Why You Can't Invest Like Warren Buffett

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Warren Buffett, chairman of Berkshire Hathaway Inc., tours the vendor floor during the Berkshire Hathaway annual shareholders meeting in Omaha, Nebraska, May 5, 2012.

No investor is more closely watched and more imitated than Warren Buffett. Millions of investors, mesmerized by this man who has become a legend in his own time, seek to follow in his investing footsteps.

They fall deeper into a trance of idol worship with Buffett's every pithy comment. Dreaming of riches to come, they buy whatever Buffett does. Yet these Buffetteers could no sooner mimic his methods than they could dunk a basketball like LeBron James. The reasons come down to a reality that is eclipsed by the media aura surrounding Buffett and his renown as the Oracle from Omaha.

Buffett's wealth stems from running Berkshire Hathaway, a vast conglomerate that owns dozens of large companies, including Fruit of the Loom, GEICO, Dairy Queen, Helzberg Diamonds and NetJets.

Buffett, Berkshire's chairman and CEO, makes all the investment decisions for the company and its subsidiaries. His mind-boggling wealth comes not from his own personal portfolio, but from his ownership stake in Berkshire Hathaway.

See my Buffett Mythbuster video.

Buffetteers purchase the stocks that Berkshire Hathaway does without considering the significant advantages that Berkshire gives Buffett, enabling him to generate spectacular returns. Chief among these is a permanent stream of capital from companies like GEICO, which is awash in cash from insurance premiums. As Berkshire businesses have grown over the years, so has the amount of money that Buffett has put to work in the markets.

Investing for a cash-rich corporation puts Buffett in an extremely unusual, if not unique, position because it enables him to weather market storms that the rest of us can't. This gives him an advantage not only over individual investors but also over professional portfolio managers who, to keep clients, must produce returns for them year in, year out or investors may bail. Because of these demands, they can't take the hits that Buffett can.

Understanding the differences between investing for a corporate conglomerate and doing so for yourself can keep you from losing your shirt trying to be Buffett. It can also help you understand key investing principles and how to apply them to your portfolio. To do this, you must learn to identify the Buffett traps — investing moves that sparkle with Buffett allure but, for non-conglomerate investors, are fraught with risk. By finding the right routes around the following traps, you can improve your investing process:

• Time horizon trap: Your time horizon for investing isn't infinite. Someday, you'll be investing less because you'll stop bringing home a paycheck and will be drawing from your portfolio to pay for living expenses during retirement.

In planning for this, the goal is to build up assets and manage them well so you don't outlive your wealth. Yet Berkshire will keep going long after Buffett dies, and the corporation will never retire; it will always have a source of investment capital from its many companies.

Buffett's lack of a time horizon allows him to dollar-cost average for immortal time periods. Dollar-cost averaging is periodically buying a fixed dollar amount of a stock on a regular schedule, thus getting more shares when the price is low and lowering the average price of shares accumulated. Without a time horizon, Buffett can do this indefinitely. But if you do it too long, your portfolio may not have time to recover from purchasing shares at a high price.

You should consider your time horizon with every investment move you make.

• Capital trap. Your source of investment capital is your salary. Once you retire, you won't have this capital. If you take a pay cut or lose your job before retiring, the effect is the same: You'll have less — or no — investment capital. Meanwhile, Berkshire's investment capital is virtually infinite.

• Activist trap. Often it is Buffett's reputation that assures success. He has become an activist investor, and in times of crisis he exerts the power of his brand as a measure of value. Stocks sometimes rise immediately merely because he buys them. Buffett can go to public companies and negotiate the purchase of shares at prices unavailable to us mortals.

His investment in Goldman Sachs during the financial crisis is a good example. Media articles lauded this successful move as savvy but overlooked the fact that Buffett had purchased various other bank stocks before they cratered during the crisis. He suffered a big loss, and so did Buffetteers who made the same move. They are still licking their wounds, but Buffett's advantages meant that he wasn't even scratched.

Buffett is widely regarded as the greatest value investor of our time. Value investing is the practice of buying stocks that are currently out of favor with the market with an expectation that they will rise in value.

Aswath Damodaran, a finance professor at New York University, discusses Buffett's stellar record as a value investor in his paper "Value Investing: Investing for Grown Ups?"

Damodaran explains that Buffett's renown for this particular kind of investing comes from his successes in the '60s and '70s, when few investors had access to information and the market wasn't dominated by institutional trading, as it is today. Damodaran believes that Buffett would have a hard time replicating this success in today's market.

Buffett's advantage of having epic periods to recover from steep losses contributes to his long view of the markets. Damodaran believes this long view is a key reason for Buffett's continued success.

"While [Buffett] has had his bad years, he has always bounced back in subsequent years," writes Damodaran, a prolific author on investment analysis and philosophy.

One aspect of Buffett's investing philosophy that is highly instructive for individual investors is his rigid discipline — what Damodaran describes as his "unwillingness to change investment philosophies" during tough market periods. Instead, Buffett stays true to his process.

Today, Buffett's process involves his ability to be an activist investor. Anyone can be a value investor, but few can be an activist investor.

Though your process should be quite different than Buffett's, your portfolio will do better if you develop one that suits your goals and risk tolerance and faithfully stick to it. By developing Buffettesque discipline, you can ignore Buffett's moves and instead focus on what's right for you.

Craig J. Coletta cj@cjcoletta.com has 20 years of experience in the financial industry. He is president of C.J. Coletta & Co., a Registered Investment Advisor firm, and president of Coletta Investment Research Inc. Coletta is a Chartered Financial Analyst charterholder, a Chartered Market Technician and a Certified Hedge Fund Professional. He holds a B.S. in accounting and business administration from Rider University, and is a member of the American Institute of Certified Public Accountants.