Sunday, March 8, 2015

Warren Buffett's Advice for Individual Investors

Warren Buffett is probably the most successful individual investor alive today. He also gratuitously and generously takes time to guide individual amateur investors with respect to how we too can achieve long term investing success. The rules he advocates that we follow are simple, based on common sense and easy to understand and apply.

These simple and useful rules aren't generally applied by most people, including advisers, so it's a good idea to share them when the 'Oracle of Omaha' has something to say. With that in mind, here goes.

5 stock-market rules that Warren Buffett insists you follow says this:

1. A stock is a business, not a piece of paper

First, although it seems banal to say, a stock is an ownership unit of a business. . . .

The lesson for investors is that a stock represents the value of a business’s future earnings. You should own it for that reason, and not because you think you can capitalize on its short-term gyrations, which generally have nothing to do with its business value.

Although they can be crazy in the short term, stock prices are ultimately governed by the profits their underlying businesses generate, and you should treat them that way. . . . Price gyrations provide opportunities to buy at unreasonably low prices and sell at unreasonably high prices.

2. Stocks serve as inflation protection over the long haul

Buffett remarks that from 1964 through 2014, the S&P 500, including dividends, generated a return of more than 11,000%. Over that same period of time, the U.S. dollar lost 87% of its purchasing power, meaning it now costs $1 to buy what in 1965 cost 13¢.

According to Buffett, it has been far more profitable to invest in a collection of American businesses for the past 50 years . . . .

Investors should remember that U.S. stocks didn’t do well in the 1970s, when inflation was rocketing. But Buffett is clearly correct in arguing that stocks certainly improved the purchasing power of their owners over the half-century period from 1964.

Finally, although stocks may not be priced to deliver outstanding returns at any given moment, Buffett adds the phrase “bought over time” when talking about accumulating stocks. Investors should take that to mean regular periodic investments in stocks will likely turn out fine over a multi-decade period.

3. Volatility is not risk

Investors must tolerate far greater volatility in stocks than in securities tied to U.S. currency....

If you need money for a home purchase or to fund tuition payments over the next few years, then short-term bonds and cash are required. Stocks’ volatility makes them inappropriate for short-term goals.

But if you have a long time frame and can make regular investments, then the risk to your financial well-being is in not owning stocks. So if you’re relatively young, and you’re contributing to a 401(k), for example, you’ll do yourself a favor in old age by making contributions to stocks now and periodically through your life.

4. Keep a multi-decade time horizon

Buffett thinks long-term. . . . Being able to have a longer time horizon allows you to tolerate the volatility that stocks necessarily present, and reap the inflation-beating rewards they deliver.

5. Keep an eye on fees, and use index funds

Buffett is particularly ruthless this year in his discussions of investment bankers, asset managers, and advisers. He remarks that although there are some excellent money managers (presumably he’s counting himself), it’s difficult to identify them ahead of time or know whether their results are due to skill or luck.

Advisers’ core competence is in salesmanship, and they’re generally more adept at generating high fees for themselves than returns for their clients."

Summing up

For long term oriented individual savers and investors, the biggest financial risk is in not owning stocks for the long haul.

Perhaps the second biggest risk is for individuals to panic and sell when prices fall from time to time, and sometimes dramatically.

And the third may be the tendency to pay 'professionals' and brokers for services not worth the price charged. MOM (my own money) rules apply.

If we always keep in mind that the only two prices that really matter are the total amount we pay initially and then the net price we sell for eventually, we'll do fine.

And always remembering that price volatility and risk are two entirely different things wil stand us in good stead as well.

In other words, what Buffett has to say about investing makes sense.

That's my take.

Thanks. Bob.

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