Last Saturday, investors all over the world got a chance to look into the minds of billionaire investor Warren Buffett and his business partner Charlie Munger. In the 50th letter to shareholders of their company Berkshire Hathaway Inc, investors can read about the company's annual performance, but the two investing legends always add their own business wisdom for intelligent investing as well.
In the letter Buffett listed off the big mistakes that investors make. He believes investors make investing less profitable than simple long-term wealth creation by making these mistakes:
Fear of volatility
The mind set of avoiding share price volatility actually leads investors to take riskier actions. Stocks are volatile by nature, but you make your best gains when quality companies swing to discounted prices. To avoid volatility, investors try short-term "solutions", which in the end cost them more.
Active trading
Buying and selling too frequently limits long-term share price gains and potential dividend income growth and increases fees that reduce your returns.
Attempts at market timing
No one knows where the market will be in one week, month or year from now. If you focus too much on share price, you give up most of the advantages a private investor has versus the market. You can buy good companies when the market sells them down due to temporary problems. It's like buying dollar bills for 70 cents. Keep the edge you have and take advantage of others' trading mistakes.
Inadequate diversification
Investors should have a mix of stocks in different industries that combine earnings growth and solid dividend income. Five to ten stocks is probably enough for an average investor if they can devote enough time to keep up with each company.
Paying high and unnecessary advisor and manager fees
These various fees eat away at your rate of return over the long term. Buffett suggests index funds for those who don't have the time or inclination to practice good stock picking. They track the market's average return and have lower fees.
Borrowing money to invest
Borrowing to invest in stocks, called margin lending, is a really big no-no. You have to pay interest on the borrowed money, yet the biggest risk is brokers can sell out an investor's margin position. If a stock's price falls too much, you either have to pay more money to keep the stock or be forced to sell. Paying 100% cash for stocks means you decide when to buy and sell. Investors should buy quality stocks when they're down, not sell them.
Foolish investors may want to pick stocks from among established, profitable businesses like Wesfarmers Ltd (ASX: WES), Commonwealth Bank of Australia (ASX: CBA) and Ramsay Health Care Limited (ASX: RHC). All potentially could generate satisfying long-term returns.
