Tag: Investing

Warren Buffett — The Best Book On Investing And What It Can Teach You

When legendary investor Warren Buffett was asked what the best money advice he ever received, he replied referencing “by far the best book on investing ever written,” The Intelligent Investor, written in 1949 by Benjamin Graham.

Buffett was a student of Graham’s at Columbia and subsequently worked for him before breaking off on his own.

“Chapters 8 and 20 have been the bedrock of my investing activities for more than 60 years,” he says. “I suggest that all investors read those chapters and reread them every time the market has been especially strong or weak.”

So what’s the core of these two chapters?

The Investor and Market Fluctuations

Buffett explains 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.

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.

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.

… [A]n 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. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.

Margin of Safety as the Central Concept of Investment

The core of this idea to know what a business is worth and pay less.

Again Buffett explains in his own words. At the 1997 annual meeting, Buffett explains this concept (quoted from Andrew Kilpatrick’s, Of Permanent Value: The Story of Warren Buffett)

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety.

When Mr. Market is happy he can materially erode the “margin of safety” that is the cornerstone of Buffett and Graham’s approach to investing.

Still curious? If you want to learn more about investing, there is no better education than the legendary investor himself. Read his shareholder letters online for free, in Kindle eBook, or book.

Hetty Green — The Richest Woman In America

Hetty Green knew a thing or two about making money. “A millionaire a hundred times over, she made made her mark beside Carnegie and Morgan, Vanderbilt and Rockefeller.”

Oh yea, and she did this in an era when women were traditionally excluded from all business dealings.

Janet Wallach’s biography of Green, The Richest Woman in America: Hetty Green in the Gilded Age, tells the story of her extraordinary life. Hetty’s principles, on life and investing, are as relevant today as they were during the late 1800s

“Never losing faith in America’s potential, she ignored the herd mentality and took advantage of financial panics and crises. When everyone else was selling, she bought railroads, real estate, and government bonds. And when everyone was buying and borrowing, she put her money into cash and earned safe returns on her dollars. Men mocker her and women scoffed at her frugal ways, but Hetty turned her back on them and piled up her earnings.”

“Cash combined with courage in a crisis, is priceless.” — Warren Buffett

Hetty had a way of stirring the pot, much the same way as present-day billionaire Charlie Munger. Her reputation for harshness was based on her independence, outspokenness, and disdain for the upper crust of society.

“She was,” writes Janet Wallach, “a woman alone in a world of envious men.” And she certainly wasn’t going to follow the men.

Everyone but Hetty seemed to be buying. She did not buy industrials, she said, and never bought with borrowed money. Once in a while she cornered a stock like Reading Railroad, but that was the exception, not the norm. “I don’t believe in speculating as a rule, and I don’t speculate as much as people think.” Her approach was far more cautious: “When good things are so low that no one wants them, I buy them and lay them away in the safe; when owing to some new development, they go up and my shares are so needed that men will pay well for them, I am ready to sell.”

Hetty experienced several financial panics during her lifetime. She believed they offered valuable lessons for the future: “exaggerated expectations, wild speculation, and high leverage would lead to disaster.”

Indeed, Hetty’s wisdom was well ahead of its time:

“There’s one reason why we have hard times: money easy coming and easy going. American children are not taught how to save money but how to spend it. Everything they want—give it to them so long as you know the price of the credit. That’s the policy of the modern mother and she is raising a nation of spendthrifts whose one thought is to get what they want when they want it.”

The wisdom of Hetty Green is as relevant today as it was during her time.

Before deciding on an investment seek out every kind of information about it.

Watch your pennies and the dollars will take care of themselves.

After your business is over you may take your colleague to dinner
and the theater, or allow him to take you, but wait until the
transaction has been closed and the money paid.

Before making a deal, if anyone is fool enough to offer you the
full amount, take it. If you are offered less, tell the man
you will give him the answer in the morning.
Think the matter over carefully in the evening. If you decide that it
will be to your advantage to accept the offer, say so the next day.

In business generally, don’t close a bargain until you have
reflected on it overnight.

The secret of good nursing is common sense, just as common sense
is the secret of making money.

What man has done, women can do.

It is the duty of every woman to learn to take care of
her own business affairs.

An ordinary gift to be bragged about is not a gift
in the eyes of the Lord.


Some young women do better in business than men.

A girl ought to be careful about the man she marries,
especially if she has money.

A girl oughtn’t to marry until she’s old enough to
know what she’s doing.

When good things are so low that no one wants them, I buy
them and lay them away in the safe; when owing to some new
development, they go up and my shares are so needed that men
will pay well for them, I am ready to sell.

I am always buying when everyone wants to sell,
and selling when everyone wants to buy.

If one can buy a good thing at lower cost than it has ever sold for
before, he may be fairly sure of getting it cheap.

Every girl should be taught the ordinary lines of
business investment.

Railroads and real estate are the things I like.
Government bonds are good, though they do not pay
very high interest. Still, for a woman safe and low
is better than risky and high.

Common sense is the most valuable possession
anyone can have.

The Paradox of Skill

Michael Mauboussin talking about his new book The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing with the WSJ:

The key is this idea called the paradox of skill. As people become better at an activity, the difference between the best and the average and the best and the worst becomes much narrower. As people become more skillful, luck becomes more important. That’s precisely what happens in the world of investing.

The reason that luck is so important isn’t that investing skill isn’t relevant. It’s that skill is very high and consistent. That said, over longer periods, skill has a much better chance of shining through.

In the short term you may experience good or bad luck [and that can overwhelm skill], but in the long term luck tends to even out and skill determines results.

WSJ: You say people generally aren’t very good at distinguishing the role of luck and skill in investing and other activities. Why not?

Our minds are really good at linking cause to effect. So if I show you an effect that is success, your mind is naturally going to say I need a cause for that. And often you are going to attribute it to the individual or skill rather than to luck.

Also, humans love narratives, they love stories. An essential element of a story is the notion of causality: This caused that, this person did that.

So when you put those two together, we are very poor at discriminating between the relative contributions of skill and luck in outcomes.

May The Odds Be Ever in Your Favor

In Mobs, Messiahs, and Markets: Surviving the Public Spectacle in Finance and Politics, Will Bonner writes:

…you don’t win by predicting the future; you win by getting the odds right. You can be right about the future and still not make any money. At the racetrack, for example, the favorite horse may be the one most likely to win, but since everyone wants to bet on the favorite, how likely is it that betting on the favorite will make you money? The horse to bet on is the one more likely to win than most people expect. That’s the one that gives you the best odds. That’s the bet that pays off over time.

And here is Charlie Munger speaking about the same topic:

The model I like to sort of simplify the notion of what goes o­n in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based o­n what’s bet. That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so o­n and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system.

And then the track is taking 17% off the top. So not only do you have to outwit all the other betters, but you’ve got to outwit them by such a big margin that on average, you can afford to take 17% of your gross bets off the top and give it to the house before the rest of your money can be put to work.

Herbert Simon: Scientific Research has much in Common with Successful Stock-Market Investment

This is a fascinating expert from How Managers Express Their Creativity” by Herbert Simon that deals with information flow within grounds and organizations. Simon compares successful scientific research with successful stock-market investing. Both scientists and investors are looking for mis-priced bets

In this respect, successful scientific research has much in common with successful stock-market investment. Information is only valuable if others do not have it or do not believe it strongly enough to act on it. The investor pits his knowledge, beliefs and guesses against the knowledge, beliefs and guesses of others.

In neither domain—science or the stock market—is the professional looking for a “fair bet.” On the contrary, he or she is looking for a situation where superior knowledge—knowledge not yet available to others—can be made, with some reasonable assurance, to pay off. Sometimes that superior knowledge comes from persistence in acquiring more “chunks” than most others have. Sometimes it comes from the accidents that have already been mentioned. But whatever its source, it seldom completely eliminates the element of risk. Investors and scientists require a “contrarian” streak that gives them the confidence to pit their knowledge and judgment against the common wisdom of their colleagues.

If you’re interested in learning more about Herbert Simon, I recommend reading Models of My Life. I’ve also written about Simon before (here, and here).