Highlights in this issue:

*** Want to be a better investor? Follow Buffett’s example…
*** The greatest secret: Keep a long-term perspective…
*** 3 ways to ensure your defence is better than your offence…

-----------------------------------------
From the pen of Karin Iten…

Dear Investment Academy Reader,

“Don’t ask the barber whether you need a haircut”. With that piece of folk wisdom the Oracle of Omaha, Warren Buffett, summed up the nature of investment bankers’ advice on a potential merger or acquisition. It’s pithy comments like this that makes reading Warren Buffett’s annual letter to shareholders so much fun to read – and so insightful. This year’s letter came out two weeks ago and contains lessons for all of us who want to become better investors.

Because of this, I’ve asked Bob Irish, a leading investment director over in the US whose main aim is to fix the fundamental behavioural flaws of investors, to share the highlights of this year’s letter with you.

Wisdom pearl #1: Stay liquid

“We (Berkshire Hathaway) will never become dependent on the kindness of strangers.... Any requirements for cash we may conceivably have will be dwarfed by our own liquidity.... When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system, not a supplicant.... We pay a steep price to maintain our premier financial strength.... But we sleep well.”

Wisdom pearl #2: Keep your emotions under control
The returns from Berkshire Hathaway’s derivatives contracts have been volatile. Buffett’s comment? “These wild swings neither cheer nor bother Charlie [Munger, Berkshire’s vice chairman] and me.... We expect to earn further investment income over the life of our contracts.”

Notice the long-term perspective.

Wisdom pearl #3: Avoid fads
Buffett reminded investors that Berkshire Hathaway avoids “businesses whose futures we can’t evaluate, no matter how exciting their products may be.” He goes on to explain that many investors fared poorly investing in the automobile industry in 1910, the aircraft industry in 1930, and TV makers in 1950. A dramatic business story doesn’t always mean big profits and a great return on investment.

Wisdom pearl #4: Admit your mistakes
Buffett also promoted and sold the idea of offering a credit card to GEICO policyholders. GEICO’s managers didn’t like the idea from the start. Mr. Buffett says “I subtly indicated that I was older and wiser. Then adds “I was just older.” The cost of closing the books on this disaster? $50 million.

Wisdom pearl #5: Bad news is often good news
We’re all well aware of the problems in the global housing market. But Buffett’s perspective is interesting:

“In 2009, [US housing] starts were 554,000, by far the lowest number in the 50 years for which we have data. Paradoxically, this is good news. People thought it was good news a few years back when housing starts – the supply side of the picture – were running about two million annually. But household formations – the demand side – only amounted to about 1.2 million. After a few years of such imbalances, the country unsurprisingly ended up with far too many houses.”

Because housing starts are far below the rate of household formation, Buffett suggests that within a year or so the problems with America’s residential housing should largely be behind them. And as you all know, where America sets the trend, the rest of the world will follow.

Wisdom pearl #6: Play defence
“[Though] we have lagged the S&P in some years that were positive for the market, we have consistently done better than the S&P in the eleven years during which it delivered negative results. In other words, our defence has been better than our offense, and that’s likely to continue.”

Wisdom pearl #7: Be opportunistic
“Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.”

Wisdom pearl #8: Focus on value
“In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what that business earns in the succeeding decade or two.”
There’s that long-term perspective again.

So what can you learn from this?

Here at The Investment Academy we take investing seriously. As you assemble your portfolio don’t forget the following:

Trailing stops – To minimise losses before they become catastrophic. We believe that a 25% stop loss is appropriate for most investors. When Mr. Market “disagrees” with our analysis by taking the price down 25% or more, we don’t second-guess it by buying more. We assume there’s something about that company or the sector or the market mood we’ve failed to understand. So we swallow our pride and cut our losses.

Position sizing – A simple way to diversify your portfolio so you never have too much money invested in any particular stock or industry. Assembling a portfolio of stocks without position sizing is very risky. You might feel you’re diversified because you have a dozen or more stocks in your portfolio. But unless the size of each investment is limited by company, sector, or geography, you can quickly lose much of your capital when some unforeseen market event occurs that affects all or most of your stocks.

Income stream – From companies providing dividends gives you a way to make money even when the stock market is going down. You can double your income in less than five years from companies hiking their dividends by an average of 15% a year.

A little bit more from Buffett
Buffett’s observations about investing are legendary. Let me share with you three of my favourites:

*** “Someone’s sitting in the shade today because someone planted a tree a long time ago.”
*** “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
*** “You only have to do a very few things right in your life so long as you don’t do too many things wrong.”

Hope this helps.

Good investing,

Bob Irish
For The Investment Academy