Are you listening to the advice of the world’s greatest investors? More importantly, are you acting on that advice?
If it isn’t clear already, the latest swing banking failures show that risky bets are capable of producing devasting results. Protecting your money should be first and foremost on your mind.
So with that in mind, I’ll ask again. Are you listening and acting on the strongest advice of the world’s most successful investor?
The Salad Oil Swindle of 1963
Do you remember the salad oil scandal? I do. Well, not really. But I was born that year.
In the same week as JFK’s assassination, the investment world was rocked by the revelation that they had been fooled by a con man who claimed to have a corner on the nation’s soybean market. American Express was this crook’s primary financial backer, and their stock tanked, dropping over 40%.
33-year-old Warren Buffett unemotionally reviewed the history and overall business of AMEX and viewed this as a temporary blip. He judged them as a solid corporation that made one big mistake.
He also knew that about 99% of Wall Street investors trade on emotions and couldn’t be trusted to value this 100+-year-old staple of the U.S. economy properly.
In the face of colossal negative public sentiment, Buffett loaded up on $20 million of AMEX stock. The stock soon doubled in value. Buffett chalked up one of his first big public wins.
The Dot-Com Bubble
It was 1999, and Buffett hadn’t yet turned 69. But some called him an old fool. A washed-up has-been. Some friends at his annual Idaho billionaire gathering whispered that he must be senile.
But that didn’t stop Buffett from boldly warning his friends and detractors against the epic run-up in tech stocks that drove non-income producing tech companies to dizzying heights.
Buffett deemed it speculation. Buffett was later credited with saying, “I can’t predict where technology will be in ten years. I’d rather buy Wrigley because I know how people will be chewing gum in a decade.”
Of course, we all know Buffett was proven right again when the tech bubble burst and millions of investors lost a total of about $5 trillion in the collapse.
The Crypto Bubble
92-year-old Buffett has been a major critic of Bitcoin and the whole cryptocurrency realm. He told CNBC in 2014, “You’re going to be a lot better off owning productive assets over the next 50 years than you will be owning pieces of paper or bitcoin.”
Of course, we don’t know where the cryptocurrency saga will end. But Bitcoin clearly hasn’t been the smooth sail to $100k people predicted this year.
I’m not saying Buffett is always right. He’s made lots of mistakes by his own admission. But there must be a reason Berkshire Hathaway could lose over 99% of its value and still beat the S&P 500 in the same timeframe. Think about that.
So if you’re going to follow just one of Buffett’s principles, it would probably pay to start with the first one.
Buffett’s Most Important Advice For Investors
You’ve probably heard about Buffett’s #1 rule for investing: “Rule number one, never lose money. Rule number two, don’t forget rule number one.”
The most certain path to wealth: start with safety. A lot of investors are looking for safety after last week’s banking failure.
This is nothing new at my firm, and in the circles I travel in. We’ve been having the same internal and external discussions in boom times and busts. (You can read years of my BiggerPockets and company blog posts to confirm this.)
Like many seasoned commercial real estate investors, we have seen lots of booms—and as many busts. As a result, the folks we run with (operators and investors) favor these priorities in this order:
- Safety of principal
- Predictable cash flow
- Market-beating appreciation
- Tax deferrals
Syndicators and fund managers with these priorities shouldn’t have to fear a downturn, rising interest rates, expanding cap rates, and more. Their investors should be sleeping like babies in the middle of all the questions and fear that could soon give way to panic in some sectors.
If you’re not sleeping like a baby in the current uncertainty, go back through this short list and ask yourself if you prioritized these issues when you first made your current investments. Did you?
If not, don’t despair. Mistakes are perhaps the best opportunity to learn what to do better next time. This could be the “break” you’ve been looking for to build and maintain multi-generational wealth.
I’m not being flippant here. As the host of the How to Lose Money podcast, I interviewed 238 successful entrepreneurs and investors. Their paths to success were paved with mistakes, losses, and pain. And most say they wouldn’t trade these for the world. Most are doing business and investing differently now, building success by not doing what got them in trouble last time.
Speaking of learning from our mistakes and Warren Buffett, here’s a quote from Warren Buffett’s long-time investment partner, Charlie Munger:
“I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.”
Well said, Mr. Munger.
The Math On The Safety of Principal
Did you know there is math to prove Buffett’s safety of principal prioritization? At first glance, it doesn’t make sense.
Why would two of America’s most safety-minded investors also be America’s most successful investors?
I mean, when I think of safety, it’s easy to picture these:
- Old curmudgeons with piles of cash under their lumpy mattresses.
- A conservative financial planner too fearful of investing in anything but U.S. Treasuries.
- Dave Ramsey and his repulsion with every sort of leverage (and everyone who uses it).
Here is the logic and the math behind this important principle. It’s really quite simple, and I’ll use a 50% return to make the math even more obvious.
It is widely believed that risk is proportional to return. Low risk leads to low return. So high risk leads to high return.
High risk leads to the potential for high returns—the potential for high loss, including the loss of all your investment.
So let’s say you took some risk. You hoped for a high return, say 50%.
If you achieve that 50% gain in a reasonable time frame, you should celebrate. That is a wonderful return.
But the whole concept of risk means the future is uncertain. Let’s say your investment produces a 50% loss rather than the projected 50% gain you hoped for. What is the impact of a loss like this?
A 50% loss will hurt you much more than a 50% gain will help you.
Because it drastically reduces your starting point. And it takes a devastating emotional toll that could tempt you to make significantly poor future investment decisions.
If you lose 50% of your principal, you will have to double your money just to get back where you started, and this may tempt you to take even higher risks to make up for the lost ground. This could lead to a death spiral that consumes all your principal and leaves you with nothing. It happens all the time.
So great investing may be seen as more of a matter of loss avoidance than gain attainment. Warren Buffett and his partner, Charlie Munger, have built a fortune by acting on this principle.
So what’s this have to do with you or you or your investments? Everything. Do the math.
While it’s wonderful to admire these investment greats and plan to imitate them ourselves, it’s harder than it looks for most. It means being patient. It means suffering ridicule. It means holding on to investments when everything in you is screaming to sell. It can mean being greedy when others are fearful and fearful when others are greedy.
Fear and greed (aka market cycles) are as sure as death and taxes. Just because the last big financial crisis ended a decade ago does not mean we are cured of the fear of contagion.
Predicting when and how bad (or good) these market cycles are is a fool’s game. But Buffett says it’s easier than that. Just act appropriately when the time is right.
You Can’t Strike Out By Not Swinging
Warren Buffett is a big baseball fan. He analogizes investing to standing at the plate with a pitcher throwing baseballs at you, enticing you to swing. In baseball, you can strike out by swinging and missing three times. Or you can strike out by not swinging at all when three good pitches sail through the strike zone.
In investing, you can strike out by “swinging” at bad investments. But Buffett reminds us that, unlike baseball, you can’t strike out with your bat on your shoulder. Not swinging at a thousand great pitches is okay in investing.
This is part of Buffett’s logic in keeping well over $100 billion in reserves these past several years. While other investors find a good deal under every rock, Buffett and Munger say that great deals are nearly impossible to find. Opportunities so good that it would be hard to lose money are rare.
The Cost of Missed Opportunities
As he ages (98 now), Munger seems to be talking more about losses due to opportunity cost. He says opportunities that he and Warren missed over the decades cost them and their shareholders multiple billions.
He regrets not investing in Walmart, for example. And there are dozens of other missed opportunities that Charlie and Warren admit cost their shareholders a lot of profit.
So what does this have to do with you?
There are going to be quite a few opportunities to acquire profitable deals in the coming years. I’ve already been hearing about multifamily, and other deals acquired in the past few years that are in danger of going back to the bank now, costing investors most or all their equity. Scott Trench wrote about this recently.
We’ve been quoting Warren Buffett and warning investors for years about the day the tide would go out. That day appears to be upon us now, and skinny dippers are already being exposed. (I sincerely wish them all of them the best, and I hope they escape without harm!)
But this painful (for some) downturn could actually be your opportunity. The opportunity you’ve waited for to put the knowledge and relationships you’ve gained through BiggerPockets and elsewhere to work to acquire that asset that has been unattainable over this past decade of euphoric buying and speculation.
Buffett and Munger have often said the acquisition price is one of the most important aspects of any deal. You may have heard the oft-quoted maxim, “You make money when you buy.”
If this coming few years is like most of the last economic slowdowns, you may be able to acquire deals at up to 50% or more of the former acquisition price. This opportunity is often available through lenders who took back assets and don’t want to hold and operate them.
Buffett’s friend and fellow billionaire Howard Marks bought billions in financial assets when the market was in a panicked meltdown in late 2008. He reminds us that “the worst of deals are acquired in the best of times, and the best of deals are acquired during the worst of times.”
Am I predicting the worst of times? No. But we can all see cracks in the real estate ice right now. Those who have patience and courage, and access to capital may find game-changing opportunities in the coming years. Will that be you?
Whether that is you or not, I want to urgently remind you about the importance of ranking the safety of principals as your highest priority. You may miss out on some screaming deals, but the math proves this Buffettesquely powerful path to wealth.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
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