Thursday 19 May 2011

Believe It or Not, Warren Buffett Might Not Be Right

Many investors look to "gurus" like Warren Buffett for advice and try to mimic their style of investing. I do believe that Buffett offers some excellent core methods, but there are many reasons why "the Buffett Way" may not work for most of us.
In my book Your Options Handbook, I detail several styles and methods of investing. I take you through several scenarios and help you find the most appropriate methods to fit your personality and ability to manage risk.
In today's complex marketplace, certain methods, like Buffett's, may look simple, but prove hard and maybe even downright frustrating for the average investor to follow. Here is an excerpt from Chapter 4 in my book:
The Oracle of Omaha Did It, Why Can't I?

Historically, a large group of stocks (in major companies) have been shown to appreciate over time. Investors like Warren Buffett buy quality companies when they feel they are valuable and hold them indefinitely.
Even though some of the holdings may never appreciate in value in a big way, on average, major market indices have shown positive returns if held for at least 10 years. (Of course, there are many exceptions.)
Mr. Buffett also invests in companies in ways that most of us cannot. A perfect example was his monetary injection into Goldman Sachs in late 2008 where he got $5 billion in senior preferred stock paying 10% (Warren also forced Goldman Sachs to make the preferred shares callable at a 10% premium, where most preferred shares are callable at par). In addition to that, Buffett got $5 billion worth of stock (warrants) at $115 per share for a "sweetener." Think of getting 435,000 Goldman Sachs $115 call options for free, just for buying a stock.
There are several flaws in this investment technique. The first is time, which many of us do not have the patience for or the luxury of "waiting it out." Some investors just throw in the towel before their stocks finally return to profitability and obviously there are some stocks that never do. The other issue is stop losses, which might boot you out of a trade early and end your long holding game. Then if you hold on and forgo the stop loss, dealing with potentially losing more than 40% of your account value can have effects not only you wallet, but also on your mental well-being.
It's all about your timing and tolerance. Take a look at Figure 4.1.

View larger chart
Figure 4.1 is a quarterly chart of the Dow Jones from 1978 to mid-2010; each line represents a year. There are periods of extreme growth (mid-1990s until 2000) and again from 2003 until 2007. But what if you bought in 2003 and waited until 2009?
Looking at the chart in Figure 4.1, it's fairly safe to say that if you bought the Dow Jones index and held it for 10 years, you would have some sort of profit in your account. The question is not only how much, but also the amount of anxiety you may have had to endure to get to the end of that 10 years.
Again, this is why trading stocks can be difficult and frustrating for many of us. At what point do you "cut the cord" on an investment you are in? How long is too long to stay in an investment? Long spans of time tend to be hard for the average mind to comprehend.
Think about how many things in your life will change in 10 years -- your career, your likes and dislikes, music, possessions, weather, location . . . and more. The average person stays in a home for seven years, but you should be expected to hold the same stock investment for longer? Holding a stock long term is not always a bad thing, especially when things are going well, but what happens when they are not? Can you afford to hold on?
And besides, if it's that easy, then why isn't everyone rich beyond their wildest dreams from investing?
Why don't all long term buy and hold investors succeed?
One reason may be that stocks really have an unlimited horizon and most traders fail to place time horizons on their investments, along with profit goals and stop-losses. I feel personally that this ability to "hold forever" is a detriment, not a benefit, to most investors.
(Investing doesn't have to be complicated. Sign up for Smart Investing Daily and let me and my fellow editor Sara Nunnally simplify the stock market for you with our easy-to-understand investment articles.)
Change the Way You Invest!
The last paragraph is the key here. Instead of just buying a stock that you think will go up and simply holding it, try forming a complete strategy with a beginning, a middle and an end. Make sure that your strategy has a time horizon. In other words, set checkpoints and an ultimate goal for the stock to reach by a chosen week or month.
Learn the option markets!
Options, unlike stocks, can allow you to really set up their time horizons, reduce risk, and make investments with odds better than stocks and your chance at gains better than 50/50.
What if I told you that certain option strategies have an 80%+ statistical probability of winning and those same strategies can reduce your risk to 10% of what you could lose if you invested just in the stock? Would you be interested? I think so!
The reality is that there is a learning curve and of course there is still risk, though I can show you how those risks can be much lower than stock investing. Trading options offers a world of possibility and in the right hands, with some practice, options can give the investor returns that even Mr. Buffett would envy!
Editor's Note: If you're interested, you should check out my trading research service WaveStrength Options Weekly. I offer my readers straightforward, low-risk opportunities with options. You can learn more about WaveStrength Options Weekly here.

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