Berkshire: the Pilgramige

Last night I returned from the Berkshire Hathaway annual meeting. Hearing the most successful investor in the world speak about hundreds of topics was an amazing experience; I recommend it to anyone who has the opportunity.  Buffett is, of course, one of a kind and there will probably never be another investor quite like him, but that doesn’t mean the rest of us should give up and accept the poor returns of many large mutual funds. Buffett himself has said that emotional stability, a favorable temperament, is the most important key to investing success, not a high IQ. This is good news.

Buffett spoke to this topic in particular at the annual meeting and he said one thing I’ve heard him say a few times before:  if he were going to teach people how to invest there would be two courses, how to think about the market and how to value a business. The introductory concepts to each of these imaginary courses are presented in chapter 8 and chapter 20 of Benjamin Graham’s The Intelligent Investor.

In chapter 8 the reader is introduced to the ignominious Mr. Market. Buffett says this chapter is the most important thing he has ever read about in his life. Mr. Market is to be thought of as an occasional drunk or mentally ill business partner. Sometimes he is feeling euphoric and will only sell you his shares of the businesses at a high price, and sometimes he has fallen off the wagon (again) and is willing to unload businesses at a substantial discount. The trick is to take advantage of him, not to mimic his moods. Taking advantage of a mentally ill Mr. Market sounds a little bit exploitative, but be honest with yourself–it sounds fun, too.

While this seems easy, it is very challenging in practice because we are all hardwired to follow the herd. Even as my father-in-law and I were rushing through the Centurylink Convention Center (where the Berkshire meeting is held) on our way to find our seats, we found ourselves saying “let’s go this way, that’s where everyone else is going.” A lot of that behavior came from not knowing what we were doing and the irony at following the crowd was pretty thick given that we were there to glean wisdom from one of the world’s foremost contrarians. I couldn’t help but think that the market often functions exactly like a crowd rushing to find their seats. There is a major difference between seat selection and investing though; if you make a wrong seat selection you can still see the entire event, if you make a bad enough investment decision your retirement is gone (maybe not gone, but I had to add a little drama). In most cases there is safety in numbers and comfort in consensus. In the stock market, however, the consensus is often wrong, therefore, if you’ve followed along, so are you.

Joel Greenblatt, in his book “The Big Secret for the Small Investor” explains that the best performing mutual fund of the last decade compounded at an incredible 18% per year. However, the average investor in that fund lost 11%. How can that be? Remember the saying “buy low, sell high?” It turns out the average investor does just the opposite. (See the Wall Street Journal article here.) This behavior is not unique to this mutual fund either; almost every stock fund sees inflows of money after a period of outperformance and outflows after a period of underperformance. Deduct the fees that the average mutual fund charges and you have the unmistakable disappointment of very low returns.

So don’t do it! Benjamin Graham once said something to the effect of, “an investor’s biggest enemy is likely to be himself.” It follows that if you remain disciplined through Mr. Market’s highs and tantrums you will have eliminated the largest obstacle standing between you and good returns.

How can it be done? There are two ways. You can either be born with a favorable disposition, disinclined to follow the crowd, or develop an understanding of investment principles sufficient that your rationality can overcome your tendency to get your lemming on. I can’t do anything for you on the former; this blog is hopefully a resource to those interested in the latter.

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