Buffet’s words of Wisdom – Three primary causes of terrible returns for investors

by Manshu on May 4, 2008

in Opinion

Every year Warren Buffet writes a letter to his shareholders in which he discusses the year gone by and his views and opinions about the businesses they are in, economy and investing as a whole. This letter contains pearls of wisdom from the great investor.

In the 2004 letter, Buffet briefly touched upon three primary causes because of which investors make mediocre returns from investing in the stock markets.

Buffet starts by saying that over the past 35 years American business has delivered terrific results and an investor’s return from owning the S & P Index would have been 11.2% compounded annually. To put this growth into perspective $100 invested in 1960 would have translated into $4,108 at the end of 35 years at this CAGR.

So all an investor needed to do was to buy the S & P index fund and sit back and enjoy. However this has not been the case and most investors have experiences which are nightmarish.

Buffet attributes the following three reasons for this experience:

1.High Costs. Trading frequently and getting in and out of stocks increase the brokerage costs for investors and eats into their profits. Another reason for high costs is paying excessive amounts for investment management.

2.Portfolio decisions based on tips. Many investors have the habit of investing into the markets based on tips rather than thoughtful analysis. This leads to buying stocks because of fads and getting into businesses that investors do not really understand. Very often investors do not do any analysis of the profits and revenues of the company and jump into stocks based on tips. These tips fizzle out quickly and turn into losses more frequently than is good for any investor’s health.

3.Start and stop approach to investing. This means not investing consistently and timing an entry or exit into the market which investors usually get wrong.

So investors end up buying stocks long after they have already advanced quite a bit. And in the same manner end up selling stocks long after a decline has already taken place or long period of stagnation has existed.

Buffet cautions that investors should keep in mind that excitement and expenses are enemies of investors and if an investor wants to time the market then they should try to be fearful when others are greedy and greedy only when others are fearful.

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