Wednesday, October 22, 2008

Should you invest like Warren Buffet?

In this piece I discuss whether one should follow the advice of Warren Buffet's NYT op-ed on Friday. When trying to decide the answer to that the first question you have to ask yourself is what kind of person are you.

Before you can answer that I can answer at least part of it for you: you are not Warren Buffet. By saying you are not Warren Buffet I am not saying that you are not a billionaire, you probably aren't, but that isn't the important part. Warren Buffet has a lifetime of experience in the markets and total confidence in his own judgement in matters financial. He also has proven time and again that he can successfully execute the buy and hold strategy, even through difficult times. For most people this is not the case.

Mr. Buffet points out that he is not a market timer and there may be more storms ahead, indeed the market has dropped 5% since he made his call. For Warren, however, a 5% or 10% or 25% or 50% decline will probably not shake his 10 year view that this too shall pass. That is probably not true for many investors. Many ordinary people when confronted with loss begin to behave non-rationally either through panic or denial.

This makes it likely that many ordinary investors would be shaken out at some point if the market declines, and therefore would not be around for the rebound. They would execute only half of the buy and hold strategy with likely negative results. So instead of buying now and resiging yourself to the possiblity that the market may continue to go down, it might make sense to resign yourself to the fact that you will miss the first 30% of the rebound and not buy until you are totally sure this is over.

Odds are the market will not recover as quickly as it had fallen.

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