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5 ways to invest like Warren Buffett (from the man himself)

You don’t need to own Berkshire Hathaway stock to benefit from the investing wisdom of the world’s richest man.

His annual letter to Berkshire shareholders [1] explains just how to invest like Warren Buffett. (It also includes more jokes than the average CEO manages in a year!)

Here’s five highlights from Buffett’s latest letter to get you started.

1. Always have plenty of cash

An emergency fund [2] is the first priority for all investors. Your emergency fund should be very liquid [3] – which means instant access cash savings.

But you might prefer to take billionaire Warren Buffett’s word for it:

We will never become dependent on the kindness of strangers. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity.

Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses. […]

We pay a steep price to maintain our premier financial strength. The $20 billion-plus of cash-equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.

Don’t dismiss cash. Focus on income [4] to create your own ‘gusher of earnings’, and invest like Warren Buffett into a diversified portfolio [5]. But don’t chase high returns [6] with every last penny – the low return on your cash component is the price you pay for sleeping well each night.

2. Know that fear is your friend

Buffett didn’t get insanely rich by following the crowd. To invest like Warren Buffett, you need to be greedy when others are fearful:

Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.

We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance.

In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what that business earns in the succeeding decade or two.

Don’t lose track of your objectives just because the market has lost its head. Buy in bear markets [7]. When the stock market crashes like in March 2009 [8], a cool head and spare cash will net you the buys of a lifetime.

3. Don’t believe the headline news

I enjoy the financial media, and my spin-off site Stock Tickle [9] is a product of my fascination with the markets.

Warren Buffett is the same – he’s a CNBC addict.

But Buffett always looks beyond the headlines, and he knows the pundits can be even worse than fortune tellers:

Last year we saw, in one instance, how sound-bite reporting can go wrong. Among the 12,830 words in the annual letter was this sentence: “We are certain, for example, that the economy will be in shambles throughout 2009 – and probably well beyond – but that conclusion does not tell us whether the market will rise or fall.”

Many news organizations reported – indeed, blared – the first part of the sentence while making no mention whatsoever of its ending.

I regard this as terrible journalism: Misinformed readers or viewers may well have thought that Charlie and I were forecasting bad things for the stock market, though we had not only in that sentence, but also elsewhere, made it clear we weren’t predicting the market at all.

Any investors who were misled by the sensationalists paid a big price: The Dow closed the day of the letter at 7,063 and finished the year at 10,428.

The financial media has an agenda – to entertain you and scare you into watching more programming (and hence more advertising). It can’t make you rich, and it doesn’t try to.

4. Understand you will make mistakes

You won’t get everything right:

Even if you (sensibly) shun stock picking and invest via an index tracker [11], you may regret putting money in some particular year, or wish you’d bought more corporate bonds. You may also regret buying – or not buying – your own home.

Warren Buffett could blame others – or the markets – for his mistakes. He’s the world’s greatest investor, so who could contradict him?

Yet like every year Buffett blames himself:

And now a painful confession: Last year your chairman closed the book on a very expensive business fiasco entirely of his own making.

For many years I had struggled to think of side products that we could offer our millions of loyal GEICO customers. Unfortunately, I finally succeeded, coming up with a brilliant insight that we should market our own credit card.

Our pre-tax losses from credit-card operations came to about $6.3 million before I finally woke up.

GEICO’s managers, it should be emphasized, were never enthusiastic about my idea. They warned me that instead of getting the cream of GEICO’s customers we would get the – well, let’s call it the non-cream. I subtly indicated that I was older and wiser.

I was just older.

Investors too often deny their mistakes (“I knew that would happen!”) or else get angry (“that shouldn’t have happened!”). It’s better for your long-term wealth to admit you’re human, and to try to learn from your mistakes [12].

5. Appreciate your good fortune

There’s an unattractive side to some who try to get wealthy. They become bitter about others who are already successful, or nasty and overly judgemental about poorer people.

Just as I try to invest like Warren Buffett, I personally prefer to follow Buffett’s attitude towards his life [13]:

At 86 and 79, Charlie and I remain lucky beyond our dreams. We were born in America; had terrific parents who saw that we got good educations; have enjoyed wonderful families and great health; and came equipped with a “business” gene that allows us to prosper in a manner hugely disproportionate to that experienced by many people who contribute as much or more to our society’s well-being.

Moreover, we have long had jobs that we love, in which we are helped in countless ways by talented and cheerful associates. Indeed, over the years, our work has become ever more fascinating; no wonder we tap-dance to work.

If pushed, we would gladly pay substantial sums to have our jobs (but don’t tell the Comp Committee).

Count your blessings. Find something you like doing that pays well, invest like Warren Buffett in equities for the long-term, and get rich!