WHAT WARREN BUFFETT HAS TO SAY ABOUT SEIZING BIG OPPORTUNITIES

Warren Buffet has often said that the average investor should practice diversification by investing in index funds.

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I’ve written several times (here, here, and here) about index funds and how investing in an S&P 500 index fund and using a dollar-cost averaging strategy is a great way to make money in the stock market over the long-run – and this point has been well documented by both research and results.

Part of the magic in this strategy is that an investor who doesn’t have much experience and who doesn’t know how to analyze or calculate the intrinsic value of a stock… doesn’t have to.

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Instead, he or she can invest in all of the stocks in the stock market – thereby diversifying risk while earning the average return of the entire stock market (which has historically been ~9.5%over the long-run). And Warren evidently agrees with this.

However, Warren Buffett sings a very different song for investors who want to beat the average stock market return.

WARREN BUFFETT ON DIVERSIFICATION

Warren does not believe an investor who wants to generate an above-market return should diversify his or her holdings. Here are some of his quotes on this subject:

Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.
Wide diversification is only required when investors do not understand what they are doing.
The strategy we’ve adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it.

Warren’s saying that if you invest in too many stocks in pursuit of portfolio diversification, you (a) take yourself out of your circle of competence and (b) lose the intensity and concentration that you would have if you were only thinking about a few great businesses.

WARREN BUFFETT ON SEIZING BIG OPPORTUNITIES

Warren Buffett described the below analogy during a lecture he gave to University of Georgia business school students in 2001. This “20 slot punch card” approach to investing underscores just how focused Buffett is when it comes to investing and highlights how we should all seize and capitalize on big opportunities when they come our way.

Big opportunities in life have to be seized. We don’t do very many things, but when we get the chance to do something that’s right and big, we’ve got to do it. And even to do it in a small scale is just as big of a mistake almost as not doing it at all. I mean, you really got to grab them when they come. Because you’re not going to get 500 great opportunities.

You would be better off if… you got a punch card with 20 punches on it. And every financial decision you made you used up a punch. You’d get very rich, because you’d think through very hard each one. I mean if you went to a cocktail party and somebody talked about a company and they didn’t even understand what they did or couldn’t pronounce the name but they made some money last week in another one like it, you wouldn’t buy it if you only had 20 punches on that card.

There’s a temptation to dabble – particularly during bull markets – and in stocks it’s so easy. It’s easier now than ever because you can do it online. You know you just click it in and maybe it goes up a point and you get excited about that and you buy another one the next day and so on. You can’t make any money over time doing that.

But if you had a punch card with only 20 punches, and you weren’t going to get another one the rest of your life, you would think a long time before every investment decision– and you would make good ones and you’d make big ones. And you probably wouldn’t even use all 20 punches in your lifetime. But you wouldn’t need to.

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Ben Graham, the father of value investing, wasn’t born in this century. Nor was he born in the last century. Benjamin Graham – born Benjamin Grossbaum – was born in London, England in 1894. He published the value investing bible Security Analysis in 1934, which was followed by the value investing New Testament The Intelligent Investor in 1949. Warren Buffett, the value investing messiah and Graham’s most famous and successful disciple, was born in 1930 and attended Graham’s classes at Columbia in 1950-51. And the not-so-prodigal son Charlie Munger even has Warren beat by six years – he was born in 1924. I’m not trying to give a history lesson here, but I find these dates very interesting. Value investing is an old strategy. It’s been around for a long time, long before the Capital Asset Pricing Model, long before the Black-Scholes Model, long before CLO’s, long before the founders of today’s hottest high-tech IPOs were even born. And yet people have very short term memories. Once a bull market gets some legs in it, the quest to get “the most money as quickly as possible” causes prices to get bid up. Human nature kicks in and dollar signs start appearing in people’s eyes. New methodologies are touted and fundamental principles are left in the rear view mirror. “Today is always the dawning of a new age. Things are different than they were yesterday. The world is changing and we must adapt.” Yes, all very true statements but the new and “fool-proof” methods and strategies and overleveraging and excess risk-taking only work when the economic environmental conditions allow them to work. Using the latest “fool-proof” investment strategy is like running around a thunderstorm with a lightning rod in your hand: if you’re unharmed after a while then it might seem like you’ve developed a method to avoid getting struck by lightning – but sooner or later you will get hit. And yet value investors are for the most part immune to the thunder and lightning. This isn’t at all to say that value investors never lose money, go bust, or suffer during recessions. However, by sticking to fundamentals and avoiding excessive risk-taking (i.e. dumb decisions), the collective value investor class seems to have much fewer examples of the spectacular crash-and-burn cases that often are found with investors’ who employ different strategies. As a result, value investors have historically outperformed other types of investors over the long term. And there is plenty of empirical evidence to back this up. Check this and this and this and this out. In fact, since 1926 value stocks have outperformed growth stocks by an average of four percentage points annually, according to the authoritative index compiled by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College. So, the value investing philosophy has endured for over 80 years and is the most consistently successful strategy that can be applied. And while hot stocks, over-leveraged portfolios, and the newest complicated financial strategies will come and go, making many wishful investors rich very quick and poor even quicker, value investing will quietly continue to help its adherents fatten their wallets. It will always endure and will always remain classically in fashion. In other words, value investing is vintage. Which explains half of this website’s name. As for the value part? The intention of this site is to explain, discuss, ask, learn, teach, and debate those topics and questions that I’ve always been most interested in, and hopefully that you’re most curious about, too. This includes: What is value investing? Value investing strategies Stock picks Company reviews Basic financial concepts Investor profiles Investment ideas Current events Economics Behavioral finance And, ultimately, ways to become a better investor I want to note the importance of the way I use value here. It’s not the simplistic definition of “low P/E” stocks that some financial services lazily use to classify investors, which the word “value” has recently morphed into meaning. To me, value investing equates to the term “Intelligent Investing,” as described by Ben Graham. Intelligent investing involves analyzing a company’s fundamentals and can be characterized by an intense focus on a stock’s price, it’s intrinsic value, and the very important ratio between the two. This is value investing as the term was originally meant to be used decades ago, and is the only way it should be used today. So without much further ado, it’s my very good honor to meet you and you may call me…