Warren Buffett is currently ranked No. 3 on the Forbes' list of wealthiest billionaires in the world, after Carlos Slim and Bill Gates. Despite his overwhelming investment success since the 1960s, and his fairly intuitive value investing philosophy (buy only what you know, buy when others are fearful, and invest like an owner), not many investors seem to really follow his lead.
And this goes for the average retail investor, too. Buffett and his partner-in-crime Charlie Munger stipulate a very simple, easy-to-follow investing methodology that can be adopted by every mutual fund manager as well as every mom and pop investor interested in buying stocks.
So why is it that there are not more Warren Buffetts in the world with a similar level of wealth and investing success? After all, his investing philosophy is based on Graham's The Intelligent Investor. The principles have been round for a long time -- why is it so difficult to follow them?
I believe there are three reasons in particular why both professional and retail investors have an extraordinarily hard time in applying the invaluable investing wisdom of Warren Buffett and Charlie Munger:
1. Crowd psychology
Stock markets are mostly an experiment in crowd psychology where investors follow the price action.
Speculators dominate the marketplace in hopes of taking advantage of ever increasing stock prices. The problem is that you'll never know if you find someone who is willing to pay an even higher price than you did. The bottom line is: If you are chasing investment returns, you're not investing -- you are gambling.
And this gambling approach to investing stands in stark contrast to Warren Buffett's value investing methodology.
Buffett has repeatedly stated that his favorite holding period is forever. Investing with the ambition to hold onto your investment forever has a powerful psychological effect on your decision-making: You will be extremely discriminatory toward potential investments, because you really would want to make sure that you have done your research and that you pay a reasonable price for what you get in return.
Or as Buffett phrased it: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Patience is a vital attribute for any successful investor. Warren Buffett, for instance, bought Coca-Cola in the 1980s, and still holds his investment to this day. Buffett's true long-term investment horizon differentiates him from a lot of average investors.
The stock market itself has a weird disposition for testing an investor's patience. Oftentimes, a stock can pull back and consolidate for extended periods of time, especially when the company goes through a painful restructuring process, or when the economy enters into a recession. At times like these, it is easy to abandon your investment thesis and give in to negative stock market commentary and falling stock prices.
While most investors panic in such circumstances, Buffett often emerges as a buyer in periods of uncertainty, and then plays the patience game. Just consider his investments in Goldman Sachs, General Electric and Bank of America at the height of the financial crisis when other investors were panicking and losing confidence in the U.S. economy.
Buying panic and being patient can have a tremendously positive influence on your investment return.
3. Trading mind-set and overconfidence bias
Constant stock market news, rating upgrades, and a never-ending stream of economic news suggest to investors that they need to be active and trade in order to not 'miss out'.
The 24-hour news cycle is not helping the average mom and pop investor either, and instead seduces them into trading. Warren Buffett, on the other hand, "stays away from any environment that stimulates activity".
A trading mind-set also implies that investors think they can be successful market timers, and that they are ultimately smarter than most investors. This mind-set is closely related to the overconfidence bias, which stipulates that investors overestimate their chances of success and misjudge risk. It goes without saying that the overconfidence bias is not a good investment ally.
Buffett really excels in separating emotions from his investment decision-making, and refuses to be influenced by stock market reporting, ticker alerts and hot stock tips. Trading and chasing returns is a display of herding behavior (another emotional bias) and quite the opposite of what Warren Buffett advocates for.
Why it matters
Investors can learn a lot from Buffett if they refrain from desiring quick stock market returns (clearly not an easy thing to do), and when they understand their role as individuals as part of a crowd that always chases action.
Herding behavior, an impatient character as well as a display of overconfidence have the potential to kill investors' returns. If investors want to achieve sustainable, above-average returns, the sound value investing strategy of Warren Buffett is just about the only way to go.
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