Even Buffett makes mistakes

Even the best investors make mistakes and not every stock you invest in will be a winner. All that matters over time is that your winners outweigh your losers.

In 1998, as the Internet boom raged, Bloomberg asked Warren Buffett whether he would ever join the party. ‘The answer is no’, he replied, because he didn’t ‘know what that world will look like in 10 years’.

So it came as a shock when he invested in IBM in 2011, eventually building his stake to over 70m shares.

Following IBM’s announcement on Monday that it was struggling to adapt to the rise of cloud computing, Buffett’s shareholding is now under water. While it’s still early days for Buffett’s investment, the situation offers some great lessons.

First, even the best investors make mistakes and not every stock you invest in will be a winner. All that matters over time is that your winners outweigh your losers.

Second, investing is a game of averages, where randomness can greatly impact your returns, particularly in the short term. If Australian cricket captain Michael Clarke makes four ducks in a row this summer, some sports journalists might start calling for his head. That’s despite his wonderful track record over many years. Clarke’s performance should be judged over a long enough period – say three or four test series – for any bad luck or temporary loss of form to take a back seat to his natural talent.

The same principle should be applied to investing. What matters is the performance of your portfolio over a long period (at least three to five years), not whether an individual stock has fallen 50% or risen 200% over the past week or month.

Finally, stock prices are far more volatile than the underlying value of the businesses they represent, as the past month has shown. When you purchase a stock it is just as likely to go down as up in the short term and you’re unlikely to pick the absolute bottom consistently. Ignoring short term stock price fluctuations in favour of understanding a business’s competitive advantages, insisting on a margin of safety and having an intelligently diversified portfolio is the best recipe for successful investing.

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