Forget the news. Ask what Buffett would do

November 15, 2012, 12:10 pm Peter Switzer Yahoo7

Why headlines don't matter if you have the right investment strategy.

Right now stock markets will be under pressure because of the usual suspects — Europe’s problem children Greece and Spain, China and its question mark recovery, and the USA with a new anxiety-creating problem: the fiscal cliff!

I often have readers, financial planning clients and TV viewers ask me how do they cope with the volatility in stock markets nowadays as they worry about their super and retirement nest eggs.

To answer this question, I have taken a leaf out of the book of The Gruen Transfer’s Wil Anderson who once asked: “What would Putin do?” Now he’s asking “What would Clive Palmer do?” However for me, I ask: “What would Warren Buffett do?”

Buffett once counseled: “I think the worst mistake you can make in stocks is to buy or sell based on current headlines” but that’s based on the fact that you bought the stocks for the right reasons.

Get rich slowly

The news is more relevant for short-term traders and so when I wrote on Monday in my blog that Share Wealth System’s Gary Stone was telling us to go to cash, that was a timely warning for a trader but has less relevance to a long-term investor trying to build up wealth over time.

I recommend that a great strategy to avoid losing money on the stock market is to get rich slowly. Buffett, who is the boss of Berkshire Hathaway, has best shown us the way and he is regarded as the best investor in the world.

Watch your money

Let me do Buffett in a nutshell to explain why I don’t care about the fiscal cliff, though I hope it won’t happen and I believe it won’t.

Buffett is really protective of his money and advises you spend your money wisely. I argue we shop unwisely and if you tried to cut your spending by 10% or even 5% and invested it in a good quality stocks or property, you will end up rich — especially if you do it as early as your 20s!

Wazza, like me, believes you can get 10% out of good stocks per year on average over a 10-year period, and that kind of return will make you richer. Just consider the money you waste and lose that will never help you.

Buffett also argues that no one cares about your money more than you. This is a great argument to become really money savvy, but if you won’t, can’t or haven’t got the time to do it yourself, you have to get an adviser you trust to help you.

Do your homework

The next tip is to do your homework and look at companies on the stock market religiously until you understand them and then either accept or reject them. Buffett often says, “never invest in a business you don’t understand” and think, “do I want to be a part-owner in this company?”

This is a great test before you buy a stock.

Are stocks safe?

An issue many of us have to deal with is our fear of risk, which Buffett says you have to understand. He says, “risk comes from not knowing what you are doing”. He argues that for some 90 years, good quality stocks have returned 10% and have outperformed bonds, bank deposits and gold. He also adds, which will surprise many, stocks are safer than the three investments above! That’s a big call but the right shares bought wisely can be pretty damn safe over time.

In it for the long-term

He also emphasises that you must have a long-term view and says you build wealth like a snowball, so find “wet snow and a really long hill!” There’s a great example of someone who saves $500 a month from age 21 to 30. With 7% return, this snowballs into $1 million. If someone starts at age 31, they will have to put $500 a month into shares between 31 and 65 to get the million. The first guy gets $1 million for a $4500 contribution while the other guy has to stump up $150,000!

Invest often and invest early.

When it comes to what to invest in, Buffett makes it simple: “An investor needs to buy stocks as if he is buying the company down the road”. You want great companies with a long-term future.

Buy during a crash

When do you buy? During a crash is a good time he argues. He has been quoted advising to be “fearful when everyone is greedy and greedy when everyone is fearful”.

Another important issue is that you have to like the management, and penny pinchers are a good sign. Legend has it that he once bought a company where the founder actually counted the number of sheets in a toilet roll to find out that the ads were telling lies!

On the technical side

On the measurements Buffett likes, try to focus on the ROE, or return on investment, which looks at the company’s net profit divided by the shareholders equity. So imagine you bought a company for $1 million and the net profit was $200,000. You then have a 20% ROE.

Another important measure of a company is the ROCE, which is the return on capital employed. This is found by getting the earnings before interest and tax (EBIT) and dividing it by the total asset minus total liabilities.

If you don’t understand these terms, do some homework or ask your accountant or financial adviser, but they’re important.

Buy quality at great prices

How many companies should you have? Buffett says 10 to 15, but I like 20 so you only have 5% exposure to some dumb CEO or a crazy government decision that could hurt a company. He also advises that quality companies survive bad times, and in fact they’re the times to buy.

Finally, dump bad stocks in a rising market but buy great ones in crashes. The game should be simple — buy great companies at great, low prices.

How to get richer

Buffett once admitted that he and his business partner, Charlie Munger, had a simple plan and it went like this: “The beauty of stocks is they do sell at silly prices sometimes. That’s how Charlie and I got rich”.

I reckon these lessons will help you get richer.

Peter Switzer is the founder of the Switzer Super Report, a newsletter and website for self-managed super funds.

Stock Quotes

e.g. BHP, CBA