Sixty years ago, Warren Buffett bought control of Berkshire Hathaway. He’s highlighted that mistake on and off ever since.

He did so once again in this year’s annual letter, which came out over the weekend. Handling mistakes was the first of several lessons in his letter.

Quick to Fix Mistakes

Sometimes I’ve made mistakes in assessing the future economics of a business I’ve purchased for Berkshire – each a case of capital allocation gone wrong. That happens with both judgments about marketable equities – we view these as partial ownership of businesses – and the 100% acquisitions of companies…

A decent batting average in personnel decisions is all that can be hoped for. The cardinal sin is delaying the correction of mistakes or what Charlie Munger called “thumb-sucking.” Problems, he would tell me, cannot be wished away. They require action, however uncomfortable that may be.

No investor is perfect. Not even Buffett. Mistakes are part of the game. It’s a recurring theme throughout his annual letter going back decades.

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Quote for the Week

The really hard part about investment policy is not figuring out the best feasible combination. While it takes some time and analytical discipline, this part of the problem-solving is far from advanced science.

The really hard part is managing ourselves: our expectations and our interim behavior. Walt Kelly’s Pogo puts it as “we have met the enemy and he is us.” Most investors are too optimistic about the long run and much too optimistic about how well they will do compared to the averages, so they set themselves up for disappointment.

Even worse, most investors do harm to their longer-term investment results by trying and trying again to do better: changing managers and changing asset mix at the wrong time and in the wrong way. — Charley Ellis (source)

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Had you bought the S&P 500 on January 1st of any year since 1922, 69.2% of the time you’d have more money one year later. Using the Dow produces the same results: 69.2%.

Both those stats ignore dividends, by the way, which would help improve those numbers.

The idea behind it should set aside the concern of buying at a market top, only to sit at a loss for any number of years. It happens. No amount of market timing will prevent it. And worrying about it, based on those odds, appears to be overrated.

It’s interesting that those numbers don’t change much if you look even further back in time. Which is exactly what Edgar Lawrence Smith did:

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Quote for the Week

I divide investors into two schools: The “I know” school and the “I don’t know” school. For my first 20 years in business in what I would call the institutional establishment, I ran into the “I know” school most of the time. These are people who will tell you exactly what is going to go on one, three, five, or 10 years from now in the economy, in the markets, in interest rates, which economies will do best, which industries, and which stocks. They tend to invest on the assumption that they are right. Then when they turn out to be wrong, they try to correct their mistakes and invest on the next set of scenarios rather than acknowledging that perhaps rightly there are limitations on their foreknowledge.

The “I know” school invests for one outcome, economy, market, interest rates, industry, and company. They concentrate their portfolios given that they know what the future holds. They lever heavily, and they target maximum price gains.

Most of the outstanding investors that I have known over the years belong to the “I don’t know” school with regard to the macro environment. They may know companies and securities better than anybody else in the world, but with regard to the macro they assume that they don’t know what the future holds. So they hedge against uncertainty. They diversify. They avoid or limit leverage, and they emphasize the avoidance of losses rather than – or I would say as least as important as – the acquisition of gains.

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Quote for the Week

Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum.

In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.

Even with a 10% per annum investment, paying a 35% tax at the end gives you 8.3% after taxes as an annual compounded result after 30 years. In contrast, if you pay the 35% each year instead of at the end, your annual result goes down to 6.5%. So you add nearly 2% of after-tax return per annum if you only achieve an average return by historical standards from common stock investments in companies with tiny dividend payout ratios…

There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You’re paying less to brokers. You’re listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded. — Charlie Munger (source)

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