What Warren Buffett Can Teach Us

Buffett's investing wisdom boils down to seven key points, though it may not even matter what they are. The one question you must really consider is whether you can actually do the things he recommends without getting emotionally involved.

I read the other day that Warren Buffet had slipped to the third spot on the list of the world's richest, now worth (only) some $40 billion. And yet, he pays himself only $175,000 per year. Now that's what I call thrifty!

There are a few basic lessons that translate from his world to that of the average practicing doc just trying to build a net worth in the black, that could stand us in good stead.

First, a brief review. If you had invested $10,000 ($60,000 at todays value) with his Berkshire Hathaway in 1965, you would now be worth $80 million. That's an average of 22% per year for 45 years, factoring in the miracle of compound interest and automatic reinvestment of dividends. Compare this to the best performing mutual fund over that time period, the famous Fidelity Magellan, which returned 16% (you'd be worth $9 million). Not bad, but an order of magnitude lower. For comparison's sake, the S&P returned a 9.3% annual average.

In 2009, Berkshire Hathaway's profit was up 61% (!) with share prices standing at $5,193. How in the world did he do this, especially considering the bath that the rest of us took?

I've boiled down his wisdom (which by the way, and incredibly, he freely shares with anyone and everyone) to 7 points. You'll see that the advice is easy to understand but hard to execute because, when it comes to money, we act so frequently on emotion.

Maybe Buffett's genius is simply that he is somehow able to actually do the things he recommends without getting emotionally involved.

Number 1 - Buy When Others Sell

I know, he's immediately lost many of you right there. He's already made a fortune buying into the teeth of the 2008 meltdown when everyone else was panic selling. Now, it wasn't willy-nilly buying of anything, but the timing of it that it is the point. We'll get to what to buy in a minute.

Number 2 - Don't Buy When Others Buy

Oops, there go another bunch of you. But as Buffett puts it, if you buy into a rising market, you "pay a heavy price for meaningless reassurance." That's heavy. It's tough to keep your own council and stick to a plan. Do you remember saying something similar to patients about weight loss programs and Kegel exercises? It used to be called "hoisted by your own petard."

Number 3 - Be Patient...Very Patient...for a Very Long Term Approach

I think we just lost the immediate gratification cohort with that one, but buy and hold makes great sense, especially for the young doc who has the time to make this pay off. If you do buy and hold, you avoid growth killing taxes, trading costs, and stress, and you minimize the vicissitudes of the financial markets.

Mutual funds, for example, turn over an amazing average of 100% of what they hold every year to chase short term returns as a marketing tool to gain investors. The best funds may only return 8-10% per year.

Number 4 - Be Wary of Rapid Growth

Yes, the technology may be impressive, but we are interested in profitability. Companies and sectors of the economy that are undergoing rapid growth may churn out a lot of flashy products, but growth alone does not equate with profits.

I once sat on the advisory board of an insurance company that was considering the purchase of the latest industry software. A company rep dazzled my colleagues to the edge of a Buy vote when I asked a few simple questions - not about the "Gee whiz!" product, but about the financial strength of the software company.

The Board realized that they were about to acquire a very expensive, likely to be orphaned, product and prudently turned it down.

Number 5 - Defense before Offense

Chasing the biggest returns in an up market will not cover the inevitable outsized declines that rapid growth companies and financial instruments are linked to when financial markets cycle downward, as they always do.

If you have diversification that is protective in a down cycle, then it doesn't take as much to get you out of a smaller hole.

Number 6 - Own Only What You Understand

Here we lose another contingent amongst us. It's a version of Avoid the Dazzle, unless you really know the Dazzle business. If you think you know healthcare, own that. If you don't understand diversified credit swaps, don't own that. Simple, huh?

Number 7 - Only Buy Value, Value, and Value

This is the hard one for me, and may be at the heart of what is Buffett's (or his well-paid research staff's) genius. Presumably that means companies that have low debt (good luck with that!), good cash reserves, and a history of increasing profits through various markets over time.

But how does the uninformed, time-pressured doc find those? I try, really try, not to see this as a version of Only Buy Stocks That Will Go Up. Will "Ask Chuck" be enough?

The thing that Buffett does not say, is that when you get to a certain size and influence, as he has, that he is in a position to "make a market." So many people follow him when and where he buys, the stock goes up just because of his interest and he is a genius again.

But I still don't understand how he built his empire making $175,000, and I know that he had kids...