Invest Like Warren Buffett

I received the latest issue of Fortune magazine in the mail the other day and found myself staring at the Oracle of Omaha, Warren Buffett.  The caption next to his photo basically says “Warren is ‘wild about’ such and such company, shouldn’t you be?”

Warren Buffett has found himself in the position of being something of a beacon of hope for investors.  He has spent his life investing and is quite successful at it.  So successful in fact, that he is one of the richest men on the planet (second only to Bill Gates as of this article).  With a reputation like that, there is no reason why the average investor shouldn’t follow his every move in order to become wealthy along with him, right?

I have a problem with following the advice of any single person blindly.  It boils down to doing what you are told rather than making informed decisions for yourself.  Why is following the moves of Warren Buffett any different than following the advice of Jim Cramer?  Is it because Buffett has proven himself to be wise and savvy in the ways of investing?  Is it because he knows more than you do?

Warren Buffett is not your average investor.  He has power, something you and I do not possess.  He is able to invest in a company and sit on the Board of Directors, keeping the management team in line and offering advice and suggestions of how to improve the company.  His ability to do this helps him have control over the future of his investments.  Wouldn’t it be nice if you had that power?

What can you do to invest like Buffett?

The first thing you need to do is to find a company you might want to invest in and research that company.  Don’t listen to the advice of your cousin Joe and invest your money in the hot new stock.  By the time there is a “hot new stock”, it is too late and you’ll be jumping on board right before the stock tanks.  Follow these wise words of Mr. Buffett himself:

          “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

This is a great philosophy for investing.  Had I followed this advice when I was trying to make a quick dollar by investing in Washington Mutual just before it went bankrupt, I probably wouldn’t have invested my money in them and would still have that money available to me.  Instead, I saw the possibility of making a quick dollar, and I could have if I would have pulled out sooner, but the end result was due to buying a weak company because of the price of its stock.

Another technique Buffett uses is buy and hold.  As Warren says, “Our favorite holding period is forever.”  Even the best day traders end up with returns inferior to those who buy and hold over the long term.  Why?  Commission and capital gains taxes.  For the little guys it doesn’t make sense to be actively trading.  We do not have the kind of money required to offset the commissions and taxes we would pay by making frequent trades.  Your best chance at success is investing in strong companies over the long haul.

Should you be following Warren Buffett’s every investment decision?  That is a choice you need to make as an individual.  If you were to ask The Oracle, I have a suspicion that his advice would be this:

         “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

That says a lot about whether or not you should be doing what Warren Buffett is doing, straight from the mouth of the Oracle himself.

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Typically if you’re searching for good CD rates then a bank is a pretty obvious place to find CDs. However, banks are often overlooked when people are looking for credit cards. Banks are a great place to find a new credit card, especially if you’re trying to open a new credit card. A bank is more likely to give you credit if you already have a relationship with them.

Greater Risk, Greater Reward

This is the 2nd of a 2 part series discussing different types of investments based on their risk level.  You can find Part 1 of this series, called “Low Risk Investing”, here.

I am no prodigy when it comes to investing my money. I tried stock picking for a while but lost quite a bit of money for a guy with my income. I bought 90 shares of Washington Mutual just before they announced they would be filing for bankrupcy. I was convinced by their new CEO that everything was going to be okay. He was wrong. I woke up one morning to see my account balance worth pennies. I tried my hand at investing in more stable companies such as Exxon Mobil. Despite the fact that they once again made record profits, I watched the value of my stocks slide every day.

Where a person invests their money is a decision that needs to be made based on many factors. Maybe the most widely discussed factor for investment decisions is a person’s tolerance for risk. Simply stated, the greater the risk, the greater the reward. The other side of that equation is that you stand a greater possibility of losing your money as I did with my Washington Mutual investment.

401(k)- This is one of the more common retirement accounts around today.  With great enthusiasm I say that 401(k) accounts are one of the best things to happen to workers all across the country.  Of course there will be people with contrary opinions about this, but let me explain.  The money that is deposited into your 401(k) account is pre-tax which means that you aren’t being taxed on your investment or your earnings until you are ready to begin taking distributions.  For people like myself, that means that our money grows, earns interest and compounds for years upon years before the government gets its fingers on any of it.  The contributions you make to your 401(k) account also lower your taxable income, meaning you have less tax liability.

Many employers will also make a matching contribution to your account.  The most common amount is a 50% match up to 6% of your contributions.  That’s just like giving yourself an automatic 50% return on that first 6%.  Good luck find that anywhere else!

These accounts are not without their flaws.  Depending on which funds you have in your account, they may have high fees which eat away at your returns.  For the most part the fees found in 401(k) accounts are reasonable, but be sure to take the time to weigh your options and carefully consider where you are putting your money.   While an employer match is a great thing for you and your account balance, many times the employer contribution goes directly into company stock.  If you are working for a great company whose stock only seems to increase, good…but don’t get overconfident either.  Do I even need to convince you that having the majority of your money in company stock is a bad idea?  ENwRONg!  Another minor inconvenience with employer contributions is that they don’t belong to you until you have become vested in the company, which means you have to work there for a specified time period before you have any rights to that money.

I recommend investing in a 401(k) to everyone who is eligible to participate in their company plan.  In order to minimize your risk while maximizing your gains, be sure to do your research on the funds available to you and plan accordingly.

Mutual Funds- These are another great investment tool.  The basic concept of a mutual fund is that it is a collection of individual stocks from a multitude of companies.  They allow you to create instant diversification in your portfolio so that you are not weighted down too much by one single company, though you will likely be weighted down by a specific sector in a single mutual fund.  Like the stock market, mutual funds go up and they go down and for anyone who has a short time horizon for investing I would recommend a more conservative fund.  Mutual funds are available in all shapes and sizes, from penny-pinching conservative to investing in developing countries.

I recommend investing in mutual funds to someone looking to get access to a wide variety of companies in a specific sector of the market while reducing their risk to exposure from one specific company.

Stocks- Stocks are shares of a company which a person can buy.  Essentially by purchasing a share of stock, you own a peice of that company.  Stocks are often considered the riskiest of investments, and from the story I shared above, you can see why.  It is easy to buy stock, but difficult to make an informed decision.  There are many different things to consider before buying a stock, all of which are too complex for me to try to explain here.  You should analyze financial data for the company and fully understand the company before you put your money into it.  I did not do this when I invested in Washington Mutual.  I got excited at seeing a depressed stock price and was blinded by the prospect of hitting it big.  I didn’t pay attention to the overall picture, and even though their newly chaired CEO was insisting everything was okay and that there was enough capital to weather the storm, they went bankrupt.

I would recommend individual stock picks to a person who is able to watch their money disappear overnight in exchange for the possibility of a high return.

Commodities- Commodities are tangible items like crude oil, corn, wheat, coal, salt, sugar, coffee beans, gold, silver and rice.  The price of commodities fluctuates with supply and demand.  There is a great deal of money to be made in this market if you know what you are doing.

I would recommend investing in commodities if you know the market well and understand the cycle of supply and demand of that given item.

Of course there are numerous other avenues in which you can invest your hard earned money and I recommend that you do the research to find what is the best investment vehicle for your needs.  A person shouldn’t only consider the rate of return or their tolerance for risk when investing.  There are other things to consider as well such as whether or not the company you want to invest in meshes well with your values.  Are they doing what you consider to be the right thing?  Are they making the right moves?  Do they have a strong balance sheet?  What are the fees involved with the investment?

The most important thing that a person can do before they invest is to get educated.  Find time to read a basic book about investing, spend some time learning about a company or a mutual fund.  The only way that you can learn is to seek information.  You won’t become an investing guru overnight and you will make some mistakes.  I know I sure have and I also know I have a very long way to go before I understand all of this investing stuff myself.

Disclaimer- I am not a financial advisor I cannot speak to all of the benefits and disadvantages of each.  I am also not a tax specialist and therefore am not qualified to offer advice about the tax consequences of each investment.  I encourage you to continue your research about different investment options and speak with a financial advisor.

Low Risk Investing

This is the first of a 2 part series discussing different types of investments based on their risk level.  You will find Part 2 of this series in days forthcoming.

Investing money is a great way of preparing for the future and an important step in your journey towards accomplishing your goals.  There are numerous investment options available today and sorting through them can be confusing.  I’d like to look at a few of the more common investment options.

Emotion drives a person’s decisions when it comes to investing.  A lot of choices are made based entirely on emotion; either a person is afraid to take any risk so they keep their money under their mattress or a person picks a stock based on the advice of Jim Cramer.  Neither approach is a sound financial decision.  Today I’d like to discuss investment options which fall into the spectrum of low risk.

Piggy Bank- Many people have some sort of money saving mechanism in their homes.  Maybe they have a piggy bank or a shoebox under the bed stuffed with bills.  Personally, I have a 20 gallon bottle that I toss my spare coins into.  While many people see this as being a safe way of saving their hard earned money, I disagree.  There are 2 reasons I feel that this is one of the more risky ways of saving your money.  The most obvious threat is theft.  If you keep large amounts of money tucked under your mattress you never know when something may happen and that money may end up missing.  Yes, the chances are slim, but the risk is still there.  Inflation is less obvious of a threat than theft but has greater consequences.  Imagine you were able to have saved $25 in 1965 and tucked it under the mattress for nearly 45 years.  It would still be worth $25, but that $25 back then would have had more value and could have bought $170 worth of today’s goods.  Thank you inflation.

I would recommend using a shoe box and piggy bank for long term savings to no one. 

Savings Accounts- A common way for people to save money is an old fashioned savings account.  These accounts offer very low interest rates and may not beat inflation but provide security for your money.  Savings accounts in banks and credit unions are now federally insured up to $250,000.  You need not worry about the value of your account as it will not decrease.

I recommend a savings account for your Emergency Fund and any other amount of money which you will be needing in the near future.  Though interest rates on a savings account are practically nothing, you have the security of knowing that the money will be available to you immediately if a need would arise.

High-Yield Savings Account- These accounts are essentially the same as a savings account except that they are generally online.  Because of the low overhead of providing customers with online services rather than brick & mortar banks, they offer a competitive interest rate, often much higher than you would recieve at a bank or credit union.

I recommend a high-yield savings account for people who want to earn a bit higher interest rate and still have the security of a federally insured savings account.  The drawback to these accounts is the transfer time of your funds.  I use these accounts for savings for things like vacations and my car insurance deductible, money that I don’t need immediately but will be used soon.

Certificates of Deposit- Banks offer certificates of deposits, or CDs, to customers who are seeking a higher interest rate in exchange for depositing their money for a specified period of time.  The longer you deposit your money the higher the interest rate you generally earn on that deposit.  There are a couple of drawbacks to this vehicle of investing.  While the interest you earn is guaranteed, it is somewhat low.  It is usually higher than most savings accounts, however.  The other problem with CDs is that you lock in your interest rate for the duration of the deposit.  For example, if you decide to purchase a 5 year CD and a year later interest rates climb, the interest on your CD remains the same.  The flipside to this is when interest rates fall your rate will remain the same and that is good.

I recommend CDs to people who are looking for a safe investment vehicle with a guaranteed return on their investment and are able to deposit their money for a specified duration of time without needing access to their money before that time period.  Early withdrawls on certificates of deposit result in penalties and fees, which should be avoided at all costs.

Savings Bonds- Savings bonds are government issued savings vehicles.  They are backed by the full faith and credit of the United States government.  Savings bonds are not subject to state or local taxes.  Because they offer interest rates higher than most savings accounts, you may want to invest in bonds if you are looking for a way to preserve your principle while earning a moderate interest rate.

I recommend Savings Bonds to people who are looking for safety and security of an investment which is backed by the US government.  Because Savings Bonds offer an interest rate which is generally higher than banks, an individual looking for moderate but competitive interest rates should add them to their portfolio.

Traditional IRA- An IRA is an Individual Retirement Account.  You can chose to invest your money within these funds in a variety of ways and can chose from very conservative investment options to more risky choices.  In 2009 a person may invest up to $6,000 into one of these accounts.  When you invest your money in a Traditional IRA, that money is tax-deductible, which is the main benefit to these accounts.  Traditional IRA accounts are taxable upon distribution and distributions made before the age of 59 1/2 will result in an early withdrawl penalty of 10%.

I recommend investing in a Traditional IRA if you expect to find yourself in a lower tax bracket at the time of your retirement and are not eligible for a Roth IRA.

Roth IRA- Roth IRA accounts are similar to Traditional IRA accounts with the exception of the money you deposit is not tax-deductible.  Despite the fact that there are no immediate tax-benefits, unlike a Traditional IRA, distributions are tax free.  In order to be elibible for full contribution to these accounts a person must not earn more than $101,000.

I recommend a Roth IRA to everyone who is eligible to invest in one.  A Roth IRA is one of the few cases which your investments and earnings can grow and compound for years and at distribution are tax-free.  This is a good deal.

Although these investment options offer their own benefits they also come with a risk.  That risk is low return on your investments.  Especially when considering retirement, return on investment is a very important factor to consider.  Many people simply cannot save enough money to fund their retirement without the help of interest. 

A person should not make investment choices based solely on emotion and investing your money on the basis of your risk tolerance is doing just that.  Even though your money is safe you may be missing great opportunities for yourself.

Disclaimer- I am not a financial advisor and cannot speak to all of the benefits and disadvantages of each.  I am also not a tax specialist and therefore am not qualified to offer advice about the tax consequences of each investment.  I encourage you to continue your research about different investment options and speak with a financial advisor.