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Even the legendary Buffett is fallible

Mr. Buffett says, "An investor needs to do very few things right as long as he or she avoids big mistakes." The concepts we have discussed so far in this guide will help you do just that.

However, it should be borne in mind that investing is not a perfect science and hence, mistakes cannot be completely eliminated. A few of them might creep in every now and then.

In fact, even Mr. Buffett has acknowledged that he has made quite a few mistakes in his investment career. In a section titled 'Mistakes of the First Twenty-five Years' from the 1989 letter to shareholders, Mr. Buffett has reviewed some of the major investment related mistakes that he has made in the twenty-five years preceding the year 1989. These are the conclusions that he has drawn from them.

Mr. Buffett on Quality over Quantity

Mr Buffett says, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie (Buffett's business partner) understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for firstclass businesses accompanied by first-class managements. Good jockeys will do well on good horses, but not on broken-down nags. The same managers employed in a business with good economic characteristics would have achieved fine records. But they were never going to make any progress while running in quicksand."

It is worth mentioning here that in the early years of his career, Mr. Buffett bought into businesses based on statistical cheapness rather than qualitative cheapness.

While he experienced success using this approach, the difficult time faced by the textile business made him realise the virtue of a good business i.e., businesses with worthwhile returns and profit margins and run by exceptionally smart people.

According to him, while one may make decent profits in an ordinary business purchased at very low prices, lot of time may elapse before such profits can be made. Hence, he feels that it is always better to stick with a wonderful company at a fair price, as according to him, time is the friend of a good business and an enemy of a bad business.

Mr Buffett's 'If you can't confront them avoid them' attitude

In his 1989 letter to shareholders, Mr. Buffett said, "Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers."

Mr. Buffett's reluctance to invest in tech stocks during the tech boom is legendary. Invest in companies whose businesses are within your circle of competence and keep it easy and simple. According to him, human beings have this perverse tendency of making easy things difficult and one must not fall into such a trap.

Mr. Buffett on Managers

In his 1989 letter to shareholders, Mr. Buffett talked about the quality of managers managing businesses he would have invested in. This is what he had to say - "After some other mistakes, I learned to go into business only with people whom I like, trust, and admire. As I noted before, this policy in itself will not ensure success: A second-class textile or department store company won't prosper simply because its managers are men that you would be pleased to see your daughter marry. However, an owner - or investor - can accomplish wonders if he manages to associate himself with such people in businesses that possess decent economic characteristics. Conversely, we do not wish to join with managers who lack admirable qualities, no matter how attractive the prospects of their business. We've never succeeded in making a good deal with a bad person."

Next on the list of investment mistakes is a confession that makes us realise that even Mr. Buffett is prone to slip up occasionally. But what makes him a truly outstanding investor is the fact that he has had relatively fewer mistakes of commission rather than omission. In other words, while he may have let go of a few very attractive investments, he has hardly ever made an investment that cost him huge amounts of money (Like he says "avoid big mistakes").

Mr. Buffett on Mistakes of Inactivity

This is what Mr. Buffett has to say - "Some of my worst mistakes were not publicly visible. These were stock and business purchases whose virtues I understood and yet didn't make. It's no sin to miss a great opportunity outside one's area of competence. But I have passed on a couple of really big purchases that were served up to me on a platter and that I was fully capable of understanding. For Berkshire's shareholders, myself included, the cost of this thumb-sucking has been huge."

Mr. Buffett rounds off the list with a masterpiece of a comment. It gives us an insight into his almost superhuman like risk aversion qualities and goes us to show that he will hardly ever make an investment unless he is 100% sure of the outcome. It comes out brilliantly in this, his last comment on his investment mistakes of the past twenty-five years.

Mr. Buffett on Leverage

In his 1989 letter to shareholders, Mr. Buffett said, "Our consistently conservative financial policies may appear to have been a mistake, but in my view were not. In retrospect, it is clear that significantly higher, though still conventional, leverage ratios at Berkshire would have produced considerably better returns on equity than the 23.8% we have actually averaged. Even in 1965, perhaps we could have judged there to be a 99% probability that higher leverage would lead to nothing but good.

Correspondingly, we might have seen only a 1% chance that some shock factor, external or internal, would cause a conventional debt ratio to produce a result falling somewhere between temporary anguish and default."

He further stated, "We wouldn't have liked those 99:1 odds - and never will. A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns. If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things along faster. Charlie and I have never been in a big hurry: We enjoy the process far more than the proceeds - though we have learned to live with those also."

To sum up, invest in businesses that besides being easy to understand have strong fundamentals and are run by able and honest managements. Secondly, always beware of the irrationality that may lead you to take decisions that would harm you in the long run. And finally, no matter how good the opportunity, do not borrow funds to make investments i.e., invest with your own funds.

» Next: Mr. Buffett's Owner's Manual

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