I often have readers, financial planning clients and TV viewers who ask me how to cope with the volatility in stock markets nowadays as they worry about their super and retirement nest eggs.
To answer this question, I have taken a leaf out of the book of Gruen Transfer’s Will Anderson, who once asked: “What would Putin do?” Now he’s asking ,“What would Clive Palmer do?” However for me, I ask: What would Buffett do?
He once counseled: “I think the worse mistake you can make in stocks is to buy or sell based on current headlines,” but that statement is based on the fact that you bought the stocks for the right reasons.
Traders vs Stayers
The news is more relevant for short-term traders and so when Share Wealth System’s Gary Stone told us to go to cash a few weeks back, that was a timely warning for a trader, but it had less relevance to a long-term investor trying to build wealth over time.
I recommend that a great strategy to avoid losing money on the stock market is to get rich slowly. And the guy who has best shown us the way is the boss of Berkshire Hathaway — Warren Buffett — regarded as the best investor in the world.
Let me do Buffett in a nutshell to explain why I don’t care about the fiscal cliff, though I hope the US doesn’t fall off it and I believe it won’t.
Buffett is really protective of his money and advises you to spend your money wisely. I argue we shop unwisely and if you tried to cut your spending by 10% or even 5% and invested in good quality stocks or property you will end up rich — especially if you start in your early 20s!
Wazza, like me believes you can get 10% out of good stocks per year on average over a 10-year period and that kind of return will make you richer. Just remember, the money you waste and lose will never help you.
Who cares about your money?
Buffett also argues that no one cares about your money more than you. This is a great argument to become really money savvy, but if you don’t, can’t or have not got the time to do it yourself, you have to get an adviser you trust to help you.
The next tip is to do your homework and look at companies on the stock market religiously until you understand them and then either accept or reject them.
Buffett often says “never invest in a business you don’t understand,” and think “do I want to be a part-owner in this company?”
This is a great test before you buy a stock.
An issue many of us have to deal with is our fear of risk, which Buffett says you have to understand. He says “risk comes from not knowing what you are doing.” He argues that for some 90 years, good quality stocks have returned 10% and have outperformed bonds, bank deposits and gold. He also adds, which will surprise many, stocks are safer than the three investments above! That’s a big call, but the right shares bought wisely can be pretty damn safe over time.
He also emphasizes that you have to have a long-term view and says you build wealth like a snowball, so find “wet snow and a really long hill!”
There’s a great example of someone who saves $500 a month from age 21 to 30 and with a 7% return, this snowballs into $1 million. If someone starts at age 31 they will have to put $500 a month into shares between 31 and 65 to get the million. The first guy gets $1 million for a $45,000 contribution while the other guy has to stump up $150,000!
Invest often and invest early.
When it comes to investing in what Buffett makes ,it’s simple: “An investor needs to buy stocks as if he is buying the company down the road.” You want great companies with a long-term future.
When to buy
When do you buy? During a crash is a good time he argues. He has been quoted advising to be “fearful when everyone is greedy and greedy when everyone is fearful.”
Another important issue is that you have to like the management and penny pinchers are a good sign. Legend has it that he once bought a company where the founder actually counted the number of sheets in a toilet roll to find out that the ads on TV were telling lies!
On the measurements, he likes to focus on the return on investment (ROE), which looks at the company’s net profit divided by the shareholders equity. So imagine you bought a company for $1 million and the net profit was $200,000, then you have a 20% ROE.
Another important measure of a company is the ROCE ,which is the return on capital employed. This is found by getting the earnings before interest and tax (EBIT) and dividing it by the total assets minus total liabilities.
If you don’t understand these terms, do some homework, ask your accountant or financial adviser because they’re important.
How many stocks?
How many companies? Buffett says 10-15, but I like 20 so you only have 5% exposure to some dumb CEO or a crazy government decision that could hurt a company. He also advises that quality companies survive bad times, in fact they’re times to buy.
Finally, dump bad stocks in a rising market, but buy great ones in crashes. The game should be simple — buy great companies at great, low prices.
Buffett once admitted that he and his business partner, Charlie Munger, had a simple plan and it went like this: “The beauty of stocks is they do sell at silly prices sometimes. That’s how Charlie and I got rich.”
I reckon these lessons learnt will help you get richer, albeit slowly.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.
