Warren Buffett changed the way people think about investing. He made it mainstream. When you look at his body of work, all of the investing letters, the media appearances, conferences, and portfolio research, no one has done more for the art of investing than Buffett. In this post, I wanted to write about those lessons and share my favorite moments.
“First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy.” – Warren Buffett
The Traits of Great Investors According To Buffett 💰
Self-control is essential. You want to show a patient, methodical, and clever approach to taking action. Never act on impulse. As Buffett would later say:
“The most important quality to do well is temperament which would permit the control of fear and greed which have ruined many. Anyone who has become rich twice is dumb. Why would you risk what you need and have for what you don’t need? If you are already rich, there is no upside to taking on a lot more risk, but there is disgrace on the downside.”
– Warren Buffett
Or as Gertrude Stein put it: “Money is always there, but the pockets change.”
The best investments happen when you wait for opportunity. You will be rewarded for being patient. You never have to swing all at once. Time is on your side. Sit back and wait. Buffett is famous for this approach, as he once said:
“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.”
– Warren Buffett
Stock market crashes are impossible to predict. Do not assume they will happen or predict it. In-fact, according to Buffett, it’s usually the other way around. Crashes are not predicted, they instead come to us without any foresight and that’s why they are a crash.
“No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”
– Warren Buffett
Sales, in general, is underrated. Most people think money is just made in markets and in finance. The reality is most deals are made because of sales. Someone made an agreement or arrangement. Your job is find out what sales have the best intentions. Sales is what drives everything from Wall Street and beyond. Buffett has a story about this:
“Long ago, a brother-in-law of mine, Homer Rogers, was a commission agent working in the Omaha stockyards. I asked him how he induced a farmer or rancher to hire him to handle the sale of their hogs or cattle to the buyers from the big four packers (Swift, Cudahy, Wilson and Armour). After all, hogs were hogs and the buyers were experts who knew to the penny how much any animal was worth. How then, I asked Homer, could any sales agent get a better result than any other? Homer gave me a pitying look and said: “Warren, it’s not how you sell ‘em, it’s how you tell ‘em.” What worked in the stockyards continues to work in Wall Street.”
– Warren Buffett
The Best Things Warren Buffett Said 🎙
1. “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
2. “I insist on a lot of time being spent, almost every day, to just sit and think. That is very uncommon in American business. I read and think. So I do more reading and thinking, and make less impulse decisions than most people in business. I do it because I like this kind of life.”
3. “Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”
4. “There comes a time when you ought to start doing what you want. Take a job that you love. You will jump out of bed in the morning. I think you are out of your mind if you keep taking jobs that you don’t like because you think it will look good on your resume.”
5. “Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
6. “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.”
7. “It’s better to hang out with people better than you. Pick out associates whose behavior is better than yours and you’ll drift in that direction.”
8. “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
9. “Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the models. Beware of geeks bearing formulas.”
10. “If you aren’t thinking about owning a stock for ten years, don’t even think about owning it for ten minutes.”
The Habits of Warren Buffett 💪
Warren Buffett’s biographer, Alice Schroeder, once did a Q&A on Reddit. Very few people were reading this Q&A or even know it exists. In her Q&A she revealed skills and habits of Buffett. I felt compelled to share the most notable quotes here.
Time Management and Saying “No”
“Warren is a master of time management. He knows how to ease people off the phone without making them feel dismissed. He is great at saying no and I learned a lot about saying no tactfully. That’s an important time management technique. Also, he manages his energy, reading when it’s optimal, talking on the phone when he’s got the right energy for that and so forth. It’s fairly compartmentalized and he does not multitask through his day. That was a useful lesson.”
Alice Shroeder Reddit Q&A
Buffett’s Incredible Brain Power
“Warren does his reading in the morning. He had cataract surgery not long ago and it’s made things much easier for him. He starts with the newspapers. He looks at them page by page but doesn’t read every article. He is very interested in news about companies and less interested in general news. Warren is outstanding at pattern recognition and prefers to do his own synthesis so when he reads he’s looking more for data points rather than other people’s conclusions.”
Alice Shroeder Reddit Q&A
He Reads… And Reads Again
“The annual reports — he reads them for the most part as they are received. He’s been following some companies for fifty years or longer and as noted earlier he’s got quite a memory, so the process of reading annual reports is pretty efficient for him. He can go through one in an hour or less and get what he needs. On the other hand, say when Google went public, he spent more time on their filings because it was new information. He reads a lot of annual reports of companies he would not buy to expand his knowledge.”
Alice Shroeder Reddit Q&A
Meet Buffett’s Mentor Ben Graham
Isaac Newton was famous for saying all of his great achievements were accomplished because he the people who came before him. He said he was standing on the shoulders of giants. Likewise, Buffett did learn from others. He did study the methods of other investors. One of them was his mentor and college teacher Ben Graham.
Ben Graham is the founder of value investing. He is the man who made it popular and what it is today. It’s why it’s taught in business schools. To get a sense of Ben Graham and Buffett’s mentor, read some of these quotes for which he is famous for saying to shape the art of investing.
Ben Graham was a proponent of the long-term. Stay away from day-to-day price swings and focus on the core business.
“Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
Ben Graham was the father of value investing. He lived and taught to find undervalued companies and investments. He was looking for sales. He would later compare his investing style to shopping for groceries.
“If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.”
Buffett is an investor. So is Graham. They are not traders or speculators. They research, read, study, and find the opportunity they believe in. Ben Graham lays out the distinction perfectly in many of his sayings.
“The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices… As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years. The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances.”
Ben Graham was a master at ignoring day-to-day price fluctuations in his stock investments. Patience and long-term thinking was the key. He passed that down to Buffett and you can read it in all of his sayings.
“The investor should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down. He would not be far wrong if this motto read more simply: Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”
More Great Things Buffett Said 📣
“In the business world, the rearview mirror is always clearer than the windshield.”
“Only when the tide goes out do you discover who’s been swimming naked.”
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
“You only have to do a very few things right in your life so long as you don’t do too many things wrong.”
“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”
“We always live in an uncertain world. What is certain is that the United States will go forward over time.”
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”
“The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.”
“It’s never paid to bet against America. We come through things, but it’s not always a smooth ride.”
“One word sums up our country’s achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.”
“That old line, “The other guy is doing it, so we must as well,” spells trouble in any business”
The Writings That Taught Me Most About Buffett 📚
Poor Charlie’s Almanack: The Wit and Wisdom of Charles Munger
A must-read for those who are the biggest students of Charlie Munger. There is truly no better book or item to own than this. It’s everything about Charlie Munger packaged into one colorful and masterful book. If you don’t know who Munger is, it’s Buffett’s business partner. He is known for his wit and skepticism of everything.
“Charlie and I cringe when we hear analysts talk admiringly about managements who always “make the numbers.” In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers.”
Warren Buffett on how Charlie Munger and him think
Berkshire Hathaway Letters to Shareholders
One of the best ways to learn about Charlie Munger, and even more about Warren Buffett, is to read what they’ve wrote to shareholders since Berkshire Hathaway was founded. This is a special read because it is every shareholder letter compiled into one book.
The Most Important Thing: Uncommon Sense for the Thoughtful Investor
A book from Howard Marks who has become a thoughtful investment thinker and money manager. He applies things he’s learned from Munger and Buffett in all of his work. Today he manages one of the biggest funds in the world Oaktree Capital.
Oaktree Capital Investment Letters
These letters are written by Howard Marks, who is a value investor and proponent of Ben Graham and Buffett. He writes monthly and his letters are known across the investment landscape. He even sounds like Buffett at times.
The Intelligent Investor: The Definitive Book on Value Investing
This is the book that inspired both Buffett and Munger. It’s written by their investment teacher Ben Graham. He walks investors through the foundation of value investing and the book dates back now 50+ years.
The Autobiography of Benjamin Franklin by Benjamin Franklin
Both Buffett and his business partner Charlie Munger are fans of Ben Franklin. As kids, they grew up appreciating his wit and wisdom. As investors, they love his simplicity, cleverness, and peace of mind. Munger especially always says one man has inspired him and had the biggest impact on who he is. That person is Ben Franklin.
Stress Test: Reflections on Financial Crises” by Tim Geithner
A defining investment moment for Warren Buffett was the 2008/2009 Financial Crisis. At that point, the global economy almost crumbled. It was fragile and it barely made it out. Buffett recommends this book to everyone because it tells the story and complexities of finance. Especially the global growth of it.
Has Buffett Ever Made A Mistake? 🥺
The answer is yes. All great investors make mistakes. I’ve compiled this quote to share more about that, which comes from one of his investor letters:
“Despite that cautious approach, I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter’s value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6 billion.”
What Buffett Done For The Industry 👨🔬
Buffett has inspiring the financial industry more than most realize. He has been writing about Wall Street’s ways, high fees, demystifying finance, and the simplicity of markets since he began. Very few will mention this to you, though. In-fact, in the world of tech, most products are inspired by his writing and musings. Read this quote from one of his investor letters to see exactly what I mean:
“In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial “elites” – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is –on an expectancy basis – clearly the best choice.”
In a similar manner to his inspiration on personal finance and even tech products being built today, Buffett is also a pioneer of simple index investing. Dollar cost averaging and long-term planning. Yes, he runs his own fund. But he also does not shy away from the entire market:
“If a statue is ever erected to honor the person who has done the most for American investors, the hands down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.”
When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.
What Does Buffett Think About Wall Street?
Warren Buffett just used more than 3,200 words to basically destroy Wall Street and one of its main sources of income — taking fees from the cash you invest with them.
If you’re not sure what‘s going on here, there’s a quick story you need to know about. In 2005, Buffett made a $500,000 bet. He essentially said an S&P 500 index fund would outperform any basket of hedge funds. The hedge funds might have the look or a ridiculously over the top name like Swift Eagle Crane Capital or Stat Sig Alpha Management, but still a basic low-fee S&P 500 index fund would outperform them over a long period.
Buffett won. And in his recent letter to investors he explains in detail what happened and what he thinks everyone can learn from his $500,000 wager. Here are 10 hand-picked quotes from his letter and at the bottom you can find a link to the entire document.
- Here’s Buffett explaining exactly what happened:
“I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds — wildly-popular and high-fee investing vehicles — that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers — who could include their own fund as one of the five — to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities.”
2. Here’s Buffett explaining how he straight up eviscerated hedge funds with his simple bet. Mic dropped. Game over:
“In it, the five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000.”
3. In which Buffett drops an amazing parody based on a classic Wall Street movie:
“I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal — really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved — fees that were totally unwarranted by performance — were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”
4. You might have a Vanguard fund. Do you know who the founder of Vanguard is? Buffett says he’s one of the most underrated men in all of finance:
“If a statue is ever erected to honor the person who has done the most for American investors, the handsdown choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing — or, as in our bet, less than nothing — of added value.”
5. Buffett explains how Bogle fought against countless enemies, critiques, and haters. A lesson even for anyone trying to start their own firm or business today:
“In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.”
6. Plot twist. You ready? Buffett thinks no other class has been scammed by Wall Street harder than the elite. And not because of their incompetence, but because of their desire to feel elite:
“In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial “elites” — wealthy individuals, pension funds, college endowments and the like — have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is — on an expectancy basis — clearly the best choice.
7. How much money have hedge funds earned in fees regardless of performance? Here’s Buffett’s calculation:
“My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused it, in aggregate, to waste more than $100 billion over the past decade.”
8. One of Buffett’s greatest skills is his ability to observe human behavior and watch it repeat over time — in panics and in booms. He writes:
“Human behavior won’t change. Wealthy individuals, pension funds, endowments and the like will continue to feel they deserve something “extra” in investment advice. Those advisors who cleverly play to this expectation will get very rich. This year the magic potion may be hedge funds, next year something else.”
9. When Buffett drops an adage, you have to pay attention:
“The likely result from this parade of promises is predicted in an adage: “When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.””
10. Yes, Buffett has a brother-in-law named Homer. And of course Homer has a great little lesson for everyone:
“Long ago, a brother-in-law of mine, Homer Rogers, was a commission agent working in the Omaha stockyards. I asked him how he induced a farmer or rancher to hire him to handle the sale of their hogs or cattle to the buyers from the big four packers (Swift, Cudahy, Wilson and Armour). After all, hogs were hogs and the buyers were experts who knew to the penny how much any animal was worth. How then, I asked Homer, could any sales agent get a better result than any other? Homer gave me a pitying look and said: “Warren, it’s not how you sell ’em, it’s how you tell ‘em.” What worked in the stockyards continues to work in Wall Street.”
Now if you want to read Buffett’s entire letter to investors, and even see his annual report for 2016, go to this PDF right here. If you enjoyed this little compilation of Buffett quotes, press the green heart below.
What Warren Buffett Thinks About Bubbles and Crashes
Insights, wisdom, and ideas from the world’s best investor.
Let’s go back to 2008 when the Financial Crisis was at its worst. Markets were crumbling. What was one of the greatest investors of our time thinking? What was he saying? I found that answer in Warren Buffett’s 2008 letter to investors.
Buffett’s 2008 letter is absolutely incredible (full letter here). I think everyone should read it. For those who don’t have time (it’s 25 pages long), I’ve made it easier for you and I highlighted 35 of the most important things to read. If you want all of my notes in a PDF, sign-up for my newsletter. I hope you learn something new after reading this! I’ve structured the post to start each segment with a quote in bold from his investment letter and then my commentary on what it means below:
“In God we trust; all others pay cash.”
During the early 1950s, in small towns across America, this slogan was a friendly way of stores letting their customers know they did not take credit. In 2008, you wanted to be in a position to say this line.
“The U.S. — and much of the world — became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.”
It is paradoxical, but a reality of markets. I think that this feedback cycle is actually under appreciated across markets. I also believe it works both ways. More negativity begets additional negativity. More positivity begets additional positivity. It’s why markets get euphoric, crashes go to ultimate despair, and how momentum works.
“Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 21.5% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges.”
This is the one thing that’s made Buffett almost all of his money. If you don’t understand it yet, let me explain using a small anecdote I was once taught: unless a meteor hits or the entire world collapses, America is only going up.
“The real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497.”
The stock market has been the best game in town for over 100 years. Period.
“Charlie and I simply focus on four goals: 1. Maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash. 2. Widening the “moats” around our operating businesses that give them durable competitive advantages. 3. Acquiring and developing new and varied streams of earnings. 4. Expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.”
Write these 4 goals down. Read them again. If you run a business or want to learn anything about how Buffett operates as an owner, it’s all right here.
“Moreover, we are fortunate that Berkshire’s two most important businesses — our insurance and utility groups — produce earnings that are not correlated to those of the general economy. Both businesses delivered outstanding results in 2008 and have excellent prospects.”
People love to glorify Buffett his massive investments from Coca-Cola to Wells Fargo. But the reality is that he owns much more than that and his two most important assets are not correlated to the general economy– a boring insurance and utility company.
“I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.”
It’s the worst kind of mistake. Buffett and his partner Charlie Munger despise this error. What is it? It’s when they hear or see new facts and do nothing with that new information. That’s called an error of omission. When the facts change, you need to change your mind.
“Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
You just read the value investing bible explained in two sentences.
“Our long-avowed goal is to be the “buyer of choice” for businesses — particularly those built and owned by families. The way to achieve this goal is to deserve it. That means we must keep our promises; avoid leveraging up acquired businesses; grant unusual autonomy to our managers; and hold the purchased companies through thick and thin (though we prefer thick and thicker).”
The ethos of Buffett. Or in other words, when he looks to buy companies, he follows this code.
“Most buyers competing against us, however, follow a different path. For them, acquisitions are “merchandise.” Before the ink dries on their purchase contracts, these operators are contemplating “exit strategies.” We have a decided advantage, therefore, when we encounter sellers who truly care about the future of their businesses.”
Here’s why Buffett believes his strategy for buying companies and partnering with them will always beat Wall Street and other competitors.
“This past year has retaught clients a crucial principle: A promise is no better than the person or institution making it.”
Don’t get fooled by what the promise is. No matter how good it is. Instead focus on who is making it.
“Ben Franklin once said, “It’s difficult for an empty sack to stand upright.”
Buffett using Ben Franklin to preach about character and good people.
“That certainly looks like a $2,000 cat to me” says the salesman who will receive a $3,000 commission if the loan goes through.”
A hack for life and business: always know the incentives of a salesmen. That will expose their true goal.
“Lenders happily made loans that borrowers couldn’t repay out of their incomes, and borrowers just as happily signed up to meet those payments. Both parties counted on “house-price appreciation” to make this otherwise impossible arrangement work.”
The next time someone asks you to explain the housing crisis, use this paragraph from Buffett.
“Homeowners who have made a meaningful down-payment — derived from savings and not from other borrowing — seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can’t make the monthly payments.”
The lesson here: don’t take excessive risk. One way to avoid that is not being tempted by credit.
“Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified.”
I guess this is how Buffett would fix the mortgage system so 2008 never happens again. Just something to think about.
“Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition.”
The interesting thing here, at least in my opinion, is how most people view their home as a place to make money. But is that the right way to think about a home? The answer to that question might remove risk and speculation from a massive purchase.
“Let’s go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds — virtually all uninsured — were heavily held by the city’s wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city’s fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution… Now, imagine that all of the city’s bonds had instead been insured by Berkshire. Would similar belt tightening, tax increases, labor concessions, etc. have been forthcoming? Of course not. At a minimum, Berkshire would have been asked to “share” in the required sacrifices. And, considering our deep pockets, the required contribution would most certainly have been substantial.”
First of all, did you know NYC almost went bankrupt in the 1970s? Neither did I. The solution, to avoid bankruptcy, apparently involved a number of parties and people working together. Compare that to a situation were only one person or company would have been responsible. There’s a philosophical argument here in life and markets. I’m not sure where I stand on it but it’s interesting to think about.
“If merely looking up past financial data would tell you what the future holds, the Forbes 400 would consist of librarians.”
The best investments are not going to come from you ability to look into the past.
“Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols.”
When Kobe Bryant suffered his worst career injury, he said knowing exactly what was happening to his body at any given time was what helped him heal so fast. He wanted to study every aspect of the injury, and how the healing worked down to the cell. Likewise, no one should trust an algorithm or equation without knowing just what it means down to each symbol.
“I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.”
Does it get any better than Buffett beating himself up because of poor “timing”? Even the best are prone to regret and make mistakes.
“During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”
I was in this situation once. I had a lot less capital. Like $243.99 million less. But as stocks started to bottom, I went out and bought the National Bank of Greece. There’s something about FOMO that’s make you do dumb things. You look for narratives to catch-up. “This could come back like Bank of America just in Greece!” I like to think Buffett thought the same but with Irish banks.
“We never want to count on the kindness of strangers in order to meet tomorrow’s obligations.”
A common theme throughout Buffett’s letter is his appreciation for his cash position and how much it means now in a time of panic. This line is another example.
“When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.”
Never chase or compromise for anything. In stocks and in business.
“When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.”
Pay attention here. Seriously. When Buffett wrote this about the “bond bubble” in late 2008, he was just dead wrong. Several years after he wrote this, we got to a point of zero and negative interest rates. The bond bubble only got bigger. Which leads to a quote I recently stumbled across from George Soros, “When I see a bubble forming, I rush in to buy, adding fuel to the fire. That is not irrational.”
“They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.”
The one downfall of cash is growth and inflation. Over time, for the last 100 years, the Dollar has been losing its purchasing power. You need to keep up with inflation.
“Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”
You don’t need to be fancy in markets. In-fact sometimes that is dangerous. It means you are chasing headlines and popularity. I was once told the stock market is the only game in town were being uncool and a loner are the best strategies.
“So indecipherable were Freddie and Fannie (derivatives) that their federal regulator, OFHEO, whose more than 100 employees had no job except the oversight of these two institutions, totally missed their cooking of the books.”
The lesson here, at least in my opinion, is don’t count on a third party to do your research. Do it yourself if you really want to take a stake in something.
“When Berkshire purchased General Re in 1998, we knew we could not get our minds around its book of 23,218 derivatives contracts, made with 884 counterparties (many of which we had never heard of). So we decided to close up shop. Though we were under no pressure and were operating in benign markets as we exited, it took us five years and more than $400 million in losses to largely complete the task.”
I love this line. It reminds me of the old trader adage “cut your losers fast and let your winners run.” When Buffett and Munger don’t like something, they cut it. End of story.
“Improved “transparency” — a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks — won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives.”
I’m not entirely sure what to make of this, but to me it sounds like Buffett was worried about derivatives at the time, and perhaps thinks they still could cause another problem today.
“When I read the pages of “disclosure” in 10-Ks of companies that are entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then I reach for some aspirin).”
A common wisdom of Buffett is staying within his circle of competence. Focus on what you know and stay away from what you don’t. Do that for the rest of your life and you’ll be okay.
“Only companies having problems that can infect the entire neighborhood — I won’t mention names — are certain to become a concern of the state (an outcome, I’m sad to say, that is proper). From this irritating reality comes The First Law of Corporate Survival for ambitious CEOs who pile on leverage and run large and unfathomable derivatives books: Modest incompetence simply won’t do; it’s mind-boggling screw-ups that are required.”
Some of Buffett’s biggest investments were bailed out or aided by the Government. But still he saw the moral hazard of too big too fail. It’s also only fair to wonder if that simple phrase is still true today.
“To illustrate, we might sell a $1 billion 15-year put contract on the S&P 500 when that index is at, say, 1300. If the index is at 1170 — down 10% — on the day of maturity, we would pay $100 million. If it is above 1300, we owe nothing. For us to lose $1 billion, the index would have to go to zero. In the meantime, the sale of the put would have delivered us a premium — perhaps $100 million to $150 million — that we would be free to invest as we wish. Our put contracts total $37.1 billion (at current exchange rates) and are spread among four major indices: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan. Our first contract comes due on September 9, 2019 and our last on January 24, 2028. We have received premiums of $4.9 billion, money we have invested. We, meanwhile, have paid nothing, since all expiration dates are far in the future.”
The greatest trade of all-time no one is talking about. I plan on writing another post about this soon. I am floored. You should be too.
“For us to lose the full $37.1 billion we have at risk, all stocks in all four indices would have to go to zero on their various termination dates. If, however — as an example — all indices fell 25% from their value at the inception of each contract, and foreign-exchange rates remained as they are today, we would owe about $9 billion, payable between 2019 and 2028. Between the inception of the contract and those dates, we would have held the $4.9 billion premium and earned investment income on it.”
Omg this trade is unreal. You just read a continuation of point 33. Everyone should be talking about this.
“The Black-Scholes formula has approached the status of holy writ in finance, and we use it when valuing our equity put options for financial statement purposes. Key inputs to the calculation include a contract’s maturity and strike price, as well as the analyst’s expectations for volatility, interest rates and dividends.”
Buffett sometimes does use formulas. Equally amazing is that Buffett embraces options trading. Points 33–35 all demonstrate that. He is not just a long buy and hold investor. He trades options!
Like many investors, I spend a lot of my time reading and talking about Buffett. He’s a starting point for newbies and he’s a refreshing read for the pros. His 2008 letter, which I just happened to dig back up through curiosity, is easily one of the best investment letters I’ve ever read. The education of it alone is incredible. You are taking a trip through the mind of a great during a moment of financial panic.
Thanks for reading this post. If you enjoyed, subscribe to my email here and I’ll send you a PDF with my annotations and notes. As a bonus, I’ve copied and pasted one final segment from Buffett below. In this segment, which might be fairly complex for some, he walks you through his put option trade and what the math means to him.
“It’s often useful in testing a theory to push it to extremes. So let’s postulate that we sell a 100-year $1 billion put option on the S&P 500 at a strike price of 903 (the index’s level on 12/31/08). Using the implied volatility assumption for long-dated contracts that we do, and combining that with appropriate interest and dividend assumptions, we would find the “proper” Black-Scholes premium for this contract to be $2.5 million. To judge the rationality of that premium, we need to assess whether the S&P will be valued a century from now at less than today. Certainly the dollar will then be worth a small fraction of its present value (at only 2% inflation it will be worth roughly 14¢). So that will be a factor pushing the stated value of the index higher. Far more important, however, is that one hundred years of retained earnings will hugely increase the value of most of the companies in the index. In the 20th Century, the Dow-Jones Industrial Average increased by about 175-fold, mainly because of this retained-earnings factor. Considering everything, I believe the probability of a decline in the index over a one-hundred-year period to be far less than 1%. But let’s use that figure and also assume that the most likely decline — should one occur — is 50%. Under these assumptions, the mathematical expectation of loss on our contract would be $5 million ($1 billion X 1% X 50%). But if we had received our theoretical premium of $2.5 million up front, we would have only had to invest it at 0.7% compounded annually to cover this loss expectancy. Everything earned above that would have been profit. Would you like to borrow money for 100 years at a 0.7% rate? Let’s look at my example from a worst-case standpoint. Remember that 99% of the time we would pay nothing if my assumptions are correct. But even in the worst case among the remaining 1% of possibilities — that is, one assuming a total loss of $1 billion — our borrowing cost would come to only 6.2%. Clearly, either my assumptions are crazy or the formula is inappropriate. The ridiculous premium that Black-Scholes dictates in my extreme example is caused by the inclusion of volatility in the formula and by the fact that volatility is determined by how much stocks have moved around in some past period of days, months or years. This metric is simply irrelevant in estimating the probability weighted range of values of American business 100 years from now. (Imagine, if you will, getting a quote every day on a farm from a manic-depressive neighbor and then using the volatility calculated from these changing quotes as an important ingredient in an equation that predicts a probability-weighted range of values for the farm a century from now.)”
Thanks for reading!
I hope this guide helped. For even more reading, visit his investor letters here.
