Warren Buffett on Investing in a Climate of Fear
April 6, 2010
Advice from Warren Buffett
In an investment industry poll a couple of years ago, Warren Buffett was voted the greatest investor of all time; among the runners up were Peter Lynch, John Templeton and George Soros.
Buffett’s returns are a testimony to the power of compounding. From 1965 to the end of 2009, the growth in book value of his investments averaged 20% annually. As a result, $10,000 invested in 1965 would currently be worth a remarkable $40 million. By contrast, that same $10,000 invested in the US stock market as a whole, returning just over 9% during this period, would be worth $540,000.
In one of his annual letters to shareholders, Warren Buffett wrote that it only takes two things to invest successfully – having a sound plan and sticking to it. He went on to say that of these two, it’s the “sticking to it” part that investors struggle with the most. The quote at the top of this letter, made at the height of the financial crisis, speaks to Buffett’s discipline on this issue.
I try to apply that approach as well – putting a plan in place for each client that will meet their long-term needs and modifying it as circumstances warrant, without walking away from the plan itself.
Boom times such as we saw in the late 90’s and scary conditions such as we’ve seen in the past two years can make that difficult – but those conditions can also represent opportunity. Indeed, in his most recent letter to shareholders Buffett wrote that “a climate of fear is an investor’s best friend.”
Five core principles that shape our approach
On balance, I share Warren Buffett’s mid-term positive outlook, not least because many of the positives that drove market optimism two years ago are still in place, among these the continued emergence of a global middle class in developing countries like Brazil, China, India and Turkey. This educated middle class will fuel global growth that will make us all better off.
In the meantime, here are five fundamental principles that we look for in money managers and that drive the portfolios that we believe will serve clients well in the period ahead.
Concentrate on quality
The record bounce in stock prices over the past year was led by companies with the weakest credit ratings. Some have referred to last year as a “junk rally”, with the lowest quality companies doing the best. That’s unlikely to continue – that’s why I’m focusing my portfolios on only the highest quality companies, those best able to withstand the inevitable ups and downs in the economy.
Look to dividends
Historically, dividends have made up 40% of the total returns of investing in stocks and have also helped provide stability through market turbulence. Two years ago, quality companies paying good dividends were hard to find – one piece of good news is that today it’s possible to build a portfolio of good quality companies paying dividends of 3% and more.
Focus on valuations
Having a strong price discipline on buying and selling stocks is paramount to success – history shows that the key to a successful investment is ensuring that the purchase price is a fair one. Investors who bought market leaders like Cisco Systems, Intel and Microsoft ten years ago are still down down 40% to 70%, not because these aren’t great companies but because the price they paid was too high.
Build in a buffer
Given that we have to expect continued volatility, we identify cash-flow needs for the next three years for every client and ensure these are set aside in safe investments. That buffer protects clients from short-term volatility and reduces stress along the way.
Stick to your plan
In the face of economic and market uncertainty, another key to success is having a diversified plan appropriate to your risk tolerance – and then sticking to it. It can be hard to ignore the short-term distractions, but ultimately that’s the only way to achieve your long-term goals with a manageable amount of stress along the way.
In closing, let me express my thanks for the continued opportunity to work together. Should you ever have any questions or if there’s anything you’d like to talk about, my team and I are always pleased to take your call.
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P.S. If you’re interested, here’s a link to Warren Buffett’s 2010 letter to investors.
* Dan Richards conducts programs to help advisors gain and retain clients and is an award winning faculty member in the MBA program at the University of Toronto. To see more of his written and video commentaries and to reach him, go to www.clientinsights.ca.
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