If I polled 1,000 investors and asked them to list their top 5 rules for success, their answers would differ from Buffett's. Here is what they would probably say:
Rule 1: Take a long term perspective.
Rule 2: Keep adding money to the market and let the magic of compounding work for you.
Rule 3: Don't try to time the market.
Rule 4: Stick to companies you understand.
Rule 5: Diversify.
Few investors would think to mention Buffett's cardinal "don't lose money" rule.
Why?
- Some investors, sadly, refuse to believe that losses can occur, so accustomed are they to the unprecedented rally in the major indexes since 1987.
- Surveys done by mutual fund companies during the past few years indicate that a high percentage of individual investors still don't believe that mutual funds can lose money or that the market is capable of dropping more than 10% anymore.
- Other investors see losses as temporary setbacks or as opportunities to add to their positions.
- Still others, acting out a psychological defense mechanism, try to avoid losses by violating their own rules. They let the ticker tape infect decision making and trade in and out of winners and losers to avoid the psychological trauma of having to report a loss.
1. Avoiding losses is probably the most important tool for long-term success in investing. No investor, even Buffett, can avoid periodic losses on individual stocks. Even, if you resigned yourself to buying only at incredibly cheap prices, occasional mistakes will still occur. What differentiates Buffett from nearly all other investors is his ability to avoid yearly losses in his entire portfolio.
2. Diversification alone can't prevent losses. All diversification can do is minimise the chances that a few stocks implode (non-market risk or stock specific risk) and drag the performance of the portfolio with them. Even if you hold 100 stocks, you are forever vulnerable to "market risk," the risk that a declining market causes nearly all stocks to drop together.
3. Most investors use the market as their mechanism for avoiding losses. What does this mean? They simply sell when a stock falls below its break-even point, no matter the fundamentals. One highly touted strategy of the 1990s, espoused by Investor's Business Daily, implores investors to sell any issue that falls more than 8% below its purchase price, irrespective of events. Market timers rely on similar strategies. They make short-term bets on the direction of individual stocks and are prepared to exit quickly if the market turns against them.
4. These strategies ultimately degrade into a form of gambling, where the odds of success shrink because the investors' holding period is too short. Other investos avoid losses by continuing to hold poor-performing stocks, sometimes for years, until they rally back above their original cost. To profit from this strategy, you must pin your hopes on the market's ultimately validating your decision.
How Warren Buffett avoids yearly losses in his entire portfolio?
Warren Buffett would rather not place his faith in the hands of investors and traders. The methods he uses to lock in yearly gains take the market out of the equation.
He reckons that if he can guarantee himself returns, even in poor markets, he will ultimately be way ahead of the game.
To learn more, we should focus on how Buffett best avoids losses.
These include:
Timing the market. He is not concerned about the day-to-day fluctuations in the stock market. However, Buffett - whether by accident or calculation - must be recognized as one of the most astute market timers in history.
Convertibles. Some of Buffett's most lucrative investments in the late 1980s and early 1990s involved convertibles, which are hybrid securities that possess features of a stock and an income-producing security such as a bond or preferred stock.
Options. On a number of occsions, Buffett has expressed his disdain for derivative securities such as futures and options contracts. Because these securities are bets on shorter-term price movements within a market, they fall under the definition of "gambling" rather than of "investing." If Warren Buffett does dabble in options, and few doubt he could dabble successfully, he does so quietly. He once acknowledged writing put options on Coca-Cola's stock; at the time he was thinking of adding to his stake in the soft-drink company.
#Arbitrage. Not only did Buffett continue to beat the major market averages, but he suffered few single-year declines along the way. That second accomplishment is, by far, the more remarkable. Buffett's scorecard shows that he has increased the book value of Berkshire Hathaway's stock 35 consecutive years. In only 4 years, did the S&P 500 Index beat the growth of Berkshire's equity. Right from the start of his investment management career, Buffett resorted extensively to takeover arbitrage (the trading of securities involved in mergers) to keep his portfolio results positive. In poor market years, arbitrage activities have greatly enhanced Buffett's performance and keep returns positive. In strong markets, Buffett has exploited the profit opportunities of mergers to exceed the returns of the indexes. Benjamin Graham, Buffett's mentor, had made arbitrage one of the keystones of his teachings and money management activities at Graham-Newman between 1926 and 1956. Graham's clients were informed that some of their money would be deployed in shorter term situations to exploit irrational price discrepancies. These situations included reorganizations, liquidations, hedges involving convertible bonds and preferred stocks, and takeovers.
----
There are only 3 ways an investor can attain a long-term, loss-free track record:
1. Buy short-term Treasury bills and bonds and hold them to maturity, thereby locking in 4 to 6 percent average annual gains.
2. Concentrate on private-market investments by buying properties that consistently generate higher profits and that can sell for greater prices each year.
3. Own publicly traded securities and minimise your exposure to price fluctuations by devoiting some of the portfolio to unconventional "sure things.# "
No comments:
Post a Comment