Warren Buffett on the Individual Investor’s Greatest Enemy

Warren Buffett’s one of the best investors the world has seen. His record speaks for itself.

In 1965, he took over leadership of the U.S.-based company Berkshire Hathaway. From then to 2015, he managed to grow the company’s book value per share (a proxy for the economic worth of the company) by an astounding 19.2% annually, mainly through smart investments in the stock market and astute acquisitions of entire companies, both private and public.

Wisdom from the Oracle

With Buffett’s accomplishments, his views on investing are well-worth heeding. Last week, he had a three-hour interview with newswire CNBC and shared his thoughts on many subjects, including (what else?) investing and the future of American businesses. In the interview, he had pointed out the greatest enemy that individual investors like you and I have to face:

“The only person who can cause you to get a bad result in stocks is yourself.”

If you need some convincing as to why the man (or woman) in the mirror can be your worst investing enemy, I have some thought-provoking information.

In 2008, David Swensen, the celebrated chief investment officer of Yale University’s US$24 billion endowment fund, had delivered a lecture. In it, he shared the following information on the performance of mutual funds (the equivalent of unit trusts here in Singapore) in the U.S.:

  • Investing research outfit Morningstar had done a study on the 10-year returns of 17 different categories of mutual funds that invested in stocks.
  • On average, investors in every category had underperformed the funds. The worst underperforming-category actually saw the investors lose out to their funds’ returns by a stunning 13.4% annually.
  • The discrepancies between the investment’s returns and the investors’ returns happened because the latter had “bought after the funds had gone up and they sold after they had gone down.” In other words, investors had suffered poorer returns as a result of self-inflicted behaviour.

Investor Ken Heebner’s experience with running the CGM Focus Fund in the U.S. is another telling example. In the decade ended 2009, the fund had generated a really strong annual return of 18%. In contrast, its investors had lost 11% annually. And again, it was the fund’s investors who had a behavioural problem – they chased the fund when it was doing well and sold when it hit a rocky patch.

Getting the right behaviour

The importance of having the right investing behaviour in the market cannot be overstated, in my opinion. And, that’s because even massive winners in the stock market can from time-to-time prove to be agonising holdings for their investors over the short-term.

Take Raffles Medical Group Ltd (SGX: R01) and Riverstone Holdings Limited (SGX: AP4) for instance. Since the start of 2007, their shares have gained 398% and 576% in price alone. But, look at the chart below to see the maximum peak-to-trough loss (also known as the maximum drawdown) that the shares of the two companies had suffered in each calendar year from 2007 to 2015:

Chart 1 - Annual maximum peak-to-trough loss for Riverstone and Raffles Medical from 2007 to 2015
Source: S&P Global Market Intelligence

In eight of the nine years we’re looking at, Raffles Medical’s maximum drawdown had been over 10%; in 2008, it was a gut-wrenching 64%. The same story applies to Riverstone; in seven of the nine years under observation, the company’s shares had clocked a double-digit maximum drawdown.

In short, there were many occasions for investors to have been scared out of the two stocks between 2007 and today, a period in which both stocks have been massive winners. Those investors without the mental fortitude to ride out the painful short-term declines wouldn’t have been able to enjoy the big long-term gains.

A Fool’s take

When it comes to successful investing, mastering your own behaviour is perhaps even more important than learning how to value a business. While we are our own worst enemies in investing, the fortunate thing is that we are adversaries who can be defeated partly with the help of perspectives from history.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway and Raffles Medical.