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Warren Buffett’s Investing Mistakes: Part 4

Credit: Terrance Heath

Warren Buffett’s track record makes him one of the investing community’s all-time greats. From 1965 to 2016, he generated an incredible annual return of 19%. But you may be surprised to know that even Buffett makes mistakes.

In Buffett’s 1989 letter to his shareholders, he shared a number of investing mistakes he committed in his first 25 years of investing and the lessons he learnt from them. It’s always valuable to pick up wisdom from others, and it’s even more so when we can learn from Buffett, given his stature.

This article is the fourth of four articles that looks at mistakes Buffett detailed in his 1989 letter. The first, second, and third articles can be found here, here, and here.

A big mistake (?): Not using adequate leverage

Buffett started a paragraph with these few words, “Our consistently-conservative financial policies may appear to have been a mistake.” But he followed up immediately with, “but in my view were not.”

Buffett explained:

“In retrospect, it is clear that significantly higher, though still conventional, leverage ratios at Berkshire would have produced considerably better returns on equity than the 23.8% we have actually averaged.

Even in 1965, perhaps we could have judged there to be a 99% probability that higher leverage would lead to nothing but good. Correspondingly, we might have seen only a 1% chance that some shock factor, external or internal, would cause a conventional debt ratio to produce a result falling somewhere between temporary anguish and default.”

The above is an apt explanation for the phrase: Leverage is a double-edged sword. Although leverage can enhance our returns, it can also lead to a lot of stress. This means that in bad times – however rare those bad times may be – our investments could see substantial losses if we’re utilising leverage.

Investors with long time horizons shouldn’t be in a hurry to make big returns. If time is on our side, we should enjoy the process of picking wonderful companies year over year. Once we have done the initial hard work, we should just sit back and let our investments work their magic.

Buffett summed this up nicely:

“If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things along faster. Charlie [referring to Buffett’s long-time business partner, Charlie Munger] and I have never been in a big hurry: We enjoy the process far more than the proceeds – though we have learned to live with those also”.

To end off, let’s recap all the key points I’ve covered in my series of articles on Buffett’s mistakes. Firstly, Buffett had made a mistake by buying cheap businesses; the lesson learnt there is to pick wonderful companies instead. Secondly, we should look out for companies with both these characteristics: A business with wonderful economics, and a management team that has integrity and ability. Thirdly, we should adopt a long time horizon when investing, and enjoy the process.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.