You Are Not Mr. Buffett
There is no arguing about the tremendous investment success enjoyed by Warren Buffett, whose fortune is estimated at $66 billion according to Forbes. In fact, on Friday shares of his Berkshire Hathaway group traded above $200,000 to an all-time high of $203,350. Berkshire (BRK/A) first crossed $100,000 back in October 2006 (Figure 1). I read a statistic from S&P Dow Jones this past week that Mr. Buffett has returned 22.6% compounded since the stock first traded at $100 in May 1977. To honor the BRK/A $200,000 milestone, many offered thoughts on Mr. Buffett’s career. One very good article by Business Insider was tweeted by Jim Cramer.
Figure 1: Berkshire Hathaway Inc. Class A Shares, 1987 - 2014
The media headlines will probably encourage investors to consider how they can emulate Mr. Buffett’s investment strategies. So let’s give consideration to that and see if his strategies will work in reality for the average investor. To do so, oddly enough I will borrow some of the risk management strategies employed by one of the few legendary successful traders of our generation, Paul Tudor Jones. You see Mr. Buffett and I don’t want you trading. But I do want you to measure risk, and prioritize it first and foremost for your investment strategy like Paul Tudor Jones has for over 40 years. In doing so, that is where I need investors to dismiss themselves from believing they can invest identically to Mr. Buffett. They can’t.
Mr. Buffett seeks to buy businesses, not stocks. A great strategy, I agree. However, the difference is when the capital markets incur their invariable correction. Mr. Buffet has the financial wherewithal to look solely at the value of those businesses and not at the absolute dollar loss he is incurring in his portfolio. Unfortunately the majority of the investment community, including myself, is not afforded that luxury. Plain and simple, there are way more zeros in Mr. Buffett’s bank account then ours. The value of a business becomes irrelevant; our financial loss is what matters. Whether you are a Goldman Sachs money manager who wants to get paid on his bonus or a John Doe concerned with protecting family assets, in a market correction your first inclination will be to protect your capital.
Given the current proximity to historic highs for fixed income and equities, it is a great time to discuss this topic. Why? Because if you think like Paul Tudor Jones and focus first on risk, I suspect you can improve your outcome and actually be more like Mr. Buffett in valuing the business, not the capital in your account.
I worked for nearly 20 years as Mark Fisher’s right-hand man, the director of trading for his proprietary trading firm. Mark is a disciple, and close friend, of Paul Tudor Jones. We would always “prepare for the worst, and hope for the best” when taking positions in the market. Never would we ask, “How much can I make?” It was always, “How much can I lose?” We would incorporate strategies like using a “point of reference” to exit. It was all about discipline, maximizing winners, and most importantly, minimizing losses.
That is how investors can improve their outcome. At this moment in time, first and foremost, investors should be reviewing their portfolios and asking themselves how much loss of capital they can withstand when the invariable correction occurs. Position your portfolio so that capital loss does not become a priority during the correction and force you to turn an unrealized loss into a realized loss solely because you can’t handle losing the money. Don’t overinvest with a focus on how much you can profit.
Let’s say you do the analysis and determine that in a correction you will be placed into a position of absorbing a loss beyond what you can tolerate without forced selling, however, you are unwilling to reduce exposure at this time. Okay fine, but please identify with your advisor your “point of reference” during a market decline when you will limit risk exposure, whether to equity- or bond-sensitive investments.
People often ask me if I gamble, and candidly I don’t. I really don’t enjoy it. But I do believe for anyone that does gamble, you should only walk into a casino with what you are willing and can afford to lose. Similarly, I often receive business proposals that always seem to offer “xyz return potential” on the cover. Those get quickly trashed. I recently was offered an investment opportunity that was explained to me in a manner I truly appreciated. The proposal was all about identifying how much of my investment I could potentially lose and under what conditions capital risk would be elevated. Great strategy, count me in.
Unfortunately you and I can’t be Mr. Buffett; there are about $66 billion reasons why not. However, you can improve your investment outcome by first and foremost focusing on the risk, not the reward. This just might be the perfect time.