” makes about as much sense as suggesting you try to play golf “the Tiger Woods way.” If playing golf is your dream, if you have that talent, and if you’re willing to take the risks and do the hard work it takes to succeed—then go for it. Of course, it might have helped if, like Woods, you had started learning the game when you were three or four.
Just as golf is Tiger Woods’s business, investing is Warren Buffett’s. He started his first investment company when he was in his 20s. Researching companies’ performance, management, and future possibilities is what he does. He understands economics and is skilled at evaluating balance sheets, weighing management competence, and assessing probable risks against probable gains. Investing is his talent. He’s obviously passionate about it as well as very good at it.
Studying the masters is certainly one way we can increase our understanding of the activities that are important to us. A recreational golfer might enjoy and learn from a book or video about how Tiger Woods plays the game. An average investor might learn a few things from a book about Warren Buffett’s investing strategies. This doesn’t mean they should quit their day jobs. A weekend golfer isn’t going to become another Tiger Woods. Neither is a part-time investor going to become the next Warren Buffett.
In my 25 years of managing money, I’ve had a number of clients insist on placing a portion of their portfolios in individual stocks. After warning them of the risks, I typically set aside 5% to 10% of their portfolio and let them trade to their heart’s content. The experiment typically lasts about two years, by which time they figure out the mutual fund portion of their portfolio has garnered higher returns with far less volatility.
There is, however, one thing average investors could learn from Buffett. The U.S. News article quotes him as saying you need “the temperament to control the urges that get other people into trouble in investing.” It mentions his patience and his ability to buy when other investors are selling.
In other words, you need the ability to make your investment decisions consciously. You are likely to be a more successful investor if you understand the unconscious beliefs you have developed about money and realize how those beliefs guide your financial choices. Identifying and learning how to change your money scripts can help you avoid the “panic and sell” mistakes that so many novice investors make.
It can also help you avoid the mistake of thinking you’re Warren Buffet.