By Andrew Hatherley on Dec 10, 2019
Everyone can learn some valuable lessons from Warren Buffet, arguably the most successful investor of all time. Buffet has two strict rules about investing that anyone would find, well, frustratingly simplistic. The first – “don’t lose money,” and the second – “don’t forget rule number one.” But for Buffet, winning can only happen in the stock market. Obviously, when your money sits in low yielding savings accounts it is impossible to win. In fact, if your money is earning below two percent interest, you lose each day to inflation. Over a twenty year period, your dollars are worth just a fraction of what they were.
What Does Buffet Know that We Don’t?
Over time, Warren Buffet has graciously imparted bits and pieces of his knowledge with us average investors, and for those who really paid attention, they have managed to gain many of the advantages of his practices. See, Buffet adheres to history and he doesn’t fight the facts, while average investors tend to let their emotions guide their decisions. Buffet will be the first to tell you that emotions and investing don’t mix.
- Fact #1: Bear markets do happen – but then, so do bull markets
- Fact #2: The average duration of a bear market is 11 months as compared to 32 months for a bull market
- Fact #3: The average bear market decline is 27 percent; the average bull market gain is 119 percent
- Fact #4: Since WWII there has been as many bear markets as there have been bull markets, yet the stock market has still managed to advance more than 100-fold.
The takeaway for investors is that the losses of the bear markets have only been temporary while the gains of the bull markets are permanent. With each bull market, the losses of the preceding bear market decline were made up and the gains of the prior bull market were extended. In that perspective, bear markets are nothing more than a temporary interruption of a longer term uptrend. So, the real risk is not in the next market decline of 27 percent; the real risk is not being in the next 100 percent market increase.
How to Invest Like Buffet
The most notable successful investors, such as Buffet, are long term strategists with almost super-human patience. They believe in diversification, buy-and-hold, investing in value with a focus on wealth preservation, not wealth building – apparently a lot easier said than done for most people.
But, there are enough successful high net worth investors around from which we can glean the best practices that, when applied by any investor, can provide the edge that everyone seeks.
- First: Develop clear and meaningful investment objectives. Many investors focus on investment performance, and, consequently, they often find themselves chasing it by trying to time the markets and making risky buy and sell decisions. Successful investors focus only on their specific objectives and use them as their sole benchmarks as opposed to some irrelevant stock market benchmark.
- Second: Building and preserving wealth is as much about managing risk as it is managing investment performance. The key is to diversify your asset classes in a way that they act as counter weights to the various forms of risk, such as market risk, inflation, risk and interest rate risk. Periodically your portfolio should be rebalanced to ensure that the exposure to any one risk as not increased due to changes in your portfolio values.
- Third: Buy stock insurance. Buffet and other successful investor hedge their portfolios with financial instruments called put options that limit their losses when stocks decline. The average investor, especially those closer to or in retirement might be better off by hedging their portfolio and their retirement income with annuities. With fixed indexed annuities a portion of your portfolio can still have access to stock market gains without having to endure the losses.
- Fourth: Surround yourself with qualified and trusted advisors who have your sole interests in mind when providing you with guidance. The most successful investors rely on a team of advisors that provide unbiased advice in formulating the most appropriate investment strategy to meet their needs.
Not everyone has the courage or the patience (or the billions) that Buffet has to stay fully invested in the stock market, yet constant exposure to equities is vital if you are to have any chance of a secure retirement. And no one can pick individual stocks like Buffet either, nor should they try. Buffet has a fully diversified portfolio of hundreds of stocks invested across many industries, global regions and asset classes. You can achieve the same diversification with index funds or exchange-traded funds with the ability to allocate your assets broadly to reduce risk and volatility. Then, if you can exercise the same level of discipline and patience as Buffet, and hedge your portfolio and retirement income with annuities, you too can win by not losing.
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