Great Investors Listen to the Greatest Investors

In last month’s article, we made a major market call, which already appears to be coming true! This month, we point out some wisdom from the greatest investor of our time, Warren Buffet…Great Investors Listen to the Greatest Investors.

We at Concentus are serious students of stock market history, and we have a particular passion for learning about the great investors of history. We are fascinated by the legendary investors of the past – there is much to learn from their outlook on economics, finance, and investing. We often quote famous investors, such as John Templeton, Peter Lynch, and Benjamin Graham, as a way of emphasizing a key point of wisdom about markets and investing.

There is perhaps no greater source of wisdom, and indeed no greater investor in recent history, than Warren Buffet. We always look forward to the publication of Berkshire Hathaway’s annual letter to shareholders, which you can read here. For those who prefer a more condensed, readable version, you may prefer this article.

Berkshire’s investment results for the last year are truly eye-popping, demonstrating the investing greatness of Warren Buffett and Charlie Munger. As the article points out:

• Berkshire had a gain in net worth of $65.3 billion in 2017. That translated into a 23% increase in the per-share book value of its stock. In the last 53 years, that figure has grown at a 19% yearly compound rate. And, as Mr. Buffett points out, the firm’s figures are post-tax, while those of the index are pretax.
• Berkshire’s stock portfolio produced $3.7 billion of dividends in 2017.
• “That dividend figure, however, far understates the “true” earnings emanating from our stock holdings,” Mr. Buffett added. The firm expects undistributed earnings to produce equivalent or better earnings via capital gains.

Keeping a War Chest

Many observers have taken an interest in Mr. Buffet’s comments in his letter about the dangers of using borrowed money to invest in the stock market and how Berkshire has traditionally avoided this practice. Again, it’s worth reading his letter!

We couldn’t agree more with Mr. Buffett on the value of liquidity planning and arranging our portfolio strategies in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures. 

The best investors are realistic about the inevitability of market volatility and are well versed in the history of extended market and economic dislocations, which can cause stock prices to temporarily collapse. They plan carefully for such episodes by making sure to have an ample supply of safe, liquid funds, such as money market funds or Treasury bills, to protect them from experiencing a “liquidity crunch” during these times.

Investors who establish a liquid “war chest” sufficient to cover their liquidity needs during hard times are far less likely to panic when markets correct. Instead of “becoming rattled” by the scary headlines and making poor decisions, these great investors are able to think rationally and understand that such market disruptions are only temporary.

More importantly, investors who have done this kind of planning will be in a position to do something very few investors do: they can take advantage of the “extraordinary opportunities” to buy stocks at fire sale prices when market declines happen. Indeed, Mr. Buffett has made a career out of buying stocks at ridiculously low prices. This is, in fact, one of the key aspects of his amazing long-term investing track record.

Stocks Versus Bonds

Mr. Buffett’s shareholder letter also contained some interesting comments about the effectiveness of owning stocks, compared to bonds, over the very long run:

• “Though markets are generally rational, they occasionally do crazy things …What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals.”
• “Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date,” he wrote. While stocks are riskier than bonds in the short term, “a diversified portfolio of U.S. equities becomes progressively less risky than bonds” over the long run.
• As Mr. Buffett explains, it’s a mistake to measure investment “risk” by a portfolio’s ratio of bonds to stocks. High-grade bonds in an investment portfolio often increase risk. 

The best investors maintain a long-term view of their portfolio holdings and understand that the real goal of investing is to “forego consumption today to allow greater consumption at a later date.” However, the only way to achieve this goal is to enhance the purchasing power of our assets after the effects of inflation. Before we can enjoy a greater level of future consumption, we must first overcome the impact of annual inflation on the price of the goods and services we hope to consume in the future.

In the short run, bonds are much less “risky” than stocks because bond prices typically are much more stable than stock prices are over short periods of time. However, over long periods of time, bond returns have been significantly lower than equity returns, presenting the risk that bond returns may not be sufficient to clear the hurdle of inflation.

In a similar way, over long periods of time, the volatility of stock prices tends to fade and returns revert to the long-term average, providing a comfortable margin above inflation. In this way, stocks have reduced the “risk” that an investor may not beat inflation over time.

Having a Plan

The very best investors have a disciplined approach to making portfolio decisions and always stick to their plan, no matter what the rest of the world is doing. They are able to live through the peaks of euphoria, as well as the depths of terror, with a healthy understanding that a well-designed written investment and financial plan will get them through both.

No predictions. No witch doctor investment sorcery or magic investing formulas. Just hard work, patience, and discipline.