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Three Lessons From Warren Buffett That We Can Apply
February 23, 2009

The world's richest man has been finding value lately in falling markets. We can too, if we apply three lessons from Warren Buffett.

Author : iFAST Editorial Team

Untitled Document

Warren Buffett has been in the news a lot more these days.

The world’s richest man – according to Forbes – has been doing his Christmas shopping a little earlier than usual.

Goldman Sachs made it into his shopping list on 24 September. Buffett’s company, Berkshire Hathaway, paid US$5 billion for Goldman Sachs’ preferred shares for a 10% dividend and an additional US$5 billion worth of warrants to buy the financial firm’s common stock at US$115 per share (over a period of five years).

Shortly after the Goldman Sachs purchase, Berkshire Hathaway invested US$3 billion in US blue chip General Electric.

And it appears that his shopping spree still has some way to go.

Recently, Buffett wrote in The New York Times on 17 October that he is considering to switch 100% of his non-Berkshire fortune from US bonds to US stocks, as stocks have been bashed and value has been emerging.

What can we learn from the world’s greatest value investor?

I take away three main lessons.


1) Market fluctuations present opportunities

“Be fearful when others are greedy and greedy when others are fearful,” says Buffett.

Buffett’s advice is simple enough: buy when pessimism reigns and don’t buy (or sell to take profits) when investors are exuberant.

Sure, it is important to find if a market is plummeting because of some drastic deterioration in its economic fundamentals; if that is the case, a lower price earnings (PE) ratio, a widely-used indicator of valuation, does not spell good news.

But in a market downturn, investments may be oversold because of poor sentiment or other factors which are unrelated to their actual fundamentals. There is indiscriminate selling, as investors seek safety in low-risk instruments.

Take, for example, the Asian economies. Their foreign exchange reserves have grown to over US$3 trillion, enough for most of the governments to fall back on if they need to boost their economies.

Corporate transparency has improved since the bleak days of the Asian Financial Crisis. Most fund managers continue to find companies which show strong balance sheets and healthy cash flows. On a more individual level, Asians, unlike the Americans, save a lot more too.

Despite all these positives, Asian markets have fallen even more than US markets – and we know the economic situation in the US is bleak.

This shows that the markets go through times of irrationality. It happens during a bull run when markets skyrocket, and it also happens during a bear run when they plummet.
So, clearly we find good opportunities among Asian equities now. Our research team has been saying it for a while and we continue to advocate investing regularly to benefit from dollar cost averaging.

2) Long-term and short-term goals

Buffett advocates long-term investing. He admits he has no clue on whether the market will rise or fall in the next one month or next one year.

So in the short term, markets may continue to fall, but that has not stopped Buffett to invest in US equities. He may not be buying them at their bottom, but then again, who can? Timing the markets is out of Buffett’s league, so what makes us think we can do it confidently?

If you believe in the prospects of a company or economy to do well in the next few years, you will not be as worried over its outlook for the next few quarters.

It is also crucial to distinguish between how we use our short-term and long-term monies.

The short-term pot will take care of our daily expenses, potential emergencies and the big ticket items we intend to splash on within the next two to three years. These could include the exotic holiday to Machu Picchu or the downpayment for the home you have been eyeing. To meet our short-term financial needs, leaving the money in safe, low-risk vehicles such as a savings account or a fixed deposit makes sense.

The next pot of money is really meant for our long-term goals. We can afford to give more time for our long-term investments to perform as we do not intend to touch that money for the next three years or more.

So, the point is, each one of us will have a different definition of short term and long term. Make sure we know our goals and divide the money into the different pots accordingly.

For our long-term pot, don’t panic and sell out when our investments fall. Don’t stay on the sidelines either, waiting for the markets to bottom. By the time the market really bottoms and starts rising, you may still be holding cash because you assume the bottom is not over yet.

3) Beware of inflation

Markets are plummeting and we are worried about our portfolios, our year-end bonuses or salary increments; for some of us, our jobs could very well be on the chopping board. But there is one big risk that has taken a backseat lately: inflation.

Buffett has also mentioned inflation as a key risk. "The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our (United States) legislature," he wrote in a Fortune article titled "How Inflation Swindles the Investor".

Inflation may be seen as a lesser concern, with commodity prices dropping sharply in the last few weeks. We need our investments in the long-term pot to deliver a return higher that the inflation rate. Inflation has been hovering at relatively higher levels in the last few months. This makes our long-term investment decisions even more crucial – and cash is clearly not king when it comes to our long-term pot of money.

Buffett’s lessons

This investment guru has gone through some of the more momentous periods in the last four decades: oil price shocks in the 1970s, the competition between the US and Japan in the 1980s, both vying for the world’s number one economy; the savings and loans crisis of the late 1980s and early 1990s; the technology bubble at the start of this century; and now, the credit crisis in the US.

But here’s a man who notes that we often make use of complex analysis to invest, but in actual fact, investing is no rocket science.

During times of crises, it is easy and understandable if we lose track of the big picture. Emotions often lead us to make our investment decisions, instead of sound fundamental analysis. This analysis need not be reliant on complex equations or tools; looking at the PE and PB ratios shows that the markets are being irrational at this point of time.

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This video is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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