The Other Buffett Effect: Misperceptions About Investing

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The Warren Buffett Effect is known as the momentum effect in specific stock prices based upon their changes in the Berkshire equity portfolio. But that won't be our topic of discussion today. Instead, we will be talking about the effects on the perception of investing as a result of Buffett's prominence.

Buffett Effect - Inspiration came from the CSI Effect

The CSI effect is any of several ways in which the exaggerated portrayal of forensic science on crime television shows such as CSI: Crime Scene Investigation influences public perception. The popularity of forensic crime television shows supposedly gives rise to many misconceptions about the nature of forensic science and investigation procedures among jury members.

– Excepts from Wikipedia

Back to our home ground of investing, I'm not saying that Buffett exaggerates any aspect of investing. However, non-aficionados who only get their dosage of Buffett from mainstream media sources may suffer from certain degrees of misperception as trivial details are often glossed over by the media.

Misperception #1: Investing is exciting

Deals usually attract the most attention in the media. Recently, Berkshire Hathaway announced its second largest ever acquisition – a USD37.2bn cash purchase of Precision Castparts. Previous mega-deals by Berkshire include its USD36bn purchase of BNSF Railway as well as its USD36bn acquisition of Kraft foods by Heinz. People might envision jet setting billionaires flying around the world in their private jets to negotiate and close deals, giving the impression that professional investing is an exciting business with fame and fortune. However, the reality is that most investments are done under the radar of public attention. Even for a high profile company like Berkshire, only the most passionate of investors will be able to name some of their other less sensationalised holdings. In fact, most professional investors prefer either to only disclose their holdings to clients, or to have a significant time lapse before disclosing to the public. Consider how many funds are there in the world, and that funds typically have at least 20 positions in their portfolio; the media simply cannot pay attention to all.

Truth: Fame in investing is hard to come by. Attention is seldom given for most investments made by professionals, however well they may turn out.

Buffett Effect Misperception #2: Investing is a passive activity, yet the returns are astronomical

The returns of Berkshire and other renowned investors are legendary. In addition, investing is usually perceived as a source of passive income. Taking both factors into consideration, it may seem like the returns came easy – all they had to do was to buy a stock and go onto a beach somewhere to wait for the money to roll in.

While investing is a source of passive income for most people, it ceases to be so for serious or professional investors. Day in, day out for years after years, these people dedicate themselves to learning and researching all that they can about their field of expertise. It is a perpetual search for the next idea in order to maximise returns. Their performance records do not come easy.

As Benjamin Graham once said, “The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear his task. The minimum return goes to our passive investor, who wants both safety and freedom from concern. The maximum return would be realized by the alert and enterprising investor who exercises maximum intelligent and skill.”

Truth: The level of returns is often commensurate with the amount of effort put in.

Buffett Effect Misperception #3: Quality companies are the only way to go

Buffett is known for his preference for quality companies with good businesses. These are defined by their strong, sustainable moats and good management. He has been very vocal about this; a simple Google search will yield many quotes by Buffett in relation to quality. Because of Buffett's prominence, I believe many try to emulate his style of investing. While it is a based on solid and logical principals, the cold hard truth is that quality investing is nebulous in its definition and difficult to execute. By definition, not everyone can be a Buffett and many will fall short in using the same exact same strategy as the legendary investor. There are many relatively easy, albeit less lucrative, strategies available but they have not received the same coverage as quality investing.

Truth: There are many viable, alternative strategies besides investing in quality companies.

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Berkshire Hathaway Buffett Effect