Warren and Charlie were back to answering questions last weekend at the Berkshire annual meeting. For over five hours, the duo answered questions from a packed house.
The broader lesson from the meeting revolved around the duality of mistakes. It’s an inevitable aspect of investing that creates setbacks for some but opportunities for others.
Let’s dive in.
New things coming along don’t take away the opportunities. What gives you opportunities is other people doing dumb things… In the 58 years we’ve been running Berkshire, I would say there’s been a great increase in the number of people doing dumb things. And they do big dumb things. — Warren Buffett
The question related to how new tech (AI) might impact industries and markets and how investors might benefit from it. Of course, new tech impacts businesses. It always has. Creative destruction is a byproduct of innovation but it rarely happens instantaneously. It’s also hard to predict which companies might suffer the most.
Yet, new innovation is not all destruction. The advent of computers has been massively beneficial across all industries and will continue to be.
But as Buffett, rightly, points out, investment opportunities are a byproduct of market participants doing dumb things. In other words, human nature doesn’t change.
One of those dumb things is making incorrect assumptions about the future of a business. Investors get the time frame or impact wrong when it comes to new innovations.
How many times throughout market history were stock prices bid up to ridiculous heights because of some innovation only to tumble down to where they began because investors were “too early” or the vast growth potential was less than imagined? Inaccurate assumptions lead to mispricing and (sometimes multiple) buying opportunities for patient investors.
Another dumb thing is competing in highly competitive markets, especially if you’re trying to outperform. One small investor advantage is the ability to play in smaller, less competitive markets that the big money can’t play in.
Finally, the last dumb thing Buffett mentioned was the myopic nature of markets:
The world is overwhelmingly short-term focused. — Warren Buffett
Myopic investors focused on the next quarter create opportunities for long-term investors. In summary, human nature is the last great arbitrage opportunity that is unlikely to go away.
Circle of Competence
Some people can’t tell their best ideas from their worst. In the act of deciding that an investment already is good, they get to thinking it’s better than it already is. I think we make fewer mistakes like that than other people. That’s a blessing to us. We’re not so smart but we kind of know where the edge of our smartness is. That is a very important part of practical intelligence. And a lot of people who are geniuses on IQ tests think they’re a lot smarter than they really are. And what they are is dangerous. — Charlie Munger
In Lake Wobegon, everyone is above average. They’re above-average drivers, with above-average intelligence, who make above-average investment decisions. Even their best investments are above average.
Except, they can’t all be above average.
Overconfidence is detrimental to a portfolio because it leads to underweighting downside risks. That can lead to owning too few investments and/or having too much money in a single position.
Successful investing requires a certain level of skepticism in your investments so that you’re confident enough to take suitable risks but not so confident that you take unnecessary risks that could knock you out of the game. Knowing and avoiding what you’re not good at plays a big role in staying in the game. It’s a simple, common-sense idea that, again, goes against human nature.
Mistakes Worth Avoiding in Investing
You just want to make sure you don’t make any mistakes that take you out of the game or come close to taking you out of your game. You should never have a night when you’re worried about investing… And you should just spend a little bit less than you earn. — Warren Buffett
In one of the better questions and answers, Buffett and Munger offered general lessons on major mistakes worth avoiding.
The key ingredients to investing success are savings, time, and returns. Savings is the most important driver in the early years and one thing you can control. Time is best begun early, uninterrupted, and for as long as possible. Returns, while not guaranteed, provide a compounding effect that accelerates growth on the backend given a long enough time horizon.
The fact that returns are harder to control is why so much emphasis is placed on savings and time. The more savings you apply and/or the more time you have, the less reliant you are on higher returns to grow your net worth.
Survival is key to the uninterrupted compounding of your savings. A diversified portfolio can handle minor setbacks. Major losses, however, are harder to overcome.
Survival is so important because a major loss is not only a loss of savings but a loss of time. In fact, it turns the benefit of time against you. Time that would have been spent growing your nest egg larger is instead spent getting it back to even. And it may be time you don’t have.
Life Well Lived
In addition to the investing mistakes, Buffett added a few big mistakes worth avoiding in life too:
Praise by name, criticize by category. Well, what makes more sense than that?… And you don’t need to vilify anybody to make your point on subjects of discussion. And then the other general piece of advice, I’ve never known anybody that was basically kind that died without friends…
I’d add one more thought too, you need to know how people can manipulate other people, and you need to resist the temptation to do it yourself. — Warren Buffett
Munger weighed in as well:
It’s so simple to spend less than you earn, and invest shrewdly, and avoid toxic people and toxic activities, and try and keep learning all your life, et cetera, et cetera, and do a lot of deferred gratification because you prefer life that way.
And if you do all those things, you are almost certain to succeed. And if you don’t, you’re going to need a lot of luck. And you don’t want to need a lot of luck. You want to go into a game where you’re very likely to win without having any unusual luck. — Charlie Munger
But Buffett may have summed it up best with something he mentioned twice in the meeting:
If you want to figure out how to live your life, you write your obituary and reverse engineer it. — Warren Buffett