Why You Are Better Off In Than Out

Date: August 15, 2013

Dear reader

The headline in a recent Business Times editorial read: “The importance of equities for retirement“. It went on to highlight that many Singaporeans tend to view the stock market as a form of gambling. Others, the paper reckoned, are scarred by their memories of the global financial crisis.

However, the paper pointed out that those who shied away from the market missed out on a strong rally over the past four years, and many dividend payments in between. It said that investors lose money because they trade too much and too hastily.

The views expressed by the Business Times are absolutely correct. Perhaps one of the worst traits of investors, not just in Singapore but elsewhere in the world too, is a tendency to overtrade. Warren Buffett, who is probably the greatest investor of our time, once said:

“Since the basic game [of investing] is so favourable, Charlie [Munger] and I believe it’s a terrible mistake to dance in and out of it based on the turn of tarot cards. The risks of being out of the game are huge compared to the risks of being in it.”

Buffett went on to say:

“My own history provides a dramatic example: I made my first stock purchase in the spring of 1942, when the U.S. was suffering major losses throughout the Pacific war zone. Each day’s headlines told of more setbacks. Even so, there was no talk about uncertainty; every American I knew believed we would prevail. The country’s success since that perilous time boggles the mind.”

If an investor as mighty as Warren Buffett doesn’t believe he can successfully time the market, you have to ask why anyone else would think that they can, in the words of Buffett, dance in and out of the market successfully.

To highlight the point, Buffett details the performance of both the S&P 500 – a broad measure of the US stock market – and his company since 1965. What’s interesting is that neither Buffett nor the market has been profitable every single year. Hence the well-trodden stock market saying that nothing ever goes up in a straight line.

The S&P 500 has delivered a negative return in ten of the last 47 years. Meanwhile, Berkshire Hathaway has been unprofitable – as reflected by a decline in its book value – in two of the last 47 years.

Nevertheless, the S&P has delivered a total gain of 7,433%, which equates to a total return of 9.4% a year over the last 47 years. Put another way, $1,000 invested in the market in 1965 would be worth $75,000 today.

Of course, Buffett would not be Buffett if he hadn’t thrashed the market’s performance. His average annual return over the same period was 19.7%, which translates to an overall gain of 586,817%. In other words, $1,000 invested in his Berkshire Hathaway vehicle in 1965 would be worth around $5.6 million today.

Of course Buffett makes mistakes, too. But he reveals what he learned from them:

“The usual cause of failure is [to] start with the answer [you] want and then work backwards to find a supporting rationale. Of course, the process is subconscious; that’s what makes it so dangerous.”

What is interesting about Buffett is his ability to stand back and making long-term investment decisions based upon a deep understanding of an industry. He outlines why he is still investing in newspapers, albeit in a much more limited way. He clearly sets out the reasons why they were so successful in the past, and what is needed to make such businesses profitable in today’s environment.

You can see what he means when he says that he is a better businessman because he is an investor and a better investor because he is a businessman. The two go hand in hand.

So before you make your next investment, stand back and look at the company you are investing in. Think about where it is likely to be in the next ten years or more and act accordingly. If you have chosen a winning business, you are always going to be better off in than out.

To your investing

David Kuo

This article is contributed by The Motley Fool Singapore