Modeling the World's Greatest Investor

By Adam Khoo

How do you achieve excellence in any area within a short period of time? The key is through modeling.

Modeling is the technique of finding role models who are the best in their field and then studying and distilling the mental models and strategies that make them the best in what they do.

By learning and applying their strategies, you will be able to produce the same phenomenal results they do, or maybe even better.

While the role model may have taken thirty years of trial and error to find the winning formula and perfect his strategy, you will be able to shorten your learning curve considerably by replicating his winning patterns.

In fact, if you study the most successful people in history, they all employed the power of modeling. They believed in standing upon the shoulders of giants rather than to re-invent the wheel.

The Wright Brothers and early flight pioneers got their ideas of aircraft design by modeling the body structure and flight movement of birds.

Ancient Chinese monks developed the art of Kung Fu by observing, modeling and imitating the fighting techniques of animals (tiger, monkey, snake and bear) and insects (praying mantis).

The government of Singapore managed to turn a 'dot' on the world map, basically a trading port, into a first world economy with a GDP (Gross Domestic Product) per capita ranked 18th in the World (World Development Report, 1993) in just 28 years!

This was achieved by modeling the best practices of countries like Switzerland (governance and banking), Israel (warfare), the United States (Commerce) and the United Kingdom (law and education).

As you can see, modeling is not just about copying someone else. It is about distilling the best practices of a whole range of excellent role models, taking the best from each of them and developing an even more powerful strategy.

So if you want to be an excellent investor, who better to model than Warren Buffett, the world's greatest investor?

Warren Buffett is currently the second richest man in the world with a personal fortune of $42 billion (second only to Bill Gates $46 billion).

The amazing thing about Buffett is that he made all his money without making or selling any kind of product or service. He made it entirely by investing in the stock market.

Over the last 49 years, he managed to achieve a 24.7% annual compounding rate of return, which means he made his money double every 2.9 years!

How does he achieve this remarkable feat when 97% of professional fund managers cannot even beat the S&P 500 consistently every year?

That's exactly what got me so excited to study and model this genius a few years ago.

By reading every single book written about Buffett as well as his own personal writings, I found that the beliefs he has about the stock market and the strategies he uses go completely against what mainstream finance teaches and what professional fund managers do.

If you learn and use the same recipe, you are going to produce the same cake.

So, let's get started! Before modeling someone's strategies and techniques, it is first important to understand and model the person's beliefs.

A person's beliefs is what drives their decision-making patterns and the actions they take.

The reason why Buffett is able to make more money than any other investor in the worlds is because he has very different beliefs about how the stock markets acts and how to buy stocks.

If you want to model his success, an important step would be to adopt his beliefs and strategies.

Outsmarting The Smart Money

1. Don't be the patsy. If you cannot invest with disciplined intelligence, the best way to own stocks is through an index fund that charges minimal fees. Those doing so will beat the net results (after fees and expenses) enjoyed by the great majority of investment professionals. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."
2. Operate as a business analyst. Do not pay attention to daily excitement in the market, macroeconomic forecasts, or securities movements. Concentrate on evaluating businesses.
3. Look for a big moat. The "moat" is a metaphor for a protective belt surrounding a business that will secure favorable long-term prospects, those whose earnings are virtually certain to be materially higher 5 and 10 years later.
4. Exploit Mr Market. Market prices gyrate around business value, much as a manic-depressive swings from euphoria to gloom when things are neither that good nor that bad. The market gives a price, which is what you pay, while the business gives value, and that is what you own. Take advantage of market mispricings, but don't let them take advantage of you.
5. Buy at a reasonable price. Bargain hunting can lead to purchases that don't give long-lasting value; buying at frenzied prices results in purchases that give no value. Still it is better to buy a great business at a fair price than a fair business at a great price.
6. Insist on a margin of safety. The difference between the price you pay and the value you get is the margin of safety. The thicker, the better.
7. Know your limits. Avoid investment targets that are outside your circle of competence. You don't have to be an expert on every company, or even many - only those within your circle of competence. A large circle is not necessarily better; knowing its boundaries, however, is vital.
8. Invest with "sons-in-law." Invest only with people you like, trust and admire - men you'd be happy to have your daughter marry, or women you'd be happy to have your son marry.
9. Only a few will meet these standards. When you see one, buy a meaningful amount of its stock. Don't worry so much about diversification among stock holdings, so long as your assets are diversified in other ways, as among home equity, bank savings, and other asset classes. If you find one outstanding business, that is better than a dozen mediocre ones.
10. Avoid gin-rummy behavior. This metaphor from the card game cautions against the short-term, quick-flipping strategy, akin to the action of picking and discarding cards each turn in the game. It is the opposite of possibly the most foolish of the Wall Street maxims: "You can't go broke taking a profit." Imagine as a stockholder that you own the business and hold the investment as you would if you owned and ran the whole thing. If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes.