How Billionaire Warren Buffett Avoids Failure

It takes more than good business judgment to be an exceptional investor.

John Maxfield
John Maxfield
Jul 27, 2014 at 11:55AM

In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace.

- Warren Buffett (1987)

If you want to succeed at investing, you have to be able to control your emotions. In fact, if you want to succeed at investing, you must train yourself to act in a manner that's wholly inconsistent with the financial media's prevailing wisdom.

This is the essence of contrarianism. And no one is a bigger (and richer) contrarian than Warren Buffett, the chairman and CEO of Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B).

Why it pays to be contrarian
There are few years in the history of the stock market that prove this point better than 1987. Less than a decade after BusinessWeek infamously proclaimed "The Death of Equities," the market had not only recovered, but had soared to previously unforeseen heights.

But by October this would all come to an end. On the 19th of that month, the Dow Jones Industrial Average plummeted by 22.6%. It was, and remains, the largest single-day loss in the history of the American stock market.

Capturing the sentiment, a New York Times headline asked, "Does 1987 Equal 1929?" And a headline over at The Wall Street Journal read, "The Market Debacle Rouses Worst Fears of Little Investors."

In short, fear was in the air and everyone was headed for the exits. Everyone, that is, but Warren Buffett, who shared the following anecdote in his 1987 letter to shareholders:

Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him. Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

Buying high and selling low
The unfortunate truth when it comes to investing is that humans are programmed to fail.

When euphoria prevails, stock prices soar and greed induces us to buy into the hype, both literally and figuratively. Then, when fear takes hold, prices tank and we sell.

"We've been doing this for a long time," Carl Richards writes in The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money. "We do it because we make investment decisions based on how we feel rather than what we know."

And this is Buffett's point. In 1987, there was no reason to run for the exits. If anything, it presented a rare opportunity to buy stocks at a relative bargain.

If a tree falls in a forest...
It seems safe to assume that the level of hysteria that takes hold when the market swoons is directly related to the endless prodding of the financial media. In the latter's absence, it isn't difficult to imagine that market booms and busts would be both less frequent and less extreme.

The problem, at least according to noted financial blogger and columnist Josh Brown, is that people take the financial media too seriously. Take this point he made in a recent interview with my colleague Morgan Housel:

Let me tell you something interesting about financial media. Of all the verticals across different types of news, financial media is the only one where there's supposed to be some sort of responsibility that comes along with it. When you think about fashion, art, sports, Hollywood gossip – huge categories of news that dwarf financial news – there is no responsibility. People don't watch ESPN and then think they're supposed to go out and play tackle football with 300-pound guys. But when they watch financial or business news, they take the next step and say, "Well I'm supposed to act on this now. I'm supposed to do something about this."

Part of that is the fault of the media. The word "actionable" gets thrown around a lot. Actionable for who? Oh I don't know, it's just actionable. But a lot of the responsibility is on the public. And I think what most people do incorrectly is they focus on the news of the day, the stocks that are moving on a given day, whatever is driving the markets now, but they've got no background whatsoever about how to invest.

Are you starting to see a theme?
The point here, to return to Buffett's quote at the top of this article, if you want to succeed as an investor, it's critical that you cultivate an "ability to insulate [your] thoughts and behavior from the super-contagious emotions that swirl about the marketplace."

Remember, the financial media exists to entertain you, not to inform you.