Warren Buffett appeared on Adam Smith’s Money Game in 1998. It was the follow-up show to Adam Smith’s Money World that ended a year or two earlier. Smith (aka George Goodman) interviewed Buffett around the time of the 1998 annual meeting.

One of the questions Smith asked was related to I.Q. – combining brilliance and investing won’t guarantee success. Smith wanted to know why. Buffett felt an important third ingredient was needed. Here’s what he had to say:

Adam Smith: Why do smart people do dumb things?

Warren Buffett: That’s the big question. Why do they do it in investing? Why do they do it in managing businesses? Because you have all these smart people out there. The money doesn’t go to the people with the highest I.Q. There would be a very poor correlation between I.Q. and investing and results. And you say to yourself why does somebody with a 500-horsepower motor only get 100-horsepower out of it? And I would say that if you look at the intellect as being the horsepower that’s available, but you look at the output as reflecting the efficiency of that motor, it is rationality that causes the capacity to be translated in output.

Now, what interferes with rationality? It’s ego. It’s greed. It’s envy. It’s fear. It’s mindless imitation of other people. I mean, there are a variety of factors that cause that horsepower of the mind to get diminished dramatically before the output turns out. And I would say if Charlie and I have any advantage it’s not because we’re so smart, it is because we’re rational and we very seldom let extraneous factors interfere with our thoughts. We don’t let other people’s opinion interfere with it. We don’t get– we try to get fearful when others are greedy. We try to get greedy when others are fearful. We try to avoid any kind of imitation of other people’s behavior. And those are the factors that cause smart people to get bad results. Continue Reading…

Warren Buffett used a three-bucket approach in his portfolio during his partnership days. It’s a nice example of how to think about portfolio construction.

Each of Buffett’s buckets filled a role in meeting his long term objective. That objective can be broken down into two parts:

1. Beat the Dow by 10% over the long term.
2. Outperform in bear markets while matching performance during bull markets.

The only way he achieves either objective is by building a portfolio that looks nothing like the Dow. How did he do it?

First, he used a conservative deep value strategy. Stocks selling at a deep discount, with a wide margin of safety, offered a lot of room to be wrong on valuation but still make money.

With that strategy as a base, the three buckets did the rest — what he called Generals, Workouts, and Controls: Continue Reading…