Notes from Seth Klarman's Margin of Safety

Notes_To_Margin_of_Safety

How to use a Margin of Safety when Investing

A fundamental part of value investing is to ensure that there is a margin of safety with your investments.

What this means is that you buy a stock when its price is not only lower than or equal to your calculated fair price, but that it’s significantly lower. This provides you with some gray area where your assumptions about the company can be a little bit off, and yet the investment will still turn out okay over the long run.

The margin of safety means that your assumptions would have to be significantly off course for that investment not to work out. But even then, by diversifying across 20+ companies and into other asset classes, the scenario becomes statistical in nature. For example, if you invest in 20 companies, and you only invest when a stock is trading at least 15% below your calculated fair price, then one or two of them can go bad while your overall portfolio will still perform admirably.

In the example of this chart, the time to buy would be when the stock price (red line) falls below the intrinsic fair value (blue line). It’s easier said than done, because you won’t have the benefit of seeing the rest of the chart in front of you, and the intrinsic fair value (blue line) is your calculated estimate of what the stock is worth rather than an absolute truth.

By sticking to sound value investing principles, however, you can do well. As can be seen in the chart, the fair value of a healthy company will be far less volatile than the stock price can potentially be, with only minor adjustments occurring each year based on new information.

How to Calculate Intrinsic Value

In order to buy at an undervalued price, you’d first have to know what the fair price is. This combines art and science. The science is that given perfect company estimates and your target rate of return, you can easily calculate the objective fair value of any business or asset that produces cash flow. The art is that of course you don’t have the perfect estimates, you only have your imperfect approximations. You can make estimates based on historical growth rates, or based on future trends that could shape those growth rates, based on analysis of how the company is spending its cash, or based on realistic management projections and a pattern of meeting those projections.

Discounted Cash Flow Analysis (DCFA) is the fundamental stock valuation methodfor any asset or business that produces cash flows. When this method is applied on a share-by-share basis of a dividend stock, then it’s called either the Dividend Discount Model or Method (generally), or the Gordon Growth Model (under expectations of a perpetual static growth rate).

DCFA and the associated DDM produce perfect fair values given perfect inputs, although of course you’re always going to have imperfect inputs. And the longer the actual stock price remains under the calculated fair value, the better it is for an investor assuming that you’re reinvesting dividends, buying more shares, or the company is repurchasing its own shares.

How Big of a Margin of Safety is Sufficient?

The size of the margin of safety will vary based on investor preference and the type of investing that she or he does.

“Deep Value Investing” refers to buying stock in seriously undervalued businesses. The goal is to find significant mismatches between the current stock prices and the intrinsic value of those stocks. Due to the degree of difference, these companies are often either small, or in bad shape. If they were well known and in good shape, then there would hardly ever be a serious mismatch of value and price except possibly for major macroeconomic deterioration such as during the local market bottom of early 2009. So deep value investing requires guts. You’ve got to pick through the rubble and find value where others aren’t seeing it. You have to see information that others are not seeing, or you have to interpret and act on information that others have, but are misinterpreting or failing to act on. Needless to say, deep value investing requires a considerably large margin of safety to invest with and isn’t for most casual investors.

“Growth at a Reasonable Price (GARP) Investing” refers to a more balanced approach. With this investing method, you pick companies that have positive growth rates that are also trading somewhat below your intrinsic fair value calculation. Dividend Growth Investing falls closer to GARP investing than deep value investing, because dividend growth investing relies on selecting companies with wide moats, strong balance sheets, the ability to grow dividends through recessions, and a product or service that you can see existing and indeed flourishing 10 or 20 years from now. With GARP investing or Dividend Growth Investing, it’s important to have at least a 10% margin of safety, but it’s not very often that you’re going to find enormous differences between price and value which allows you to buy with a huge margin of safety. They’re more stable and less contrarian selections. So rather than investing with access to better information or interpretations than others, you’re merely investing with a different time horizon. While others may be fretting about a quarterly report or something Congress did or a jobs report, you’re focusing on your passive income goals a 5-10 years from now.

How to Find Undervalued Stocks

Earlier this year I published the Dividend Toolkit for readers, which along with a comprehensive investing guide, includes the spreadsheet that I developed for myself to use to calculate the fair price of stocks.

If you want to calculate the fair value of a stock using the Dividend Discount Model (which is explained in significantly more detail in the book), and you estimate that the dividend will grow by 5% per year, and you’re using 12% as your discount rate. First, you put the simple inputs into the Dividend Discount Model spreadsheet tool:

And the tool instantly updates the output chart to tell you the fair value of the stock:

This output chart will not only tell you the fair stock value based on those inputs, but will also tell you the fair stock value based on nearby inputs. In this example, in addition to calculating the results for 5% dividend growth and a 12% discount rate, it will automatically show what the fair value is if it turns out that the stock only grows its dividend by 4%, or if you use a discount rate of 11% instead.

There are four different tools in the spreadsheet tool, including DCFA and DDM models. All of them focus on showing what kind of margin of safety you have based on your inputs, and the static-growth models also show what kind of rate of return you can expect given certain growth outcomes.

Besides the Toolkit, there are other ways to calculate fair price as well. You can do the simplest versions with a calculator or with free online tools. You can develop your own model if you have the time and desire.

A Margin of Safety BOOSTS Returns Rather than Just Providing Protection

Value investing or dividend investing may often be thought of as conservative investing methods, and this may be true in many cases. But the purpose of a margin of safety is not just to protect your rate of return, but indeed to improve it.

When you buy a stock below calculated fair value, an expectation is that in some future time, the stock price will go back up to fair value in a rational market. If your growth expectations end up being correct, and you bought at an undervalued price, then you should eventually get a superior rate of return.

Alternatively, the longer the stock remains undervalued, the better it is for shareholders, because their reinvested dividends, or their new purchases, or management’s share buybacks, continue to accumulate undervalued shares. It actually becomes a demonstrably negative scenario for a long term investor when their stocks go up above fair value.

Buffett put it concisely in his 2011 shareholder letter:

Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?

I won’t keep you in suspense. We should wish for IBM’s stock price tolanguish throughout the five years.

Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.

If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the “disappointing” scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1.5 billion more than if the “high-price” repurchase scenario had taken place.

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.

Source: Berkshire Hathaway Shareholder Letter, Warren E. Buffett

That’s how Buffett made 30-50% returns in his early days. He wasn’t investing in companies that were growing earnings by 30-50% per year; he was investing in companies that were seriously undervalued. Eventually, those stocks will return to normal values, and the longer they don’t, the better it is for the investor.

(Note: Rather than picking large caps like IBM, he was a deep value investor, finding huge mismatches between price and value. As his base of capital grew, it was no longer economical for him to invest in small companies and he either had to buy whole companies or invest primarily in large caps that either have GARP or dividend growth characteristics.)

Margin of Safety Example: 
Here’s an example of how an undervalued stock selection can offer outsized returns.

Suppose you use the Toolkit Spreadsheet or some other Dividend Discount Model tool to determine the fair price of a stock. Let’s use the above example, where it was calculated that a company paying $1.80 in dividends per share this year and growing that dividend by an average of 5% per year into the future, with a discount rate of 12%, is worth $27/share.

What this means is that if the company performs as expected, then buying at $27 should give you long-term returns of around 12% per year. Now, in any given year, the stock may go up or go down; it could fluctuate wildly around that fair value. And of course you’ve got to occasionally adjust your fair value assessment to take into account new information (like how this site re-analyzes the companies I cover on an annual basis). But over the long run, earnings determines price.

For example, let’s say that the stock that pays $1.80 in dividends per share (DPS) this year has $2.50 in earnings per share (EPS) this year. If you pay $27/share for the stock, then you’re paying a price-to-earnings ratio (P/E) of 10.8, and the stock has a dividend yield of 6.67%.

Ten years from now, if it grew earnings and the dividend by 5% per year as expected, then their dividends per share are now $2.93 and the EPS is up to $4.07. This is their fundamental performance, but let’s see two different buying scenarios.

Scenario A: Buy at Fair Value
In this scenario, the investor buys 100 shares at $27, for a total investment of $2,700 and a total dividend income stream of $180/year. If the company grows EPS and the dividend by 5% per year for the next ten years as expected, and if the investor reinvests her dividends each year, then by the end of the 10 year period if the stock remains at fair value for this whole time, she’ll have over 190 shares at a price of nearly $44 each, and so her total investment will be worth $8,385 and her annual dividend income will be $559.

Now, that’s an increase in wealth from $2,700 to $8,385 over a 10 year period, which translates into a 12% annualized rate of return. (The rate of return matched the discount rate that was used to calculate fair value in the first place.) Dividend income rose from $180 to $559, which is also a 12% growth rate (which includes the natural dividend growth and the accumulation of more shares due to dividend reinvestment.)

Scenario B: Buy at 15% Discount to Fair Value
In this scenario, the fundamentals of the stock are identical. The initial EPS and DPS, and their growth rates through the 10 year period are identical to scenario A.

But this time, the market is depressed, and the investor buys shares at a 15% discount to her calculated fair value of $27, which means she buys the shares at $22.95. She can buy 100 shares for $2,295, and will have the same $180 annual dividend stream to reinvest.

Over this ten year period, let’s say the price of the stock gradually increases back up to fair value as the market sees this company continue to perform well. So in the starting period, it’s at a 15% discount, then later only 10%, 5%, and eventually is at fair value. So the price increases from $22.95 to $44. Because shares were cheaper on average over this period but her dividends were the same, she was able to accumulate more shares. By the end, she has around 200 shares at nearly $44 each, for total wealth of $8,768. Her annual dividend income is $584.

So, her investment increased from $2,295 to $8,768 over 10 years, which translates into a 14.3% annualized rate of return. (If she had bought $2,700 worth of shares initially, she could have bought more than 100, and she’d be up to $9,650 or so in wealth.) Her dividend income stream increased from $180 to $584, which is a 12.5% annualized rate of return, and it took significantly less capital to acquire the same income stream (she could have used the initial $2,700 to buy more.)

Same company, same performance, and yet buying at a 15% discount to fair value meant 14.3% annualized returns instead of 12% annualized returns. This means more money in the end, and larger income streams.

Conclusion

As a recap, the purpose of buying with a margin of safety is twofold:

1) It makes your portfolio more conservative because your growth estimates could be a little bit off and the investment will still work out.

2) If your estimates are correct, then your rate of return will be superior over time because the growth rate of the investment is augmented by the additional fact that you bought it at an undervalued price. Over the longest term, your results will be superior either because the market eventually returns the price to its fair value, or because for as long as its under its fair value, your reinvested dividends or the company’s share repurchases will be able to buy more shares for the same amount of money.

To calculate intrinsic fair value, the fundamental way is to use a version of Discounted Cash Flow Analysis, either on the company as a whole or on a share of a dividend paying company. When it’s done in the second way it’s called the Dividend Discount Model. The inputs you’ll need are the current free cash flow or dividend, the estimated growth of that free cash flow or dividend, and a discount rate, which is equal to your target rate of return for practical purposes. When DCFA is understood, then there are shortcuts that allow for reasonable valuation such as basing estimates on P/E, the PEG ratio, or shareholder yield, etc.

http://dividendmonk.com/margin-of-safety/

Definition of 'Margin Of Safety'

Definition of 'Margin Of Safety'

A principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. In other words, when market price is significantly below your estimation of the intrinsic value, the difference is the margin of safety. This difference allows an investment to be made with minimal downside risk.

The term was popularized by Benjamin Graham (known as "the father of value investing") and his followers, most notably Warren Buffett. Margin of safety doesn't guarantee a successful investment, but it does provide room for error in an analyst's judgment. Determining a company's "true" worth (its intrinsic value) is highly subjective. Each investor has a different way of calculating intrinsic value which may or may not be correct. Plus, it's notoriously difficult to predict a company's earnings. Margin of safety provides a cushion against errors in calculation.



Investopedia explains 'Margin Of Safety'

Margin of safety is a concept used in many areas of life, not just finance. For example, consider engineers building a bridge that must support 100 tons of traffic. Would the bridge be built to handle exactly 100 tons? Probably not. It would be much more prudent to build the bridge to handle, say, 130 tons, to ensure that the bridge will not collapse under a heavy load. The same can be done with securities. If you feel that a stock is worth $10, buying it at $7.50 will give you a margin of safety in case your analysis turns out to be incorrect and the stock is really only worth $9.

There is no universal standard to determine how wide the "margin" in margin of safety should be. Each investor must come up with his or her own methodology.

http://www.coattailinvestor.com/

Margin of safety

Margin of safety (safety margin) is the difference between the intrinsic value of a stock and its market price.

Another definition: In Break even analysis (accounting), margin of safety is how much output or sales level can fall before a business reaches its breakeven point.


History

Benjamin Graham and David Dodd, founders of value investing, coined the term margin of safety in their seminal 1934 book, Security Analysis. The term is also described in Graham's The Intelligent Investor. Graham said that "the margin of safety is always dependent on the price paid" (The Intelligent Investor, Benjamin Graham, Harper Business Essentials, 2003).

Application to investing

Using margin of safety, one should buy a stock when it is worth more than its price on the market. This is the central thesis of value investing philosophy which espouses preservation of capital as its first rule of investing. Benjamin Graham suggested to look at unpopular or neglected companies with low P/E and P/B ratios. One should also analyze financial statements and footnotes to understand whether companies have hidden assets (e.g., investments in other companies) that are potentially unnoticed by the market.

The margin of safety protects the investor from both poor decisions and downturns in the market. Because fair value is difficult to accurately compute, the margin of safety gives the investor room for investing.

A common interpretation of margin of safety is how far below intrinsic value one is paying for a stock. For high quality issues, value investors typically want to pay 90 cents for a dollar (90% of intrinsic value) while more speculative stocks should be purchased for up to a 50 percent discount to intrinsic value (pay 50 cents for a dollar).

Application to accounting

In accounting parlance, margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:

Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven sales Level (quantity or dollar amount)

The measure is especially useful in situations where large portions of a company's sales are at risk, such as when they are tied up in a single customer contract that may be canceled.


Formula

Margin of Safety = Actual Sales - Breakeven Sales

Reference

• Graham, Benjamin. Dodd, David. Security Analysis: The Classic 1934 Edition. McGraw-Hill. 1996. ISBN 0-07-024496-0.
• http://www.businessweek.com/magazine/content/06_32/b3996085.htm
• http://www.worldfinancialblog.com/investing/ben-grahams-margin-of-safety/26/

Notes

1. ^ Yee, Kenton K. (2008). "Deep-Value Investing, Fundamental Risks, and the Margin of Safety". Journal of Investing 17 (3): 35–46. doi:10.3905/JOI.2009.18.1.027.
2. ^ http://www.accountingtools.com/article-metric-margin-of-safet

External links

• http://www.worldfinancialblog.com/investing/ben-grahams-margin-of-safety/26/

From Wikipedia, the free encyclopedia

How Emotional Intelligence Can Improve Decision-Making

The secret to making smarter decisions that aren't swayed by your current emotions -- particularly when your emotions are unrelated to the decision at hand -- could lie in emotional intelligence, according to a new study.

For instance, "people are driving and it's frustrating. They get to work and the emotions they felt in their car influences what they do in their offices. Or they invest money based on emotions that stem from things unrelated to their investments," study researcher Stéphane Côté, a professor in the Rotman School of Management at the University of Toronto, said in a statement. "But our investigation reveals that if they have emotional intelligence, they are protected from these biases."

Emotional intelligence is a term used in psychology to signal the ability to identify and control both your and others' emotions, and to apply that ability to certain tasks, according to Psychology Today.

For the study, published in the journal Psychological Science, researchers conducted several experiments to evaluate how different levels of emotional intelligence influence decision-making. In one experiment, researchers found that anxiety's effect on a decision involving risk -- when that anxiety was unrelated to the decision at hand -- seemed to be blocked in people with high emotional intelligence. For people with low emotional intelligence, on the other hand, anxiety seemed to influence the decision-making.

The researchers said that emotional intelligence can likely help you stop any emotions -- not just negative ones, like stress and anxiety, but also good ones, like excitement -- from influencing unrelated decisions.

"People who are emotionally intelligent don't remove all emotions from their decision-making," Côté said in the statement. "They remove emotions that have nothing to do with the decision."

Indeed, a 2008 study published in the Journal of Consumer Research also showed that emotional intelligence could play a role in decision-making by helping people realize their emotions can sway the choices they make.

http://www.huffingtonpost.com/2013/11/22/emotional-intelligence-decision-making_n_4310192.html#!

Malaysian Airline System (MAS)

No of ordinary shares  16,710.8 million
Market price of MAS RM 0.315 (21.11.2013)
Market capitalization 5,263.9 m

18.11.2013

Income Statement
Latest quarterly result Q3 2013
Revenue 3,782.7 m
Loss -373.2 m
EPS -2.25 sen

Cumulative 9M 2013
Revenue 10,766.0 m
Loss  -827.0 m
EPS -6.67 sen

Finance costs  -331.5 m
Unrealised foreign exchange loss  -175.7 m


Balance Sheet (30.9.2013)

NCA 15,378.6 m
CA  7,446.6 m

CL  8,211.6 m
NCL 10,253.8 m
TL 18,465.4 m
Equity 4,359.6 m


Cash 5,443.4 m
ST Borrowings 1,591.9 m
LT Borrowings 10,253.8 m
Total Borrowings 11,845.7 m

Net assets per share RM 0.26

Cash Flow Statement

CFI
Purchase of aircraft, PPE   -3,242.7 m
Disposal of aircraft, PPE       846.5 m

CFF
Proceeds from:
Rights issue  3,074.8 m
Aircraft refinancing 833.0 m
Borrowings  1,910.0 m

Repayment of:
Borrowings  -166.2 m
Finance lease  -486.3 m


Capital changes

Weighted average number of ordinary shares
30.9.2013  16,710.8 m
30.9.2012    7,102.1 m

Only rich at risk from London’s bubble

Only rich at risk from London’s bubble

Oct 7, 2013 : UK housing bubble fears have been exacerbated by Help to Buy. But Ed Hammond, property correspondent, tells John Authers the bubble is built on equity, not debt, and that the average home price remains below pre-crisis levels


Be cautious, first-timers urged
November 17, 2013

With a threat of mortgage interest rate rises in the near future, home buyers are asked to tread carefully.



Read more: http://www.smh.com.au/money/borrowing/be-cautious-firsttimers-urged-20131116-2xnn8.html#ixzz2l4qnver1

The unfortunate truth about investing

1. Saying "I'll be greedy when others are fearful" is much easier than actually doing it.

2. The gulf between a great company and a great investment can be extraordinary.

3. Markets go through at least one big pullback every year, and one massive one every decade. Get used to it. It's just what they do.

4. As Erik Falkenstein says: "In expert tennis, 80 per cent of the points are won, while in amateur tennis, 80 per cent are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves."

5. Time-saving tip: Instead of trading penny stocks, just light your money on fire. Same for leveraged ETFs.

6. Not a single person in the world knows what the market will do in the short run. End of story.

7. The analyst who talks about his mistakes is the guy you want to listen to. Avoid the guy who doesn't – his are much bigger.

8. You don't understand a big bank's balance sheet. The people running the place and their accountants don't, either.

9. There will be seven to 10 recessions over the next 50 years. Don't act surprised when they come.

10. Most of what is taught about investing in school is theoretical nonsense. There are very few rich professors.

11. The market doesn't care how much you paid for a stock. Or your house. Or what you think is a "fair" price.

12. The majority of market news is not only useless, but also harmful to your financial health.

13. Professional investors have better information and faster computers than you do. You will never beat them short-term trading. Don't even try.

14. The decline of trading costs is one of the worst things to happen to investors, as it made frequent trading possible. High transaction costs used to cause people to think hard before they acted.

15. Most IPOs will burn you. People with more information than you have want to sell. Think about that.

16. When someone mentions charts, moving averages, head-and-shoulders patterns, or resistance levels, walk away. Or run.

17. The book "Where Are the Customers' Yachts?" was written in 1940, and most still haven't figured out that financial advisors don't have their best interest at heart.

18. The low-cost index fund is one of the most useful financial inventions in history. Boring but beautiful.

19. The best investors in the world have more of an edge in psychology than in finance.

20. What markets do day to day is overwhelmingly driven by random chance. Ascribing explanations to short-term moves is like trying to explain lottery numbers.

21. For most, finding ways to save more money is more important than finding great investments.

22. If you have credit card debt and are thinking about investing in anything, stop. You will never beat 20% annual interest.

23. A large portion of share buybacks are just offsetting shares issued to management as compensation. Managers still tout the buybacks as "returning money to shareholders."

24. The odds that at least one well-known company is insolvent and hiding behind fraudulent accounting are high.

25. Twenty years from now the ASX 200 will look nothing like it does today. Companies die and new ones emerge.

26. The government has much less influence over the economy than people think.

27. However much money you think you'll need for retirement, double it. Now you're closer to reality.

28. The next recession is never like the last one.

29. Remember what Mark Twain says about truth: "A lie can travel halfway around the world while truth is putting on its shoes."

30. Investments that offer little upside and big downside outnumber those with the opposite characteristics at least 10-to-1.

Foolish takeaway

The best investors are cleverer than they think – the worst think they are cleverer than they are. The same applies to their temperaments and behaviour.

Investing Foolishly (with a capital F!) is all about getting rich slowly. As the saying goes, there's no shortcut to any place worth going. Trying to take shortcuts is much more likely to end up in pain. And no, you're very unlikely to be the exception to that rule.


November 16, 2012

Read more: http://www.smh.com.au/business/motley-fool/the-unfortunate-truth-about-investing-20121116-29gew.html#ixzz2l3VJz9lS

Buffett's Investing Wisdom - The Best Holding Period

When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. -- Warren Buffett

What do Procter & Gamble (NYSE: PG), Coca-Cola, and Wal-Mart (NYSE: WMT) have in common? If you said that all three are in Berkshire Hathaway’s portfolio, you’d be correct. If you said all three are up more than 1,000% over the past three decades, you’d also be correct. Finally, if you said that at some point during that 30-year span, each of the stocks lost more than 30% of its value in a relatively short period of time… well, you’d be correct there, too.

Although the attraction of fast riches in the stock market can have a strong pull, real investing wealth is built over decades, not months or even years. And if you’re curious what “real investing wealth” means, consider that a $10,000 investment in Wal-Mart 30 years ago would be worth roughly $600,000 today. But there were at least five periods over that stretch when Wal-Mart’s stock fell more than 20% over the course of a year. An investor with a quick trigger finger and a lack of long-term focus might have been shaken out at any one of those times and missed out on the truly great gains made possible from owning for the whole period.

If we look at the stocks in Berkshire Hathaway’s portfolio today, it’d be hard to argue that Coca-Cola is anything but a company worth owning for that “forever” timeframe. Sure, the stock isn’t particularly cheap (see the previous quote if that concerns you), and it’s faced headwinds lately in the form of a lousy European economy and a lackluster soda market in the U.S. But when you think bigger picture in the form of the company’s brand -- it was ranked the No. 1 global brand in 2012 by brand expert Interbrand -- its strong market position in its established markets, and continued growth opportunity in emerging markets, it’s obvious there’s still good reason to own Coke stock for the next year, five years from now, and 20 years from now.

When it comes to finding an outstanding business with outstanding managers, Berkshire Hathaway itself would almost certainly need to make the list of companies worth owning for forever. To be sure, Warren Buffett won’t always be the CEO of the company, but the way he’s built the business has ensured that there are many great managers running its many wholly-owned businesses. And with a highly diversified and high-quality business mix that includes everything from The Pampered Chef and Dairy Queen to GEICO and NetJets, the company has many avenues for growth the casual observer may not appreciate. If that’s not enough, consider that there’s a team of investors -- not only Warren Buffett, but his hand-selected protégés Todd Combs and Ted Weschler -- that is expertly investing in publicly-traded stocks using all of the wisdom just discussed here.


Ref:  Warren Buffett's Greatest Wisdom

Buffett's Investing Wisdom - Buy Wonderful Companies

It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. – Warren Buffett

Interestingly enough, Buffett’s mentor, Benjamin Graham, was quite fond of jumping at fair companies trading at wonderful prices. Graham termed this “cigar butt” investing -- as in, he was looking for discarded cigars that still had a few good puffs left in them. In Buffett’s pre-Berkshire days, he ran with this page from Graham’s book. To be sure, Berkshire Hathaway itself looked a lot like a cigar butt when Buffett bought it -- at the time it was a bedraggled textile business that was markedly unprofitable.

Through his career, though, Buffett realized that the real money wasn’t in puffing on dirty cigar butts. Instead, the big profits in investing come from finding well-run companies that dominate their industries and hanging onto those companies for a long time. Of course, Buffett isn’t one to pay any crazy price for a stock, though, so part of the investment process is determining what a fair price is for the stock and looking for an opportunity to buy the stock at that price.

Costco (Nasdaq: COST) is a great example of a company that dominates its industry. Sure, there are other warehouse-shopping clubs out there, but in terms of quality of operations and management, none stack up. And Buffett -- and even more so his right-hand man, Charlie Munger -- are not shy about professing their admiration for the low-price giant. The problem for investors is that it’s highly unlikely we’ll see shares of Costco trade at true bargain levels unless something dramatically changes the quality and outlook for the company.

In a similar vein, Visa (NYSE: V) and MasterCard (NYSE: MA) are among a very small, very dominant group in the growing and highly profitable credit card industry. As the nature of the global payment system continues to move rapidly away from cash and toward cards and electronic payments, both of these payment-network operators stand to rake it in. Just like Costco, though, investors looking for a “blue light” special on Visa or MasterCard shares will likely find themselves with their hands in their pockets as long as the major growth and success continue.

It’s not just academic to say that investors who balk at a premium price for these companies missed out. Over the past five years, the S&P 500 is up 35%. Costco is up 93%. As for Visa and MasterCard, they’ve tacked on an amazing 162% and 127%, respectively. And investors that bought those companies five years ago weren’t buying on the cheap. In 2008, Costco fetched an average price-to-earnings multiple of 23.5, while Visa and MasterCard sported respective multiples of 53 and 45.

Today, the stocks of all three of these companies still sport higher-than-average earnings multiples. But all three are also still top-notch businesses with stellar growth and profit potential.


Ref:  Warren Buffett's Greatest Wisdom

Buffett's Investing Wisdom - Who's Swimming Naked?

You only find out who is swimming naked when the tide goes out. – Warren Buffett

Unwise business plans can often lead to huge profits… over the short term. When the economy is roaring and everything is moving up and to the right, it’s far easier for companies to hide dumb, corner-cutting, or even illegal practices as they rake in profits. Eventually though, the environment changes, those ill-advised practices are exposed, and the companies employing them -- and their shareholders -- get punished.

Thinking back to the dot-com boom, online grocer Webvan is a perfect example. After pricing its 1999 IPO at $15, the stock traded up to nearly $25 -- up 66%! -- on its first day of trading. So what if the company was losing money, it had a questionable business plan, the economy was booming, and internet stocks couldn’t lose!

As we know now, it couldn’t last. As the stock market boom turned to bust and the economy cooled, Webvan’s approach to online retailing -- which only led to mounting losses -- left investors cold. Unable to fund its massive cash bleed, Webvan declared bankruptcy in 2001.

Of course, we have a plethora of even more recent examples of businesses caught swimming naked thanks to the housing bust and financial-market meltdown in 2008. Chief among those examples is Lehman Brothers, which was an investment bank that was raking it in prior to the crash by employing large amounts of ultra-short-term loans to finance risky, complex real-estate investments. When the market turned, Lehman’s lack of swimming trunks was painfully obvious, and in 2008, Lehman filed the U.S.’s largest corporate bankruptcy.

Buffett’s “swimming naked” quote provides us with plenty of cautionary tales and gives us an idea of companies we might want to avoid investing in. If we flip it on its head, though, it also reveals companies that are great investing opportunities.

For example, let’s look at the credit crisis again. Lehman Brothers declared bankruptcy, Fannie Mae (OTC: FNMA) and Freddie Mac (OTC: FMCC) were put into government conservatorship, and Bear Stearns narrowly avoided bankruptcy by agreeing to be bought out by JPMorgan Chase (NYSE: JPM). But Wells Fargo (NYSE: WFC) and U.S. Bancorp (NYSE: USB) both made it through the crisis without reporting a single unprofitable quarter. Though they both accepted government bailout money, it’s unlikely that either truly needed it. In fact, Wells Fargo’s chief executive at the time argued vociferously against taking bailout money, but regulators overruled the request.

When the tide went out, we saw that both Wells Fargo and U.S. Bancorp not only had their swimming suits on, but were wearing suits of titanium. The washing out that came with the financial crisis revealed both banks as great companies to invest in for the long term. It also just so happens that both are among Buffett’s largest holdings at Berkshire Hathaway -- in fact, Wells Fargo is Berkshire’s single largest stock holding. While neither stock is as cheap as it was circa 2009, both are still reasonably priced for a long-term owner today.


Ref:  Warren Buffett's Greatest Wisdom

According to Forbes' latest list of worldwide billionaires, Warren Buffett is worth more than $50 billion.

The octogenarian’s massive fortune was built through Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B), the company he’s been a controlling shareholder of since 1965. Since that time, Berkshire’s stock has appreciated nearly 600,000% (no, that’s not a typo!) versus 7,400% for the S&P 500 index.

At that rate of return, a $1,000 investment in Berkshire would have become roughly $6 million.

Much of the success at Berkshire has been driven by Buffett’s uncanny skill as an investor. During his career as CEO, he’s made billions for the company and its investors by buying top-notch companies like American Express (NYSE: AXP) and Coca-Cola (NYSE: KO) and holding the stocks for decades.

There’s a lot we can learn from Buffett

Fortunately, not only has Buffett been one of the most effective CEOs of the modern age, he’s also been one of the most transparent. For Berkshire, each year is capped by a letter to shareholders from Buffett that not only details the company’s results, but teaches readers general investing lessons in Buffett’s down-to-earth, folksy style. Outside of those letters, Buffett is also known for delivering some of the all-time most concise, elucidating quips about investing.


Ref:

Warren Buffett's Greatest Wisdom

'Being human" costs the average investor around 3 - 4% in return every year.

The cost of being human

When it comes to investing, human nature doesn’t help. Our innate need for emotional comfort is estimated to cost the average investor around 3–4% in returns every year.* And for many, the figure can be much greater.

This shortfall in returns is partly caused by what is known as the Behaviour Gap. It explains the difference between long-term financial returns (if we were only to stick to sensible and simple rules for investing) and actual returns (which are determined by all our short-term decision-making, often based on our emotional needs).

A good example is how our investment strategy often goes off course in turbulent times. So despite the obvious costs, we can often end up buying high and selling low.


*Source: Barclays Wealth & Investment Management, White Paper - March 2013, ‘Overcoming the Cost of Being Human’.

http://www.investmentphilosophy.com/fpa/

Hesitation can cost you dearly. The average investor foregoes 4–5% in returns each year by leaving their wealth in cash.

Hesitation can cost you dearly

The average investor foregoes 4–5% in returns* each year by leaving their wealth in cash rather than investing in a diversified portfolio.

Failing to invest at all is the first way in which we exchange long-term performance for short-term emotional comfort. Here, the comfort factor is very simple – we cannot lose if we don’t get involved. But the potential cost – on average 4–5% in lost returns each year – is very high

Often those prone to reluctance only decide to invest when there is a sustained market boom. But by going in at the top of the market, they may experience the knock-on effects of buying high: a reduction in returns and an increase in anxiety and stress.

Take this Financial Personality Assessment™


*Source:  Barclays Wealth & Investment Management, White Paper - March 2013, "Overcoming the Cost of Being Human'.

http://www.investmentphilosophy.com/fpa/

Will You, Won't You? Staying out of the markets is a costly way of reducing investor anxiety.

For some investors the idea of getting involved in the markets at all is uncomfortable.  This investor anxiety is quite common in those people who get the emotional comfort they need by avoiding investing altogether.  Yet being too hesitant has large hidden costs.

What if...?

Certain people have greater natural reluctance than others to enter markets in the first place.  We call this low Market Engagement, which measures the degree to which you are inclined to avoid or engage in financial markets, usually due to a fear of the unknown or getting the timing wrong.  It is a component of risk attitude and is one of the financial personality dimensions one need to understand.

Low Market Engagement can mean you are nervous of investing at the wrong time so you tend to stay out of the markets which is a costly way of reducing anxiety.  To overcome this you may opt to invest in a gradual, phased manner, normally starting with the lower risk asset classes.  Low Market Engagement investors may also value some protection against large interim capital losses for products in riskier asset classes.

Those with high Market Engagement can find it easier to commit to investments.  However this can sometimes lead to damaging enthusiasm where investors appear "trigger happy" with investments, giving them less consideration than is due.  Investors are also more likely to invest based on passing recommendations from people they meet.


Ref:
Barclays
Wealth and Investment Management.

Recency Bias or the Party Effect

Overview

The Party Effect or Recency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves. This is a very important concept to understand. Let’s set the stage for an illustration of how this happens.

Examples

A Party Tale

“You’re Right”

One of my favorite life lessons centers around President Franklin Delano Roosevelt, also known as FDR. FDR had many strengths but I think his greatest was his ability to recognize that things are not always black and white. I think his ability to see the big picture as well as discern the subtleties of a situation is what made him such an effective leader and brought out the best in others.

In one well known FDR story, he asks one of his trusted advisors what he thinks about a particular situation and after he listens to the advisor, FDR replies “You’re Right.” Not long after FDR asks another of his trusted advisors for his opinion on the same matter and this advisor gives the exact opposite recommendation from the first advisor to which FDR once again replies “You’re Right.”

At hearing FDR’s reply to the second advisor one of FDR’s closest advisors that had listened to FDR’s response to both advisors, points out the obvious contradiction to which FDR replies “You’re Also Right.”

Much can be learned from what at first appears to be FDR’s flippant and contradictory remarks to his advisors. However, FDR was far wiser. FDR understood that all three advisors were in fact right. They were just right from their perspective. But they didn’t have a view of the big picture. The contrast between FDR’s perspective of the entire situation compared to the trusted advisor’s perspective of a narrow part of the situation is what creates the dichotomy. The stock market works much the same way.

A different example would be the poem about the six blind men and the elephant. Each of the six blind men is asked to describe an elephant. Their perceptions lead to misinterpretation because they each describe the elephant differently depending on which part of the elephant they touch. One touches the side and describes the elephant like a wall. The other the tusk and describes the elephant as a spear. The next touches the trunk and describes a snake. The next the knee and describes a tree. The next an ear and describes a fan. Finally the last touches the tail and describes the elephant like a rope.

This tale is about the stock market and how investors relate to the stock market. The stock market can be viewed as FDR or the elephant while investors or participants in the stock market can be viewed as the advisors or the blind men. When describing the stock market each participant sees their portfolio’s performance from their perspective only and thus they are always “right” which leads to what I call The Party Effect or what Financial Behaviorist call the Recency Bias.

Imagine that you attended a party hosted by your investment advisor and that in addition to you, also in attendance were several other clients. As you go around the room and meet people you learn that everyone at the party owns the exact same S&P 500 index mutual fund. I use the S&P 500 for this tale because by many measures it has historically produce an average rate of return of about 12% and as many people know, and now you know as well, it represents what many investors call “the stock market.” The question then is would everyone have the same rate of return at this party? Of course the answer is, no they would not. If they started at the same time they would but since people invest or come into the life of the investment advisor at different times, the answer is no.

Let’s tighten up the party attendee list and invite only 30 guests. For simplicity, let’s assume that Guest 1 purchased the fund 30 months ago, that Guest 2 purchased it 29 months ago, that Guest 3 purchased it 28 months ago, etc. What would the guests discuss? What would be their perspectives of the stock market?


In order to determine what the guests would discuss and how they would evaluate their performance we need to have some data in the form of monthly rates of return. So we need to develop a monthly rate of return for 30 months to see what they see. Again, for simplicity, assume that for the first 18 months the fund goes up 3% per month and for the next 12 months it goes down 2% per month. Please note that I didn’t pick this sequence of numbers randomly. I have a purpose to this. This particular sequence approximates how the stock market moves in terms of bull and bear market duration and after 30 months returns approximately 12%; 12.28% to be exact. This sequence of numbers is a good sequence to illustrate The Party Effect or Recency Bias. We can characterize the first 18 months as the bull market phase of the 30-month cycle and the last 12 months as the bear market phase of the 30-month cycle.

To illustrate The Party Effect lets focus on 4 guests and see how they describe the stock market. Remember the FDR and elephant example from the start of this tale. Let’s look at guests 1, 10, 19 and 25. I picked these 4 because readers of this tale can relate in some form or another to one of these 4.

- Guest 1 started 30 months ago, at the beginning of the bull market phase, and his rate of return is 12.28% for the entire 30-month cycle. He enjoyed the ride up for 18 months and now the ride down for the last 12.

-  Guest 10 started 21 months ago, halfway through the bull market phase, and his rate of return is 1.36%    for the 21-month period he has been invested.

-  Guest 19 started 12 months ago, at the beginning of the bear market phase, and his rate of return is             -21.53% for the 12-month period he has been invested.

-  Finally, Guest 25 started 6 months ago, halfway through the bear market phase, and his rate of return is
    –11.42 for the 6-month period he has been invested.

These 4 guests experienced entirely different rate of return outcomes and view their portfolios and thus the stock market completely different. All 4 are correct. All 4 are right and yet they couldn’t possibly have more divergent outcomes. If they don’t have a complete picture of the stock market, like the elephant, they can get themselves in trouble. The difference between the best performing portfolio that is up 12.28% and the worst performing portfolio that is down 21.53% is an astounding 33.81%. Is this too obvious? You may say, of course they have different outcomes, they started at different times but that is not the point. The point is that stock market investing will always produce different outcomes. One guest started at the worst time possible. Another guest started at the best possible time. How they look at the past determines how they see the present. Most importantly, it will determine how they will act going forward.

The Party Effect simply states that stock market participants evaluate their portfolio performance based on their perspective and their perspective only. They do not see the market as it is but as they are. Without an expert understanding of how the stock market works, this leads to incorrect conclusions that ultimately lead to incorrect decisions. The field of Behavioral Finance (BF) has shown time and time again that people have variable risk profiles. BF demonstrates that fear is a stronger emotion than greed. This means that in our simple 4 guest example, Guests 3 and 4 are more likely to exit the stock market at just the wrong time since their recent, thus Recency Bias, experience is one of losing money. It means that Guest 1 and 2 are more likely to stay invested, thus catching the next wave up that is likely to follow. All 4 have intellectual access to the events of the last 30 months. All 4 can educate themselves on the stock market. However, their particular situation is so biased by recent events that the facts are unimportant. They behave irrationally. I have witnessed this irrational behavior throughout my career. No one is immune, even advisors.

There are ways to combat The Party Effect trap but it is the deadliest of all the stock market traps that I know. Few can overcome it. The only sure way to overcome it is to become an expert on the stock market yourself, learn to manage your emotions, and then either manage your own money or hire competent managers that you recognize are expert in their chosen investment discipline. However, if you hire an expert on the stock market you have not solved the problem if you do not have expertise. Let me repeat this sentence and highlight it. If you hire an expert on the stock market you have not solved The Party Effect trap if you do not have expertise yourself. When you hire an expert on the stock market without being an expert yourself all you have done is added complexity to a complex problem. You have inserted another variable between you and the stock market. You now have three variables to worry about, the stock market, your advisor and yourself. Without expertise you have no way of knowing if your advisor is an expert. You are in an endless loop. You are in a recursive situation. Just like we ask, what came first the chicken or the egg? The Party Effect asks, how do I hire an expert without being an expert myself?

If you are unwilling to become an expert on the stock market you must find a way to solve The Party Effect trap? How do you do it? As a first step I suggest you read An Expert Tale to make sure the person you hire is in fact an expert and then hire them. The original intent of my Financial Tales project was to educate my kids and others I love. With that as a backdrop, this means I highly recommend you avoid dealing with any advisor that does not have a fiduciary relationship with you the client. Why, because you are adding a 4th variable to an already complex situation. You are adding the ever present conflict of interest that every non-fiduciary advisor has with their client. This 4th variable makes a successful outcome all but impossible. I recognize that these words are harsh but I believe your odds of success drop dramatically once you introduce the non-fiduciary variable. I don’t know what the future holds, but today you must avoid conflicted advisors at firms such as Merrill Lynch, Smith Barney, Morgan Stanley, etc. I expect that the non-fiduciary model of providing people with investment advice based on the size of the advertising budget will go the way of the dinosaur, but for as long as it exists, you must avoid this ilk of advisors.

What is the second step to avoiding The Party Effect trap? There is no second step. You either develop investment expertise or you learn to recognize experts and hire them. You can’t avoid or abdicate this charge. You must embrace your responsibility or you will suffer or those you love will suffer. It behooves the reader to invest their time in what is one of the most important decisions they will ever make and must make every day.



http://www.wikinvest.com/wiki/Recency_bias

The investment mistakes caused by framing

Behavioural finance: The investment mistakes caused by framing

In this post on behavioural investing, we'll look at the dramatic effects the concept of framing can have in an investment context.

Peoples' personality traits can hugely affect the way they react to the actual performance of their portfolio in the future. For example, consider a situation where two investors (Bob and Brian) have made the same investment. Over one year, the market average rises 10 per cent but the individual investment value increases by 6 per cent. 

Bob cares only about the investment return and frames this as a gain of 6 per cent. Brian is concerned with how the investment performs relative to the benchmark of the market average. The investment has lagged behind the market’s performance and Brian frames this as a loss of 4 per cent. Which investor is likely to be happier with the performance of their investment?

Because of the way that individuals feel losses more than gains, Bob is much more likely to be happy with the investment than Brian. Their differing reactions here will frame their future investment decisions. Another problem for investors is the strong tendency for individuals to frame their investments too narrowly – looking at performance over short time periods, even when their investment horizon is long term. People also struggle to consider their portfolio as a whole, focusing too narrowly on the performance of individual components.

The 70% rule

Consider the “70% rule” that advises people to plan on spending about 70 per cent of their current income during their retirement.

For most people, this rule of thumb is intuitively appealing, which could explain why it has become so popular among financial planners. Now let’s use slightly different lenses and reframe the 70 per cent rule as the 30 per cent rule. That is, rather than focusing on the 70 per cent of expenditures someone would sustain through retirement, let’s consider the 30 per cent of expenditures that should be eliminated. Most people find the 30 percent rule unpalatable, even though the 70 per cent and 30 per cent rules are mathematically identical. 

Investors hate losses

Individuals are extremely sensitive to the way in which decisions are presented or ‘framed’ – simply changing the wording or adding irrelevant background detail can dramatically change peoples' perceptions of the alternatives available to them, even where there is no reason for their underlying preferences to have changed. When individuals make investment decisions, emotion and reason work together, but they produce very different emotional results depending on whether the investment made or lost money. For example, according to Shefrin, people tend to feel losses much more strongly than the pleasure of making a comparable gain.

This emotional strain is magnified when the person assumes responsibility for the loss. This guilt feeling then produces an aversion to risk. But this level of guilt can be changed depending on how a financial decision is framed. For example, if an adventurous investor seeking attractive returns over the long-term made close to 100 per cent over two years and then lost 20 per cent in year three, the investor could justify the year three loss by saying that even though they suffered a hefty loss over a twelve month period, the fact remains that they had made an annual return over the three years of 21.6 per cent which would be classed by many as impressive performance.

Myopic thinking can lead to investment mistakes

Behavioral finance's answer to the equity premium puzzle revolves around the tendency for people to have "myopic loss aversion", a situation in which investors - overly preoccupied by the negative effects of losses in comparison to an equivalent amount of gains – take a very short-term view on an investment. What happens is that investors are paying too much attention to the short-term volatility of their portfolios.

While it's not uncommon for an average stock or fund to fluctuate a few percentage points in a very short period of time, a myopic (i.e. shortsighted) investor may not react too favourably to the downside changes. Therefore, it is believed that equities must yield a high-enough premium to compensate for the investor's considerable aversion to loss.

Over-monitoring performance

How frequently you monitor your portfolio’s performance can bias your perception of it. Suppose you were investing over a 5-year investment horizon in a high-risk equity portfolio. The table below presents how you would perceive the portfolio depending on the monitoring period. Over the appropriate 5-year time frame, equity performance has been positive 90 per cent of the time, and so risky investments do not lose money more than 10 per cent of the time. However, if you were to monitor the performance of the same portfolio on a month-by-month basis, you would observe a loss 38 per cent of the time!*

Once again, because of our inherent aversion to loss, monitoring your portfolio more frequently will cause you to observe more periods of loss, making it likely you'll feel more emotional stress and take on less risk than is appropriate for your long-term investment objectives.

Percentage of time seeing:	5 year monitoring period	1-monthmonitoring period
Gains	90%	62%
Losses	10%	38%

Observing short-term fluctuations in the value of an investment is likely to cause more discomfort for investors who are particularly sensitive to losses. This may prevent them from investing in such a portfolio and thus lose out on the higher potential returns that they would get by taking on appropriate levels of risk.

* Source: Kahneman and Riepe, 1998.

http://web.isaco.co.uk/blog/bid/147855/Behavioural-finance-The-investment-mistakes-caused-by-framing

AVAILABILITY BIAS

The next cognitive illusion is known as availability bias. When confronted with a decision, humans’ thinking is influenced by what is personally relevant, salient, recent or dramatic. Put another way, humans estimate the probability of an outcome based on how easy that outcome is to imagine.

Consider the following example. In the months after the September 11 terrorist attacks, travelers made the decision that travelling to their destination by car was a far safer way than by air. In light of the very recent (at the time), salient and dramatic events of September 11, this decision seemed an obvious and wise one. The probability of danger when travelling by air seemed much greater than travelling by car… when you think about it, at that time, it was far easier to imagine something bad happening when travelling by air.

However, this was the availability heuristic at work. The truth of the matter was that firstly, air travel had never been safer than in the months following September 11, on account of the massively increased security. And secondly, on account of far more people hitting the roads come holiday time, there were inevitably many more fatal accidents. Upon examination of the statistics, it was far more dangerous to drive than to fly (US road fatalities in October-December 2001 were well above average) and yet, the availability bias humans suffer from made many feel that driving was the smarter choice… this decision-making error cost some people their lives.

We also apply this bias in the world of investing. For instance, availability bias can result in our paying more attention to stocks covered heavily by the media, while the availability of information on a stock influences our tendency to invest in a stock. The dot.com boom of 1999/2000 is a great example. The availability of information and media coverage of internet stocks was such that people were more inclined to invest in them than they would have otherwise been.

Be wary of following the latest market fad simply because of the availability of information. If you have read it in the newspaper, you may well be amongst the last in the market to know!!

http://stockmarketinvesting.com.au/Availability-Bias.html

The seven simple habits of the best investors

While bad habits get all the press, it's really their beneficial flip side we should focus on. Good habits are like super powers that people forget they can have. Somewhere in our subconscious lurk automations - mental patterns and rhythms that we execute regularly - but few people realise just how significant those are.

A 2007 study out of Duke University concluded that as many as 40 per cent of our daily actions are deeply ingrained habits, not conscious decisions. Yes, 40 per cent.

When it comes to investing, it pays to look to those who have done it right before. Here are seven common habits I've identified among the world's best investors.

1. They read. And read, and read, and read ...

If you follow Warren Buffett and Berkshire Hathaway (NYSE: BRK-A, BRK-B), you've probably stumbled across his witty and equally brilliant first mate, Charlie Munger. He's a legend for his insights into successful investing, thought processes, and habits. He nailed a crucial one here: “In my whole life, I have known no wise people who didn't read all the time - none, zero. You'd be amazed at how much Warren reads - at how much I read. My children laugh at me. They think I'm a book with a couple of legs sticking out.”

2. They seek and demonstrate humility

Koch Industries may not command the recognition of its phonetic relative Coke, but it should. Koch is the second-largest private company in the United States and rakes in more than twice the revenue of the more familiar beverage-maker.

Koch Industries chief financial officer Steve Feilmeier is in charge of deploying the company's massive capital at a reasonable rate of return. When discussing what he looks for in a valuable acquisition for Koch, he said: "There is one in particular that I pay attention to when we're looking at another company, and that is humility."

Humility can be a rare virtue in an industry controlled by animal spirits, but it pays off.

3. They fail

Peter Lynch, the legendary manager of Fidelity's Magellan Fund, absolutely stomped the market over his career, averaging annual returns of 29 per cent. Here's what he had to say on picking winners: "In this business, if you're good, you're right six times out of 10. You're never going to be right nine times out of 10."

That's right. If you're king of the investing mountain, you may narrowly beat a coin toss in the long run.

4. They steal

Maybe "steal" isn't the best word for it. In investing it's called "cloning", or basically borrowing already great investment ideas and making them your own.

When it comes to cloning, no one is a bigger advocate than fund manager Mohnish Pabrai - and few are so successful at it. After managing his fund for more than 18 years and weathering two recessions, his average annual return is 25.7 per cent.

Pabrai breaks his approach down to three strategies, and one of them is, indeed, cloning. It's no coincidence that he has had this idea affirmed by someone else too: Charlie Munger.

5. They evaluate internally

A lot of investors are aware of the need to go against the grain to find success, but the judgment and evaluation of others can be a big psychological weight. It can cause doubt and insecurity in your approach.

Buffett knows this best. He was chastised for trailing the moonshot returns of the tech bubble while he stuck with boring insurance and paint manufacturers. His advice for weathering the storm? An "inner scorecard". As he said in The Snowball, a book about his life: “The big question about how people behave is whether they've got an Inner Scorecard or an Outer Scorecard. It helps if you can be satisfied with an Inner Scorecard ... If all the emphasis is on what the world's going to think about you, forgetting about how you really behave, you'll wind up with an Outer Scorecard.”

6. They practise patience

We got a wonderful reminder of the power of patience here at Fool HQ when co-founder David Gardner's 1997 recommendation of Amazon.com (Nasdaq: AMZN) became a 100-bagger. That return – a gain of 100 times the original investment – is absolutely stunning, but even more impressive is that David was an owner the whole way through.

In his original Amazon recommendation, David wrote: "We're patient investors who buy with the idea of holding on to our latest pick for at least a year or two - if not indefinitely."

He's still holding.

7. They're decisive

Don't confuse patience with indecision. The best investors are poised to act when the right opportunity comes across their radars.

John Paulson and Michael Burry didn't participate in The Greatest Trade Ever by sitting on their hands. When they saw a clear opportunity, they backed up the truck. For Burry, that often meant battling his own investors' anxiety. His fund Scion Capital returned nearly 500 per cent in less than eight years.

Foolish takeaway

Taking the time to cultivate good habits will yield incredible results. As one popular saying goes:

Your actions become your habits,

Your habits become your values,

Your values become your destiny.



Read more: http://www.smh.com.au/business/the-seven-simple-habits-of-the-best-investors-20131112-2xe2o.html#ixzz2kQj29J7f