Investing Lessons from Warren Buffett
Those saving for retirement should ask two questions:
Is my rate of return meeting my expectations?
If/when the market collapses, what protections do I truly have in place to protect my assets?
Traditional models don’t seem to be working like they used to
Traditional investment models typically employ some version of Modern Portfolio Theory (MPT). Many still hold to the belief that traditional asset allocation (as defined by MPT) is the ideal way to invest. I question this type of model in a period of rising interest rates. As interest rates rise it is hard to fathom how bonds or bond funds give one the protection they did for 35 years during a climate of falling interest rates.
Warren Buffett wrote in his annual report to shareholders, “It is a terrible mistake for investors with long-term horizons — among them, pension funds, college endowments and savings-minded individuals — to measure their investment ‘risk’ by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”
Famed investor and money manager, Jim Rogers, said, “You will see higher interest rates over the next few years. In fact, interest rates will go much, much higher. We have certainly seen a top for the bond market. There is no question about that. Bonds will be going lower for many years to come.”
Bonds have been a key part of traditional investment models for the past 35 years as they have been a primary hedge against stock market risk. Conventional thinking has been tied to some blend of stocks and bonds (equities and fixed income). Those days are behind us if you believe Warren Buffett and Jim Rogers – and I do.
If bonds are not a good hedge against stock market risk, what is?
Again, I go back to Warren Buffett. Mr. Buffett has done two things in anticipation of a major stock market crash. One, he has warned his investors that a 50% stock market crash is “inevitable”. Two, he has accumulated $118 billion in cash in order to weather such a crash and also to take advantage of a crash and be able to buy companies at much lower prices.
If we were to take that down to the level of the average person, I believe it would tell us to put a substantial portion of our money in cash and be ready for this “inevitable” crash. It would further tell us to be ready to deploy that cash when others are selling stocks – when the intense pain that huge losses can cause is inflicted on investors. In other words, the Buffett model is to accumulate cash when others are buying and to buy when others are selling.
An alternative approach
I use a version of Warren Buffett’s approach. My mathematical model “tells” me to sell positions and accumulate cash as prices rise and to be patient so I can deploy that cash when prices drop. I do not use bonds or bond funds because of the reasons stated above. My approach is different from Buffett’s, however, in that I use index and sector funds rather than individual stocks.
No single approach is perfect and can avoid all losses in a severe market crash. I believe that my approach can minimize losses and shorten the duration of those losses. Investors need to be prepared for the fact that deep losses will occur in the market, have some way to minimize those losses, and have some method to take advantage of real buying opportunities when prices are lower.
Warren Buffett quote
Warren Buffett once said, “ Be fearful when others are greedy and greedy when others are fearful.”
Past performance is no guarantee of future results. While active management seeks to produce higher returns than those of passively managed portfolios, historical pricing patterns, which are a component of our mathematical model, may not necessarily be repeated in the future. This type of strategy is not suitable for all investors and there is no guarantee that your investment objective will be met or that you will not incur losses, including loss of principal.
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