Warren Buffett’s perspectives on investing are worth their weight in gold (or better yet, stocks). Invest in things you understand. Wait for the right pitch. Don’t follow the herd. Buy things you’d be comfortable holding forever.

In a recent article in Fortune magazine, Buffett lays out his views on what he considers the three major categories of investment possibilities: fixed income (currency-based investments), assets that will never produce anything (gold), and productive assets (businesses, farms, real estate).

Not surprisingly, Warren thinks that the third category is the place to be: “I believe that over any extended period of time this category of investing [ownership of businesses] will prove to be the runaway winner among the three we've examined. More important, it will be by far the safest.”

He notes, “The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.”

Consider Buffett’s views on gold. “Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be about $9.6 trillion. Call this cube pile A. Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

There are lots of other unique perspectives in the article, which is an adaptation of his upcoming shareholder letter. Buffett fans may also be interested in watching a 12 minute segment that aired on CBS’s ‘Person to Person’ last night, in which he takes Charlie Rose and Lara Logan through his private office in Omaha.

“I think the future of equities will be roughly the same as their past; in particular, common-stock purchases will prove satisfactory when made at appropriated price levels. It may be objected that it is far too cursory and superficial a conclusion; that it fails to take into account the new factors and problems that have entered the economic picture in recent years – especially those of ... the movement towards less consumption and zero growth. Perhaps I should add to my list the widespread public mistrust of Wall Street as a whole, engendered by its well-nigh scandalous behavior during recent years in the areas of ethics, financial practices of all sorts, and plain business sense.”

Was this a quote from me responding to readers and clients who can’t believe I’d recommend a full allocation to stocks at this time of economic peril? No, it’s from a speech by Benjamin Graham, the father of value investing, which was printed in the Financial Analyst Journal’s 1974 September/October issue. At time of publication, the S&P 500 was down 48% from January, 1973. In 1975, the index was up 37%.

Stocks aren’t down nearly as far as they were during the oil crisis in 1974 (and I’m certainly not looking for a 1975 recovery), but the penchant for investors to disengage from company fundamentals and stock valuations, and instead act on political and economic news is rivaling some of the previous market lows.

(Thanks to Southeastern Asset Management for reprinting Mr. Graham’s quote in its third quarter report.)

"The risks are the usual: what you don’t know; what you’re not thinking about; probably the biggest risk is what you are 100% sure about.”

Bruce Berkowitz, Fairholme Capital Management, in a speech at Columbia University earlier this year.

A 7-game playoff series is a unique animal. It’s a roller coaster ride with potential mood swings after each game. It reminds me a lot of investing actually.

As I sit here with my Canucks jersey on, I feel like the boring realist. I’ve celebrated each victory and got pissed off after each loss, but in between, I’ve refused to get too caught up in the hyperbole.

I’ve found myself in a few conversations that go something like this.

After Game 2 – Canucks lead the series 2-0:

Freddie: This is awesome. The ‘Nucks don’t have any weaknesses. I don’t see how the Bruins have a chance.

Steady: Fred, let’s not get carried away. We won two games ... at home ... by a total of 2 goals – one with 19 seconds left and the other in overtime. Canucks are in great shape and I think they’re the better team, but against Boston they’re going to have to fight and claw for everything they get.

Freddie: But it’s our destiny. It’s the Canucks’ year.

Steady: It does feel that way, but guess what, the Bruins are having a storybook season too. Their fans feel the same way.

Two days later:

Steady: How are you feeling about the series Freddie?

Freddie: Geez, I don’t know. They blew us out last night. We weren’t able to get any clear shots on Thomas, while Louie looked shaky again. I’m worried. What do you think?

Steady: It was ugly, but that happens sometimes. In games like that, the score doesn’t mean much. After the first few goals, it’s not a normal game. We’ll bounce back.

Freddie: But 8-1? I think the Bruins have our number now. We’re going to need some luck to win this.

Steady: Luck would be good, but remember Freddie, you and I watched the Patriots rout the Jets on Monday Night Football in December - the score was forty-something to 3. And guess what, the Jets beat the Patriots a few weeks later in the playoffs.

Freddie: That’s ancient history. I hope it makes you feel better.

Steady: It’s not about feeling better, it’s about assessing the ‘Nucks chances. They are leading the series 2-to-1 and still have home ice advantage. They are deeper and faster than the Bruins ... by a mile. And they’ve been good all year at not letting a bad loss ruffle their feathers.

Freddie: I don’t know Steady. I think it’s ‘do or die’ tonight. If they don’t win, the Canucks are toast. I’m so nervous.

Steady: Freddie, you are so full of it. If we lose tonite, we’ll be coming home with the series tied 2-2. I like our chances more at 3-1, but 2-2 is just fine.

Freddie: Geez Steady, you never seem to swing too far in either direction. You know what? I need someone like you to manage my money. How about it?

Steady: I’ll think about it.

Some advice from the sage: “You want to be greedy when others are fearful and you want to be fearful when others are greedy. In my adult lifetime, I don’t think I’ve seen people as fearful economically as they are right now.”

Chris’ grandfather always said, “You make most of your money during a bear market; you just don’t realize it at the time.”

It’s easy to say, hard to do and oh so true.  Weak markets provide the fertile soil in which investors can sow the seeds of future returns. 

After the last few days, we all want to hide under our desks.  Maybe we should, but while we’re there we’ve got to be thinking about how to best use this opportunity.  The market declines have set us up for what I think will be double digit equity returns over the next few years.  We want to make sure we capture them.

To put it another way, on the ‘fear versus greed’ measure, we should be moving decidedly towards the greedy side.

Buffett put his own cash on the line (not that he’s got a shortage of it) up against Protege Partners LLC, a New York-based investment firm that manages baskets of hedge funds (also known as ‘funds of funds’).  Both parties ponied up $320,000 each and invested the total in a zero-coupon Treasury bond that will be worth $1 million in 10 years time.  The proceeds will go to the winner’s charity of choice.

Buffett is confident that he’s got the upper hand, thanks to the hefty fees that hedge funds charge – especially those that invest in other funds, where there’s multiple layers of fees.  Many hedge funds charge a “2 and 20” fee, which means they take 2% of the fund’s assets per year as a management fee, plus 20% of any profits as a performance fee.  Buffett has been a longtime critic of high investment fees and is putting his money where his mouth is in this case.

Will fees be the deciding factor in the wager?  We’ll know in 2017.

Betting against Warren...hmmm...not a very fruitful exercise the last time I checked.

Tom, You couldn't be more bang on. It is really unfathomable to think that people who are supposed to be much smarter than me would think that a 'rebate' is going to solve the problems of the day. Maybe Americans really are as stupid as the rest of the world views them. Do George and Ben really think a trip to the mall will make everything magically better? We live in a city being decimated by foreclosure. Why? There are lots of construction projects here, there are many unfilled jobs and the cost of living is reasonable, actually cheap when you compare to other places in the world. One word. Greed! Everyone wanted the BIG house and the two luxury cars and the Harley and the pool and the, and the....They used their house like an ATM and now they have to pay. Oh! The house isn't worth as much any more and since they didn't put any money down and decided not paying any interest for a few years would be a good idea, all of a sudden they are in a pickle.

As conservative Canadians we thought we should buy a home that was less than what they said we could afford, put down our 20% (which we worked hard to save) so we didn't have to get mortgage insurance and took out a 15 year mortgage (unheard of in the USA) and paid it off in 5 years when we were making lots of money so we are debt free. But the kicker is that I don't know if that was the best move because all these greedy people are driving the market value down and they are going to get bailed out and we won't get a nickle.

The Nevada gov't a few years ago gave a rebate when there was a surplus of funds and sent us all a check for $60. Like I remember what I spent that on but I'm sure it wasn't anything important. Now they are in dire straits and don't have enough to fund the education programs that my children would benefit from. I wish they would have kept that 60 bucks.

It's time to make the public grow up and start living within their means. Until Big Daddy Gov't stops handing out 'free money' this will be an ongoing problem. I love the saying, "it's not how much money you make, it's how much you spend". And I hope the public sees whats going on in the presidential campaigns with their promises to stimulate the economy. Nice talk but who is going to pay for it? Looks like I will have to become a citizen so I can vote.

As of yesterday’s close, the TSX had dropped more than 12% since the beginning of the year. Last year’s gains were gone in a mere three weeks. The S&P 500 was down 10%, Germany and France had both fallen more than 15% and Japan was off over 20%. Nowhere to run to baby, nowhere to hide (to shamelessly steal a line from Martha and the Vandellas).

Many markets bounced back today, gaining anywhere from 2-4%, as Ben Bernanke and his crew at the U.S. Federal Reserve unexpectedly slashed interest rates by 0.75% and the Bank of Canada cut our key rate by 0.25%.

What’s going on out there? To be sure, these are not normal times. The widespread decline is an indication that stocks are being dumped en masse. Fear is driving the markets and novice investors have become nauseous. Seasoned fund managers, on the other hand, are shopping for bargains as pullbacks of this extent over such a short period of time are rare.

What’s a rational investor to do? You’ve heard it before, but it’s worth repeating. In times like these, it’s best to sit back, tune out the short-term noise and ride out the volatility. If you’ve got some cash on the sideline, maybe it’s time to put it to work. Stocks are on sale. In any event, think carefully before you act. Ben Graham said it best: The investor’s chief problem – and even his worst enemy – is likely to be himself.

In the investment world, when a view is so widely and passionately held, it is noteworthy for a number of reasons.

First of all, it means the issues are well known. In this case, America’s problems are front page news (deficits, dollar and derivatives … and Bush). If the U.S. economy is weak in the coming year and the dollar declines, no one will be surprised.

Second, the degree of consensus is not a good indicator of what the final outcome will be. It may be right, but often when everyone is expecting one thing, the opposite proves to be the case.

And finally, and most importantly, a strong consensus means that the balance between reward and risk is out of whack, or 'asymmetrical.' In other words, if the consensus proves to be right, there is little money to be made because the outcome was widely anticipated. On the other hand, if the consensus is wrong and investors are positioned for it, the rewards can be substantial. Investors like Warren Buffett don’t necessarily go looking for bets against the consensus, but when their actions have run counter to the herd, the rewards have been huge.

I don’t know when the U.S. market is going to make investors money again, but to not own any U.S. securities is a big bet. In the words of Peter Bernstein, “If you are comfortable with everything you own, you're not diversified."

I got an email from Neil on Saturday afternoon:

From: njensen@steadyhand.com
Subject: Words of wisdom from Swensen
Body: Read while watching Claire at swimming today (p.60): "Sensible investors pursue diversification as a policy to reduce risk, not as a tactic to chase performance."

Upon reading his note, my first thought was 'Are we warped or what?' Even our tech/ops guy is reading Swensen (the author of Unconventional Success, which is at the top of our recommended reading list) while watching his daughter at swimming lessons. Whoa!

In reality, Neil is an excellent investor (after all, he’s been hanging around PH&N and Steadyhand for 10 years) and his Swensen quote is right on.

The next line after Neil’s quote on page 60 reads: “By following a disciplined policy of maintaining a well-diversified set of portfolio exposures, regardless of market zigs and zags, investors establish the conditions for long-run success.” I take away three things from these comments.

First of all, it’s a reminder that diversification is the only ‘free lunch’ we have available to us. In other words, by properly diversifying, we can lower the volatility and capital risk of our portfolios without reducing long-term returns.

Second, we should not confuse diversification with market timing. A properly diversified portfolio will lead to success in the long run, but it is totally random as to whether it helps returns in the near term. We should not judge the success of such a strategy based on short-term results.

And third, a disciplined diversification strategy (i.e. unemotional, automatic re-balancing) increases the odds that you will add to asset classes after they have done poorly rather than chasing them after they’ve done well.

Thanks for the note Neil. Keep swimming Claire.

1. a) prophet: an authoritative person who divines the future. b) a prophecy (usually obscure or allegorical) revealed by a priest or priestess; believed to be infallible. c) a shrine where an oracular god is consulted.

2. In complexity theory and computability theory, an oracle machine is an abstract machine used to study decision problems. It can be visualized as a Turing machine with a black box, called oracle, which is able to decide certain decision problems in a single step.

3. A seer/psychic of great power. Uses objects like a Crystal Ball.

I think these definitions are pretty revealing into why people refer to Warren Buffett as the ‘Oracle of Omaha.’ While I doubt Buffett hides a crystal ball, talks regularly with deities or dons priestly garbs in his office, I do think Buffett is able to focus better than most investors on what really matters, and make complex decisions seem simple. His ability to assess a business’ prospects and buy stocks accordingly is why many people tag him as someone who can see the future.

Though, as he tirelessly relates: “It’s not rocket science.” At Steadyhand, we share this belief.

Buffett’s clarity of thought especially comes through when he talks or writes, and this is why I particularly enjoyed these Q&A videos I found on YouTube where Buffett fields questions from an MBA class.

Hope you enjoy!

I bring this up because his quarterly letter for April is a terrific read. The title pretty much explains his topic – It’s Everywhere, In Everything: The First Truly Global Bubble (Observations following a 6-week round-the-world trip).

Rather than try to recap what he says, I’d just recommend you go to www.gmo.com and print it off. You will have to register on the site, but it’s doesn’t cost anything and you can set it up to receive notices of future Grantham missives if you wish.

I came across a wonderful quote yesterday. I was reading a piece I'd found on the Tocqueville Asset Management website (www. tocqueville.com) written by their Chairman, Francois Sicart.

"I never invest in a situation in which I cannot lose money"

He said this was his "unbreakable rule." He went on to say: "The reason why I do not invest when I cannot lose is that win-win situations simply do not exist in the investment world. Regardless of the markets' periodic infatuation with portfolio insurance, risk hedging and other intellectual constructions, plain common sense tells us that if the buyer of an investment is guaranteed not to lose, the seller must be guaranteed not to win. Since the seller is often quite sophisticated, the odds should make investors cautious: maybe there's something in this dream offer that they don't understand."

This piece was written in January, 1999.

"If something isn't worth doing, it isn't worth doing well."

This is one of my favourite Charlie Munger lines and I think it's very applicable for those of us who manage money, for clients or just for ourselves. Specifically, I'm referring to how we manage the never-ending flow of short-term information. Information that has a shelf life of a few hours or days and is useless in the overall scheme of things.

Think about it.

If we look back in 3 to 5 years, will it matter in any way that the market had a good (or bad) week in the middle of June, 2006? The wiggle on the long-term chart of the S&P/TSX index will be imperceptible.

Does it really matter if we're good at figuring out what the Fed is going to do next? Considering how many smart people are doing it, you'd have to be superhuman to beat the street at this game.

Will the fact that we correctly predicted CN Rail's quarterly earnings impact our long-term returns in the least?

Can we consistently make money by thinking about where the market leadership is going to come from next?

We spend far too much time dealing with and thinking about the barrage of information that does nothing to make us money. All it does is clog up our memory banks and take away from more productive research and thinking time. It isn't worth doing ... well or otherwise.

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