Are You an Investor?

By Bonnie Biafore, Contributor, BetterInvesting Magazine On July 16, 2012 

Successful investors tend to possess certain characteristics.  Do you have them? What do you do, if you don’t? The first step to successful investing is knowing your strengths and weaknesses in the investment game. That way, you can work on those shortcomings and make better investment decisions.  The MarketPsych website offers free tests you can take to measure your suitability as an investor as well as other aspects of your financial life.

To take any of the tests, you have to register with the site (it’s free). If you’re concerned about privacy, you can register anonymously.

The Investor Personality test helps you understand your personality traits as they apply to investing.  The report you receive gauges your suitability as an investor and offers suggestions for improving any behaviors that could undermine your investment success.   The test takes about 20 minutes and includes 60 questions about your personality followed by 15 questions about what you would do in different investment situations.

The personality questions cover a lot of ground.  Do you tend to think things through? Do you plan? How do feel about change? Are you usually relaxed or easily stressed? Do you like excitement and adventure? Do you enjoy abstract ideas or prefer practical information? Are you confident? Can you juggle several tasks at once? Can you make decisions or do you vacillate?  Do you take others’ feelings into account? Do you react quickly?

The investment questions are a bit tougher because they don’t offer answers for the gray areas we all live in.  For example, one question asks whether you would choose to spend more now and have less in retirement, or spend less now and have more in retirement.  My answer is neither of those alternatives.  Another question asks what you would do if you bought a stock and its price increased significantly over a short period — without any news or information about the company.  Yikes! I’m an engineer, so it’s almost impossible to make a decision without any information. Some of the questions include one possible answer: watch the company in order to determine a reasonable purchase or selling price, and then make a decision.

The report you receive rates your personality in several ways, such as how conscientious you are, how emotional you are, whether you are an extrovert or introvert, and your openness and agreeableness.  Ratings that appear in green (see screen capture, this page) indicate suitability as an investor, whereas yellow ratings are traits that could inhibit your investment success.

The bias section of the report rates your confidence, risk-taking, discipline, thinking, and herding instinct.  For example, the hypothetical results include a below-average score in loss aversion.  You can click the Click here link to learn how this trait might harm your investing.  For example, the Risk-Related Biases Web page discusses the common mistakes many investors make with their investments, such as holding onto a loser hoping for a comeback.  Then, it includes specific advice for high scorers and low scorers for each aspect of risk-taking, including loss aversion, emotional vulnerability, risk aversion, and cutting winners short.  In this case, the explanation warns that low scorers for loss aversion might take excessive risk.

http://blog.betterinvesting.org/?p=2020&utm_source=MailingList&utm_medium=email&utm_campaign=BI+Weekly_7-16-12

My Investor Personality Test Results  :-)

Print

Investor Personality Test PERSONALITY FACTORS Conscientiousness : High  Emotionality : Below Average  Extraversion : Below Average  Openness : Above Average  Agreeableness : Below Average For Details Click here BIAS REPORT Confidence Biases Overconfidence : Above Average Over-Optimism : Below Average For Details Click here Risk-taking Biases Risk Aversion : Above Average Emotional Vulnerability : Below Average Cutting winners short : Below Average For Details Click here Impulse-control Self-discipline : Above Average Immediate Gratification : Below Average Excitement-seeking : Very Low For Details Click here Intellectualism Intellectualism : High For Details Click here Herding Trend-following : Below Average For Details Click here

The 10 Mistakes Investors Most Commonly Make

All investors make mistakes. Otherwise, we'd all be millionaires. The trick is figuring out what our investing mistakes are -- and then trying to avoid them.

Meir Statman, one of the nation's leading experts in behavioral finance (the study of why people do irrational things with their money), has written a new book on the topic. In What Investors Really Want, published in October by McGraw-Hill, Statman goes a long way toward helping investors understand that many of their mistakes are caused by their own deep-seated emotions rather than, say, a company's unexpectedly poor earnings. 

In an interview with DailyFinance, Statman, a professor of finance at Santa Clara University in California, shared his top 10 errors that trip up average investors:

1. Hindsight error. "One of the most pernicious mistakes," Statman says. Because you can see the past clearly, you think you have a similar ability to tell the future. Hindsight error is common at the moment, Statman says, because many people are convinced they saw the crash coming in 2007. In reality, they may have thought a crash was possible, but they also thought the market might continue to zoom upward. Now, investors are convinced they actually saw the problem in 2007 but just didn't act on it. So, they believe wrongly that they can act correctly today. They think they know to sell at the precise moment the market is high and buy when the market is low. Based on their hindsight of 2007, portfolio diversification doesn't protect you from losses. But market timing rarely works, Statman says.

2. Unrealistic optimism. This is loosely related to overconfidence. Psychological studies have shown that when you ask people if they think they have the ability to pick stocks that will have above-average returns, men tend to say yes more often than women. "It's not because men are so smart. It's because men are unrealistically optimistic about their abilities," Statman says. This quality is great for job interviews, where you need to stand out from a crowd, but lousy for investing. "When you are unreasonably optimistic in the stock market, you are just readying yourself for an accident," he says.

3. Extrapolation errors. People expect that trends that existed in the recent past will continue in the future. For example, the fact that gold has gone up for the last 10 years has led many to believe it will always go up. But a study of a longer period -- going back to 1971 when President Richard Nixon ended the gold standard -- shows that gold hit a high of $850 an ounce in 1980 but was selling for $345 as long as 10 years later.

4. Framing errors. Often, Statman says, investing is like a game of tennis. People tend to see themselves hitting a ball against a wall, which seems easy. But that's the wrong frame. Investing is really like playing against another player -- when the other player is Warren Buffett or Goldman Sachs. Investors make framing errors when they see a CEO on TV talking up his stock. If it sounds good and you buy that stock, that's a framing error. Instead, you should be asking yourself: "Who else is watching this program, and what do I know that is uniquely mine?" "The answer is nothing," Statman says.

5. Availability errors. This refers to what information is available in your memory. Investors are often lulled into this error by investment companies. When you see an advertisement for a fund, it's almost invariably for one that has a four- or five-star rating from Morningstar. That way, the one- and two-star funds, with lackluster results, aren't available in your memory. "You say to yourself that there's a 90% chance I will be a winner," Statman says. Instead, look at results of entire fund families -- including the losers, not just the winning funds for a particular period, he says.

6. Confirmation errors. Investors tend to look for information that confirms their hypothesis, but they disregard evidence that contradicts it. Gold bugs, for example, constantly remind us that gold is a good hedge against inflation and a declining dollar. But when confronted with the evidence that gold actually fell price for an entire decade, they dismiss that as a different era because Ronald Reagan changed the rules of the investing game, and that problem won't be repeated.

7. Illusion of control. This is a sense investors have that they can make the market go up or down. It's like gamblers blowing on their dice before rolling. "These investors think they're riding the tiger, when in fact they're holding the tiger by the tail," Statman says. If you think you have a trick that can get the market to go your way, you better think twice: This is the illusion of control. "When you realize the market is actually a wild beast that can devour you, you try to put it in a cage," he says. A much safer approach.

8. Anger. This is an emotion we all know: It leads to things like road rage. In investing, you try to get even with the market. You do such things as double down or even sell all your stocks impulsively. "If you feel angry, it's better to wait 10 days before buying or selling, or you'll regret it later on," Statman says,

9. Fear. The other side of exuberance. When you're afraid, everything looks like a threat, and when you're exuberant, everything looks like an opportunity. Lots of investors are still afraid because of the market crash two years ago. They're sitting on the sidelines in cash earning no return or investing in things like Treasury bills, which aren't much of a bargain. "Risk and return go together," Statman says. "So, if you think the market is risky today, then you should also think the market has a good potential for high returns."

10. Affinity of groups. Also known as herding. You hear from your pediatrician that he's buying gold, so you think you should, too. But what do these people really know? What is the analysis based on? Statman notes that some herds are worth joining and some aren't. Many investors follow Warren Buffett's investment decisions and buy similar stocks. Since Buffett is usually a winner, perhaps that's a herd worth joining. But buying Internet stocks in 1999 or houses in 2005 based on what everyone else was doing was a horrible mistake.

Statman makes no grand conclusions in his book, but he does point out repeatedly that the average investor can rarely beat the market. Therefore, he recommends small investors put their money in index funds that provide average, if not spectacular returns -- and not catastrophic losses

"But if you like the pizazz of investing," he says, you might take a shot on individual stocks. Just be careful. 


By Charles Wallace

Posted 6:00AM 12/05/10
http://www.dailyfinance.com/2010/12/05/10-mistakes-investors-make/

Factors influencing Decisions: A Quest for the proper course of Decision-making in Share-investments

Factors influencing Decisions:

A Quest for the proper course of Decision-making in Share-investments

It has been seen for a long time that human being is not always rational and his decisions are not always objective. For instance, if one watches share market, technically the price of a stock should be reflection of its P/E, P/CF & P/BV values, but such is not the case most of times, because the prices of indices are also governed by various aspect and factors of human mindset- expectations, sentiments and excitement to name a few.

This unpredictability of human behavior has led to emergence of a new field in psychology termed as ‘Behavioral Finance’. Behavioral Finance is the study of roles of behavioral factors in the field of finance, especially investment

It is well-known fact that intelligence is one of the important factors, besides hard work and perseverance for achieving success in life. It is generally expected from an intelligent individual to perceive and understand situation properly, think rationally and reason out everything, before making any decision. Clarity of goal, a well-thought strategy to achieve the same, moderate level of motivation, a disciplined behavior with flexibility to reassess the strategies with new developments is certain other requirements to achieve success. This is applied everywhere, in all decisions and goals including individual’s investment decisions as well.

But since human beings do not live in isolation, therefore there are other factors as well which influence his interpersonal relations, and consequently his decisions. Rationality in a man’s decisions or behavior is not always seen as to be expected from them. For instance, people do make different decisions in the two similar situations or behave similarly in two different situations depending upon their emotive state of mind. Thus, emotion plays a vital role in influencing his behavior and decisions. This becomes more apparent in case of investment-related decisions when taken in relation to the share market.

But debate does not end just here. Human beings are not just born for investment; they have other things to do as well. There are numerous occasions when people make mistakes in investment-decisions mostly under the influence of emotions and stress. It is not possible for a person to be totally immune to his emotions, but once he is aware of the risks involved with emotional instability, one can limit the losses. In this context, fear and greed are the most well-known emotions. There is tendency in human-beings to make more money in short time and this tends him to invest in share-market, even when it is at boom. So when market is bearish, the emotion of fear replaces greed. Human-beings love profit, but hate loss even more. A slightly negative indication brings in a lot of negative emotions and consequently, fear comes in. Initially, investor holds position (while rationally, if he wants to quit, he should book losses at that time only) and once the market’s bottoming out tendency to quit gets bigger (though if investor has been rational, he should have waited for a little longer duration and should have stuck to his position). In this way, it would not be wrong to say that not only fear and greed have negative effect on rational thinking, but they also have adverse effects on the long-term strategies of individual. These two unfortunate passions bring in impulsiveness in the individual’s character and continue to press him to take irrational decisions.

Further, Defense-mechanism of denial used by a person to save his self esteem and his ego are also significant factors which prove dangerous in the long run. An investor is, most of the times, adamant to accept that he has made wrong decision. So, he sticks to his decision and end up holding his loosing position longer than what should have been. The anticipation of ‘being wrong’ by any investor, cuts his losses and enables him to take decisions which help him to recover the loss.

Another aspect of Defense-mechanism of denial is its effect on analytical reasoning. Under emotional state of denial, an individual perceives selectively. He tends to emphasize data and information which confirm his position and viewpoint. It also restricts the individual to rationally analyze any new adverse information. Sometimes, it also generates tendency to overemphasize any subtle good indicator and underemphasize the bad indicators, and so, compel the investor to continue with the loosing position, thus aggravating loses.

These factors always influence the decisions of an individual, but the degree of their influence differs. Now, it depends on the individual how he (or she) manipulates these factors for profit. A good investor is one who not only comes out of loss by applying logical thinking but also makes it profitable one. Moreover, one should not stick to his decisions, if situations have changed. The people with low self-esteem and low EQ stick with their decision and apply defense mechanism. False impression of hope leads them to further losses. They even set aside the direction of necessary indicators.

So, to be a good investor, the proper way to act is not simply to book profit at appropriate time, but also to minimize losses in the adverse situations.

’Never Say Die’

http://ansblog.com/2010/02/factors-influencing-decision-making-process/#ixzz0ehyAKUQA

Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

If I can’t convince you that a market downturn is no reason to panic, maybe the world’s greatest investor can. In his 1997 letter to Berkshire Hathaway shareholders, Warren Buffett wrote:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
The next time the stock market takes a tumble, remember Buffett’s advice. And then go out and buy yourself some hamburgers!

Facebook IPO - The Psychology driving the Investors

Facebook is the biggest IPO ever listed in the U.S.

In the light of its recent listing, this video is a very good one to understand the psychology of IPO investing.

There are great lessons one can learn from Parag Parikh, who explains this very well.

With these knowledge, your investing will be safer.

Facebook exec ducks questions about IPO debacle

May 24, 2012

Sandberg speaks during Class Day ceremonies at Harvard Business School in Allston, Massachusetts May 23, 2012. — Reuters pic

BOSTON, May 24 — Facebook chief operating officer Sheryl Sandberg spoke to Harvard University students in her first public appearance since the company’s disappointing initial public offering, but refrained from addressing the controversy around its messy, glitch-plagued debut.

Instead, Sandberg urged students graduating this week from Harvard’s business school to work for fast-growing companies, communicate honestly and address inequality in the workplace.

“We need to acknowledge openly that gender remains at issue at the highest levels,” she told a crowd of students and their families assembled Wednesday afternoon on a lawn outside the business school library alongside Boston’s Charles River. Only about 16 per cent of the highest corporate jobs are held by women, the same level as a decade ago, she noted.

Sandberg, who visited her alma mater with her parents and two children, only once made reference to the IPO in her speech. After urging the graduates to use Facebook to stay in touch, she said: “We’re public now, so could you please click on an ad or two while you’re there.”

Asked before and after the speech to comment on the IPO, Sandberg said she not speaking to the media.

She told the crowd that she sometimes suffers from anxiety: “When things are unresolved, I get a tad anxious,” said the 42-year-old who became one of Harvard’s wealthiest alumni after the IPO. “People have never accused me of being too calm.”

She chatted and posed for photos with dozens of students after the speech. Several said they had accepted jobs with Facebook. “I’ll see you over the summer,” she said to one of them.

Facebook shares closed yestersday at US$32 (RM96) a share, 16 per cent below the price at the IPO last week. The deal was beset by computer glitches at the Nasdaq market and lower-than-expected demand from investors.

Facebook and lead underwriter Morgan Stanley were sued by shareholders yesterday who claimed they hid the social networking company’s weakened growth forecasts ahead of its US$16 billion initial public offering.

Sandberg received an undergraduate degree from Harvard in 1991 and an MBA from the business school in 1995. — Reuters

How Zuckerberg cashed in $1.13 BILLION worth of his personal shares BEFORE stock cratered - now could it end up at $10?
Read more: http://www.dailymail.co.uk/news/article-2148839/Facebook-IPO-Mark-Zuckerberg-cashed-1-13bn-worth-personal-shares-BEFORE-stock-cratered.html#ixzz1vksQbPPc

Behavioural finance

The moods of some 'investors' were decisively that of fear and panic the last few days.

What did you do to your portfolio the last few days when the market was trending downwards?

1.  Did nothing   
2.  Cashed out of all your stocks (100% cash)   
3.  Cashed out of some of your stocks   
4.  Bought some more stocks   
5.  Bought a lot more stocks   
6.  Switched your stocks from A to B.  

Why did you take the action that you did?

What were the thinking driving your behaviour?

Sucess and Failure: Lecture by Parag Parikh

Behavioural Finance Solutions

Dale Carnegie ..... How to stop worrying. What is the worst that can happen if you take a decision. Analyze the facts and the situation: it may not be as bad as you think. Be prepared for the worst. GO AHEAD AND TAKE THE DECISION.

Behavioral Finance: The Role of Psychology

Uploaded by YaleCourses on Nov 19, 2008

Financial Markets (ECON 252)

Behavioral Finance is a relatively recent revolution in finance that applies insights from all of the social sciences to finance. New decision-making models incorporate psychology and sociology, among other disciplines, to explain economic and financial phenomenon, such as erratic stock price variations. Psychological patterns such as overconfidence and perceived kinks in the value function seem to impact financial decision-making, but are not included in classical theories such as the Expected Utility Theory. Kahneman and Tversky's Prospect Theory addresses such issues and sheds light on irrational deviations from traditional decision-making models.

00:00 - Chapter 1. What Is Behavioral Finance?
09:01 - Chapter 2. Market Volatility: Random, or Socially Influenced? A Present Value Analysis
19:58 - Chapter 3. Overconfidence: Its Ubiquity and Impact on Financial Markets
38:29 - Chapter 4. The Kahneman and Tversky Prospect Theory or, How People Make Choices
58:50 - Chapter 5. The Regret Theory and Fashion as a Measure of the Market

Complete course materials are available at the Open Yale Courses website:http://open.yale.edu/courses

This course was recorded in Spring 2008.

How to Apply the Secret - The Stick Man

Bob Proctor uses little stick men to explain how our mind works, how we think and create our personal attitude and overall view of life.





Always Express Gratitude.

How can Behavioural Economics Increase the Effectiveness of Financial Education?

http://www.oecd.org/dataoecd/47/62/45485586.pdf

7 Courses Finance Students Should Take

Posted on Oct 24, 2011 by Brigitte Yuille

Most careers in finance involve finding effective ways to manage an organization's money, in order to create wealth and increase the organization's value. Finance majors prepare for this career by studying topics about "planning, raising funds, making wise investments and controlling costs," according to the College Board. This knowledge sets them up for a wide array of career paths in the areas ofcorporate finance, financial institutions and investments.

Tutorial: Education Savings Account

Executives in search of well-rounded finance students look for certain skills. Studies have revealed that these executives want schools to place more emphasis on quantitative, strategic, critical decision-making and communicative skills, which are sometimes best developed in classes outside of business schools. If you want to get the best possible preparation for the finance world from your undergraduate education, put some thought into which classes to take, that may fall outside the finance curriculum.

What Companies Want
Business leaders at Booz Allen Hamilton, a strategy and technology consulting firm, discussed areas of change that could be implemented at graduate business schools, in the article "What Business Needs from Business Schools." They suggested that more courses were needed to teach graduates to effectively manage individuals and team-driven organizations, provide tools for problem solving and provide better grounding in theory. They also recommended more courses outside of the traditional curriculum. (Companies are in need of strategic candidates, not walking resumes. Learn more in Business Grads, Land Your Dream Job.)

Finance professors at Duke and Berkeley have made suggestions for courses finance students should take, outside of their business school curricula. John Graham, a finance professor at Duke University's Fuqua School of Business and John O'Brien, finance professor at Berkley's Haas School of Business, recommend the following areas of study:

• Mathematics - Courses in college algebra and calculus will help students learn how to solve equations in complex financial markets. Statistics helps with decisions based on the likelihood of various outcomes and allows finance students to learn to reach conclusions about general differences between groups and large batches of information. It also explains the movements of a company's stock.
  
• Accounting - Financial and managerial accounting courses teach finance students how to understand, record and report financial transactions, monitor the company's budgets and performance, and examine the costs of the organization's products and services.
  
• Economics - Economics looks at how scarce resources are allocated to achieve needs and wants. A course in macroeconomics will teach finance students to understand the impact of financial market activities on the overall economy. Microeconomics will help them understand the behaviors that occur within individual firms and among consumers, as well as how various financial decisions can impact a firm's success. (For more on these subjects, read Economics Basics: What Is Economics?, Macroeconomic Analysisand Understanding Microeconomics.)
  
• Psychology - Financial professionals need to understand the behaviors and thought processes that help drive the movements in financial markets. A course in critical thinking teaches a finance student to reflect and evaluate an argument, and examine situations in all dimensions before applying a solution. This involves understanding what is not known about the situation versus what is known. Behavioral finance can help finance students explore why and how the financial markets aren't working, by examining how investors' behaviors are associated with market anomalies. This subject helps financial professionals determine where investors make mistakes and how to correct them, by examining the emotion or thought behind the actions. Behavioral psychology helps finance majors look at the observable and cognitive aspects of human behavior, within a financial environment. (Find useful insight about how emotions and biases affect the market in Taking A Chance On Behavioral Finance.)
  
• Writing - A course in technical writing will teach students how to put forth strong, clear and organized ideas, purposes and explanations in memos, reports and letters.

Additional Course Recommendations

The business consultants at Booz Allen Hamilton, Joyce Doria, Horacio Rozanski and Ed Cohen, made their case for curriculum reform and also recommended courses in psychology, economics and human behavior. In addition, they recommended classes in the following areas of study:

• Communications - A communications course, such as public speaking, helps finance students present financial reports and explain the meanings behind equations and numbers, to colleagues in group settings. It also helps with the management of people and organizational relations, such as in delegating responsibilities to employees within financial departments. Business students also need courses in corporate communications, crisis communications and PR strategies, according to a 2005 Public Relations Society of America study. It states how financial scandals and downturns can affect shareholder support, consumer confidence and corporate reputation issues. Finance students will benefit from knowing how to handle corporate reputation issues, should they arise.
  
• Ethics - Corporate scandals, such as the Enron scandal, which involved irregular accounting procedures, have also encouraged some business schools, such as the University of San Francisco and Loyola University Chicago, to add a course in ethics to their finance curricula. These courses focus on moral development in an attempt to stem future misconduct in business environments.

The Bottom Line 

Students studying finance will be tasked with big responsibilities in their careers. They will have to manage the flow of money at their companies and identify financial risks and returns to make effective business decisions. Those finance majors who want to have an edge over their competition, both during the initial post-graduate job search and throughout their careers, will take advanced mathematics, accounting, economics, psychology, communications and writing courses to gain a deeper insight into their jobs and a better ability to work effectively with people. 

For related reading, see Top Job-Search Mistakes For Finance Grads, How To Land A Finance Job Straight Out Of Undergrad and Top 10 Cities For A Career In Finance. 

Author: Brigitte Yuille
http://www.investopedia.com/articles/professionaleducation/09/non-finance-courses.asp?mobileapp=1

Psychology of Investing (articles)

Psychology of Investing (13)

How anchoring sets you adrift

20 Jan 11If you bought a stock at $30 and sold simply because it fell to $20, you’re a victim of anchoring. Here’s how you can overcome it.

ARTICLES

• Aristocrat Leisure: A case study in psychology
• Evolutionary investing
• A couple of years don’t make a decade
• The power of incentives
• Don’t fall in with the sharemarket crowd
• Standing firm in a wobbly stockmarket
• Are your bank shares yielding 34%?
• Golden rules for losing money—part 2

ARTICLES (CONT.)

• Golden rules for losing money
• Handling stock price falls
• Where to Start?
• Spring cleaning for portfolios

I don't understand why business schools don't teach the Warren Buffett model of investing.

I don't understand why business schools don't teach the Warren Buffett model of investing.


Or the Ben Graham model. Or the Peter Lynch model. Or the Martin Whitman model. (I could go on.) In English, you study great writers; in physics and biology, you study great scientists; in philosophy and math, you study great thinkers; but in most business school investment classes, you study modern finance theory, which is grounded in one basic premise--that markets are efficient because investors are always rational. It's just one point of view. A good English professor couldn't get away with teaching Melville as the backbone of English literature. How is it that business schools get away with teaching modern finance theory as the backbone of investing? Especially given that it's only a theory that, as far as I know, hasn't made many investors particularly rich.

Meanwhile, Berkshire Hathaway, under the stewardship of Buffett and vice chairman Charlie Munger, has made thousands of people rich over the past 30-odd years. And it has done so with integrity and a system of principles that is every bit as rigorous, if not more so, as anything modern finance theory can dish up.

On Monday, 11,000 Berkshire shareholders showed up at Aksarben Stadium in Omaha to hear Buffett and Munger talk about this set of principles. Together these principles form a model for investing to which any well-informed business-school student should be exposed--if not for the sake of the principles themselves, then at least to generate the kind of healthy debate that's common in other academic fields.

Whereas modern finance theory is built around the price behavior of stocks, the Buffett model is centered around buying businesses as if one were going to operate them. It's like the process of buying a house. You wouldn't buy a house on a tip from a friend or sight unseen from a description in a newspaper. And you surely wouldn't consider the volatility of the house's price in your consideration of risk. Indeed, regularly updated price quotes aren't available in the real estate market, because property doesn't trade the way common stocks do. Instead, you'd study the fundamentals--the neighborhood, comparable home sales, the condition of the house, and how much you think you could rent it for--to get an idea of its intrinsic value.

The same basic idea applies to buying a business that you'd operate yourself or to being a passive investor in the common stock of a company. Who cares about the price history of the stock? What bearing does it have on how the company conducts business? What's important is whether you can purchase at a reasonable price a business that generates good returns on capital (Buffett likes returns on equity in the neighborhood of 15% or better) without a lot of debt (which makes returns on capital less dependable). In the best of all worlds, the company will have a competitive advantage that allows it to sustain its above-average ROE for years, so you can hang on to it for a long time--just as you would live in your house--and reap the power of compounding.

Buffett further advocates investing in businesses that are easy to understand--Munger calls it "clearing one-foot hurdles"--so you can come up with more reliable estimates of their long-term economics. Coca-Cola's basic business is pretty staid, for example. Unit case sales and ROE determine the company's future earnings. Companies like Microsoftand Intel--good as they are--require clearing much higher hurdles of understanding because their business models are so dependent on the rapidly evolving world of high tech. Today it's a matter of selling the most word-processing programs; tomorrow it's the Internet presence; after that, who knows. For Coke, the challenge is always to sell more cases of beverage.

Buying a business or a stock just because it's cheap is a surefire way to lose money, according to the Buffett model. You get what you pay for. But if you're evaluating investments as businesses to begin with, you probably wouldn't make this mistake, because you'd recognize that a good business is worth buying at a fair price.

Finally, if you follow the Buffett model, you don't trade your investments just because our liquid stock markets invite you to do so. Activity for the sake of activity begets high transaction costs, high tax bills, and poor investment decisions ("if I make a mistake I can sell it in a minute"). Less is more.

I'm not trying to pick a fight with modern finance theory enthusiasts. I just find it unsettling that basic business-school curricula don't even consider models other than modern finance theory, even though those models are in the marketplace proving themselves every day.

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/teachbuffet.htm