The Winning Investment Habits of Warren Buffett and George Soros
By Mark Tier
St. Martin's Press Copyright © 2005 Mark Tier
All rights reserved.
The Power of Mental Habits
Warren Buffett and George Soros are the world's most successful investors.
Buffett's trademark is buying great businesses for considerably less than what he thinks they're worth — and owning them "forever." Soros is famous for making huge, leveraged trades in the currency and futures markets.
No two investors could seem more different. Their investment methods are as opposite as night and day. On the rare occasions when they have bought the same investment, it was for very different reasons.
What could the world's two most successful investors possibly have in common?
On the face of it, not much. But I suspected that if there is anything Buffett and Soros both do, it could be crucially important ... perhaps even the secret behind their success.
The more I looked, the more similarities I found. As I analyzed their thinking, how they come to their decisions, and even their beliefs, I found an amazing correspondence. For example:
Buffett and Soros share the same beliefs about the nature of the markets.
When they invest they're not focused on the profits they expect to make. Indeed, they're not investing for the money.
Both are far more focused on not losing money than on making it.
They never diversify: they always buy as much of an investment as they can get their hands on.
Their ability to make predictions about the market or the economy has absolutely nothing to do with their success.
As I analyzed their beliefs, behaviors, attitudes, and decision-making strategies, I found twenty-three mental habits and strategies they both practice religiously. And every one of them is something you can learn.
My next step was to "test" these habits against the behavior of other successful investors and commodity traders. The match was perfect.
The feared company raider Carl Icahn — whose net worth leapt an amazing 52 percent in 2003 to rocket him past George Soros on the Forbes list of the world's richest people; Peter Lynch, who produced an annual return of 29 percent during the years he ran the Fidelity Magellan Fund; legendary investors such as Bernard Baruch, Sir John Templeton, and Philip Fisher; and every one of dozens of other highly successful investors (and commodity traders) I've studied and worked with, all practice exactly the same mental habits as Buffett and Soros, without exception.
Cultural background makes no difference. A personally dramatic moment came when I interviewed a Japanese investor living in Hong Kong who trades futures in Singapore, Tokyo, and Chicago using Japanese candlestick charts. As the conversation proceeded, I checked off one habit after another from my list until I had twenty-two ticks.
And then he asked whether I thought he was liable for any tax on his profits from trading. That completed the list. (Thanks to Hong Kong's liberal tax regime, it was easy for him to legally do what he wanted: trade tax-free.)
The final test was to discover whether these habits are "portable." Can they be taught? And if you learned them, would your investment results change for the better?
I started with myself. Since I used to be an investment advisor, and for many years published my own investment newsletter, World Money Analyst, it's embarrassing to admit that my own investment results had been dismal. So bad, in fact, that for many years I just let my money sit in the bank.
When I changed my own behavior by adopting these Winning Investment Habits, my investment results improved dramatically. Since 1998 my personal stock market investments have risen an average of 24.4% per year — compared to the S&P, which went up only 2.3% per year. What's more, I haven't had a losing year, while the S&P was down three out of those six years. I made more money more easily than I ever thought possible. You can, too.
It makes no difference whether you look for stock market bargains like Warren Buffett, trade currency futures like George Soros, scour the markets for undervalued takeover targets like Carl Icahn, use technical analysis, follow candlestick charts, buy real estate, buy on dips or buy on breakouts, use a computerized trading system — or just want to salt money away safely for a rainy day. Adopt these habits and your investment returns will soar.
Applying the right mental habits can make the difference between success and failure in anything you do. But the mental strategies of Master Investors are fairly complex. So let's first look at a simpler example of mental habits.
Why Johnny Can't Spell
Some people are poor spellers. They exasperate their teachers because nothing the teacher does makes any difference to their ability to spell.
So teachers assume the students aren't too bright, even when they display better-than-average intelligence at other tasks — as many do.
The problem isn't a lack of intelligence: it's the mental strategies poor spellers use.
Good spellers call up the word they want to spell from memory and visualize it. They write the word down by "copying" it from memory. This happens so fast that good spellers are seldom aware of doing it. As with most people who are expert at something, they generally can't explain what they do that makes their success possible ... even inevitable.
By contrast, poor spellers spell words by the way they sound. That strategy doesn't work very well in English.
The solution is to teach poor spellers to adopt the mental habits of good spellers. As soon as they learn to "look" for the word they want to spell instead of "hearing" it, their spelling problem disappears.
I was amazed the first time I showed a poor speller this strategy. The man, a brilliant writer, had gotten a string of B's in school all with the comment: "You'd have gotten an A if only you'd learn how to spell!"
In less than five minutes, he was spelling words like "antidisestablishmentarianism," "rhetoric" and "rhythm," which had confounded him all his life. He already knew what they looked like; he just didn't know that he had to look.
Such is the power of mental habits.
The Structure of Mental Habits
A habit is a learned response that has become automatic through repetition. Once ingrained, the mental processes by which a habit operates are primarily subconscious.
This is clearly true of the good speller: he is completely unaware of how he spells a word correctly. He just "knows" that it's right.
But doesn't most of what the successful investor does take place at the conscious level? Aren't reading annual reports, analyzing balance sheets, even detecting patterns in charts of stock or commodity prices conscious activities?
To an extent, yes. But consciousness is only the tip of the mental iceberg. Behind every conscious thought, decision, or action is a complex array of subconscious mental processes — not to mention hidden beliefs and emotions that can sabotage even the most determined person.
For example, if someone has been told "You can't spell" over and over again, that belief can become part of his identity. He can understand the good speller's strategy and with an instructor's guidance can even replicate the good speller's results. But left to his own devices, he quickly reverts to his old mental pattern.
Only by changing the belief that "I am a poor speller" can he adopt the good speller's mental habits.
Another, though usually minor, stumbling block is the lack of an associated skill. A tiny percentage of people simply can't create an internal mental image: they have to be taught how to visualize before they can become good spellers.
Four elements are needed to sustain a mental habit:
1. a belief that drives your behavior;
2. a mental strategy — a series of internal conscious and subconscious processes;
3. a sustaining emotion; and
4. associated skills.
Let's apply this structure to analyze another process, one that's simpler than the habits of highly successful investors but more complex than the spelling strategy.
Imagine we're at a party and we see two men eyeing the same attractive woman. As we watch, we notice that the first man starts to walk toward her but then stops, turns, heads over to the bar, and spends the rest of the evening being an increasingly drunken wallflower. A few moments later, we see the second man walk over to the woman and begin talking with her.
A while later we become aware that the second man seems to be talking to just about everybody at the party. Eventually, he comes over to us and initiates a conversation. We conclude that he's a really nice guy, but when we think about it later we realize he didn't say very much at all: We did most of the talking.
We all know people like this, who can walk up to a total stranger and in a few minutes be chatting away like they're lifelong friends. I call them "IceBreakers," and behind their behavior is the mental habits they practice:
1. Belief: They believe that everybody is interesting.
2. Mental Strategy: They hear their own voice inside their head saying: "Isn't he/she an interesting person."
3. Sustaining Emotion: They feel curious, even excited, at the prospect of meeting somebody new. They feel good about themselves, and their attention is focused externally. (If they're preoccupied with some problem or feeling depressed about something — internally focused — they won't be "in the mood" for conversation.)
4. Associated Skills: They establish rapport by making eye contact and smiling with their eyes. When they have a sense of rapport, they initiate a conversation with some innocuous remark and maintain it by listening rather than talking, keeping eye contact and focusing their attention on the person (giving that person a sense of importance), and by wondering what's going on in this person's mind.
You can get a taste of how this works by trying it out for yourself. Just imagine (if you don't already believe it) that you consider all people are interesting and hear your own voice saying, "Isn't he/she an interesting person." Then look around, and if you're alone, imagine that you're in the middle of a crowd. You should be able to feel the difference (if only for a moment).
The Wallflower, who ended up at the bar, had a very different mental strategy. After an initial flash of interest, he "ran a movie" in his head of all the times he had been hurt in a relationship, felt lousy — and went to have a beer to drown his sorrows. His emotional reaction was the expression of a subconscious, self-limiting belief that "I'm not good enough," or "I always get hurt in relationships."
Another pattern when meeting someone new is to continually wonder: "Is this person interesting (to me)?" This self-centered approach reflects a belief that only some people are interesting. And it has very different behavioral consequences.
On the next page is a chart of these three different mental habits.
The Wallflower or the Self-Centered person can easily learn all the IceBreaker's skills: how to establish rapport, how to "smile with your eyes," how to be a good listener, and so on. He can even create an internal voice saying, "Isn't he/she an interesting person."
But what happens when the Wallflower actually tries to initiate a conversation with a complete stranger? His self-limiting beliefs override his conscious attempt to do something different — and nothing happens.
In the same way, an investor who subconsciously believes that "I don't deserve to make money" or "I'm a loser" cannot succeed in the markets no matter how many skills he learns or how hard he tries.
There are similar kinds of beliefs that lie behind many investors' losses, beliefs that I call The Seven Deadly Investment Sins.
The Seven Deadly Investment Sins
Most investors are hurt by mistaken beliefs about how to achieve investment success. These are beliefs that Master Investors such as Warren Buffett, George Soros, and Carl Icahn don't share. The most widely held of these damaging falsehoods are what I call The Seven Deadly Investment Sins.
The first step in putting these mistaken notions behind you is to see what's wrong with them ...
Deadly Investment Sin No. 1
Believing that you have to predict the market's next move to make big returns.
Highly successful investors are no better at predicting the market's next move than you or I.
Don't take my word for it.
One month before the October 1987 stock market crash, George Soros appeared on the cover of Fortune magazine. His message:
"That [American] stocks have moved up, up and away from the fundamental measures of value does not mean they must tumble. Just because the market is overvalued does not mean it is not sustainable. If you want to know how much more overvalued American stocks can become, just look at Japan."
While he remained bullish on American stocks, he felt there was a crash coming ... in Japan. He repeated that outlook in an article in the Financial Times of October 14, 1987.
One week later, Soros's Quantum Fund lost over $350 million as the US market, not the Japanese market, crashed. His entire profit for the year was wiped out in a few days.
As Soros admits: "My financial success stands in stark contrast with my ability to forecast events."
And Buffett? He simply doesn't care about what the market might do next and has no interest in predictions of any kind. To him, "forecasts may tell you a great deal about the forecaster; they tell you nothing about the future."
Successful investors don't rely on predicting the market's next move. Indeed, both Buffett and Soros would be the first to admit that if they relied on their market predictions, they'd go broke.
Prediction is the bread-and-butter of investment newsletter and mutual fund marketing — not of successful investing.
Deadly Investment Sin No. 2
The "Guru" belief: If I can't predict the market, there's someone somewhere who can — and all I need to do is find him.
If you could really predict the future, would you shout about it from the rooftops? Or would you keep your mouth shut, open a brokerage account, and make a pile of money?
Elaine Garzarelli was an obscure number cruncher when, on October 12, 1987, she predicted "an imminent collapse in the stock market." That was just one week before October's Black Monday.
Suddenly, she became a media celebrity. And within a few years, she had turned her celebrity status into a fortune.
By following her own advice?
No. Money poured into her mutual fund, reaching $700 million in less than a year. With a management fee of just 1%, that's $7 million smackeroos a year. Not bad. She also started an investment newsletter that quickly grew to over 100,000 subscribers.
The business benefits of guru status made plenty of money for Elaine Garzarelli — but not for her followers.
In 1994, the shareholders of her mutual fund quietly voted to shut it down. The reason: lackluster performance and an eroding asset base. Average return over the life of the fund: 4.7 percent per annum, vs. 5.8 percent for the S&P 500.
Seventeen years after she first rocketed to the investing public's attention, Elaine Garzarelli still maintains her guru/media celebrity status — even though her fund tanked, her newsletter went out of business, and her overall track record of prediction has been dismal.
For example, on July 21, 1996, with the Dow at 5452, she was reported as saying the Dow "could go to 6400." Just two days later she announced: "The market could fall 15 percent to 25 percent."
That's called having fifty cents each way.
Those were two of her fourteen public predictions between 1987 and 1996 — as recorded by the Wall Street Journal, Business Week, and the New York Times. Of the fourteen predictions, a mere five were correct.
That's a 36 percent success rate. You could have done better — and made more money — by flipping a coin.
Elaine Garzarelli is just one of a long line of market gurus who came and went.
Remember Joe Granville? He was the darling of the media in the early 1980s — until, when the Dow was around 800 in 1982, he advised his followers to sell everything and short the market.
Well, 1982 was the year the great bull market of the 1980s began. Nevertheless, Granville continued to urge people to short the market ... all the way up to 1200.
Granville was replaced by Robert Prechter, who — unlike Granville — had predicted a bull market in the 1980s. But after the crash of 1987 Prechter declared the bull market finished and predicted that the Dow would plunge to 400 in the early 1990s. That's like missing the side of a barn with a double-barreled shotgun.
The dot.com boom of the 1990s produced another set of media heroes, most of whom disappeared from view soon after the NASDAQ began tanking in March 2000. (Continues...)
Excerpted from The Winning Investment Habits of Warren Buffett and George Soros by Mark Tier. Copyright © 2005 Mark Tier. Excerpted by permission of St. Martin's Press.
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