Why You Should NOT Invest Like Warren Buffett
Warren Buffett ranks as one of the greatest investors of all time. Over more than three decades, his Berkshire Hathaway Inc. has purchased dozens of stocks and businesses. During that time, the company has outperformed the Standard & Poor’s 500 Index by a wide margin. Buffett achieved his record by following a disciplined investment strategy. He waits years for stocks to sell at discounts. Buffett does not hesitate to hold cash if nothing meets his exacting standards.
Seeing his record, many investors seek to mimic Buffett’s style. When the master buys a stock, the imitators also make the purchase. While there is much to learn from Buffett, those who seek to copy him should beware. Buffett’s approach is difficult to implement, and even the master himself has made mistakes while using the strategy. Some trademark Buffett tactics that most investors should avoid…
Mistake: Holding a concentrated portfolio. Academics have long argued that investors should own a wide variety of stocks and other assets. That way, if some holdings fall, others may rise. Buffett understands the scholarly research, but prefers to hold “concentrated” positions, keeping big stakes in just a few industries. Altogether, Berkshire derived one-fourth of its revenue and half its profit from one industry — insurance.
Buffett’s success can be traced to his concentrated approach. But most investors should tread more carefully. In fact, Buffett says most investors should diversify extensively. Many part-time investors should stick with mutual funds. A sound approach is to buy an index fund, such as one that tracks the S&P 500. While funds may never outpace the best stock pickers, the index trackers never finish at the bottom of the standings.
Mistake: Buying nothing but cheap stocks. Stocks are often thought of as being from one of two categories — growth stocks, which have growing earnings and price multiples that are higher than average… and value stocks, which have little or no earnings growth and relatively low prices. Buffett does not fit neatly into any one camp. His portfolio includes some stocks that may be considered “growth” and others that fit into the value category.
Some investors may want to follow his example of holding growth and value. By owning both, you can diversify a portfolio because growth and value sometimes move in different directions. But for long-term investments, I prefer putting more than 50% of assets in value stocks. According to research by Eugene Fama, PhD, professor of finance at the University of Chicago, and Kenneth French, PhD, professor of finance at Dartmouth, value stocks tend to outperform growth over long periods. The best performance comes from stocks that are in the cheapest 10% of the market as indicated by their price-to-book ratios (p/b). This is the share price divided by the book value, a measure of a company’s assets minus its liabilities. Fama and French found that during the 27 years ending in 1990, the cheapest 10% of stocks returned 21% annually, compared with the most expensive 10%, which returned 8% annually.
Mistake: Investing only in big companies. Because his company is huge, Buffett finds it more convenient to buy big companies. Otherwise, to put Berkshire’s assets to use, he would need to own a great many small companies and it would be difficult to watch so many as closely as he would like. The result would be an unwieldy portfolio that would be too hard to manage. But ordinary investors should hold at least some small-company stocks. According to Fama and French, the smallest stocks in the market produce the biggest returns. During the 27-year study, the smallest 10% of stocks grew more than six times, while the largest 10% returned less than half as much.
Mistake: Favoring losers. As a value investor, Buffett often buys unloved stocks, picking up shares that have fallen. He shuns growth stocks that have been embraced by the markets. But investors seeking to build diverse portfolios should include at least some growth stars as short-term holdings.
When stocks have climbed for six months, they have tended on average to continue climbing for the next 12 months, according to a study by Narasimhan Jegadeesh, PhD, professor of finance at Emory University, and Sheridan Titman, PhD, professor of finance at the University of Texas.
Investors who take advantage of the short-term moves of growth stocks must be prepared to trade quickly. Studies indicate that after 12 months, the growth stars begin to lag.
Mistake: Holding for life. After buying a stock, Buffett holds it indefinitely. If the shares climb sharply, he still won’t sell. And if the company doesn’t show earnings growth, he still hesitates to sell. Buffett often refrains from selling because he believes that it is difficult to tell the right time for unloading a stock. Rather than making mistimed moves, he holds.
Because most investors, especially those near retirement age, can’t wait the decades that Buffett is prepared to wait, they can’t be so patient. Expensive shares with shaky earnings can deliver disastrous short-term results.
Before buying a stock, Buffett estimates its intrinsic or fair value. This requires projecting the company’s cash flow into the future and then “discounting” it to the present using an appropriate interest rate that takes the risk of the investment into consideration.
Measuring fair value precisely isn’t easy, but there are ways to estimate when a stock’s price has become too rich. Start by comparing the stock’s p/b to those of the company’s competitors. If the stock commands a relatively high multiple, then it could be priced above fair value. Additional check: Compare the stock’s current p/b to those from the past. When a stock’s p/b exceeds its typical historical level, it is another sign that the price may be too high.
Mistake: Sticking with what you know. Buffett prefers buying companies that are easy to understand. Until recently, he bought only US companies. He still has very little international diversification.
Unlike Buffett, most investors should use more international diversification. Their portfolios should include shares from the emerging markets of Asia and Latin America. Overseas markets don’t always move in lockstep with Wall Street.
For convenience, consider owning foreign shares by buying mutual funds or American Depositary Receipts (ADRs), foreign issues that trade on US exchanges.
Do Buy Utilities Like Buffett
Until recently, Buffett rarely bought utilities. Now he’s beginning to invest in power companies. You should, too. Utility companies should be a core holding in most investors’ portfolios.
Reasons: The best utility companies can generate steady cash flow. Companies with strong cash flows are able to pay their bills and invest in expanding their businesses. Many utility companies also provide solid dividends. These can provide investors with steady income, an important consideration during times when share prices are falling and portfolios are not producing capital gains.
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Bottom Line/Retirement interviewed Vahan Janjigian, editor, Forbes Growth Investor, 60 Fifth Ave., New York City 10011. 12 issues. $197/yr. He is author of Even Buffett Isn’t Perfect (Portfolio). From its inception October 6, 2000, through December 31, 2009, the Forbes Growth Investor model portfolio returned 74.78%, compared with -20.87% for the S&P 500.
3 Truths About Tax Lien Certificate Investing
Truth #1 – It is going to take some work on your part to succeed. If you have done some research into tax lien certificates and tax deeds you may have heard some so called “gurus” bragging about how easy it is to make a fortune. While it is easier and safer than many investments, it doesn’t come without some work on your part. You need to learn about the business and you need to invest some of your time to succeed. The good news is that with less work than most traditional investments you can get substantially higher returns while exposing yourself to less risk.
Truth #2 – There are hidden treasures for those that are persistent. You’ve heard the stories I’m sure. An investor buys a tax lien certificate at auction, the owner doesn’t redeem, and the investor ends up with 25 acres of land for the low price of 68 dollars.
First let me say that these sorts of things do happen and more often than you think. I personally know the gentlemen who bought the previous piece of land for 68 dollars. But you can be sure that it did not happen the first time at the auction. With some persistence and a little bit of experience you can get better at finding the jackpots.
Truth #3 – Most properties at auction do have real value. There are a lot of reasons that a property can end up at auction. The common misconception is that most of the properties do not have any real value. True – there are properties on the auction that seem worthless, and to many, they are – but to the creative investor they are literal gold mines.
Think outside the box. Put your mind to work and you’ll discover that there are a lot of things you can do with the property that no one else wants. By being creative you give yourself an advantage over 99% of the people at the auction. Now cash in on it!
Invest some time and money into the business and you will discover that there are huge returns waiting.
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Forex for Newbies: A Quick Currency Trading Tutorial
So, you want to learn how to trade currency on the foreign exchange market? The process of trading currencies appears very straight-forward on the surface; but, there is more to it than meets the eye.
The currency trading tutorial you’re about to receive here will give you a basic idea of how things works. However, you must keep in mind that this tutorial is only scratching the surface. The Forex market is complex, fast-paced and requires serious further study if you wish to trade successfully.
Now that we have that disclaimer out of the way, let’s begin by looking at the fundamental unit involved in every trade: the ‘currency pair’.
What are currency pairs?
Currency pairs are units of 2 currencies involved in a foreign exchange trade. For example, if you want to sell U.S. dollars to buy Euros, you would look at the exchange rate quoted for the EUR/USD currency pair. Or, if you wanted to sell Euros to buy U.S. dollars, you would look at the exchange rate quoted for the USD/EUR currency pair.
You might thinking: “Aren’t they the same thing?†Well, they almost are, but you must look at the correct pair, in the correct order, based on the currency being purchased.
There are two reasons for doing this:
First, it is easier to calculate the results of your exchange in terms of how much of the base currency you can purchase with your ‘quote’ currency. Your base currency is the currency you intend to buy, and the quote currency is the currency you intend to sell in exchange for the base.
When quoting an exchange rate, your broker will list the base currency first in the pair, and the quote currency second.
This means that when you see a pair like EUR/USD, you are seeing the cost of 1 Euro in U.S. Dollars. An exchange rate quote of EUR/USD = 1.4436 means that 1 Euro costs $1.4436 in U.S. Dollars.
Likewise, the USD/EUR pair indicates the cost of 1 U.S. Dollar in terms of Euros. An exchange rate of USD/EUR = 0.6834 would mean that 1 U.S Dollar costs 0.6834 Euro.
The second reason for looking at the correct buy/sell ordered pair is that you’ll want to know the difference between the ‘bid price’ (exchange rate) and the ‘ask price’ (what the market makers want for the currency).
The difference between bid price and ask price make up what is known as ‘the spread’. Forex traders are subject to spreads when opening or closing trades in the buying position.
In other words, you are always subject to a spread when you buy, regardless of whether you are opening or closing the trade.
Open buy -> spread
Close sell -> no spread
Open sell -> no spread
Close buy -> spread
Let’s say that you want to buy the EUR/USD pair. The bid price is 1.4436. The ask price may be something like 1.4440. You must pay the spread of 0.0004 in order to do the trade.
Those are the basics of a currency trade, but there are other factors to take into consideration. In order to make a profit on currency exchanges, you must also know how
to calculate the cash value of exchange rate fluctuations in terms of ‘basis points’ – or, in Forex jargon – ‘pips value’.
This currency trading tutorial will not cover pips values, but it is a concept you should investigate further if you want to master the basics of trade on the foreign exchange
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