The Best Investors Spend Their Lives Asking Why, Why, Why

I just finished reading this thread on The Bogleheads Forum (a popular place where index investors hang out and philosophize about personal finance):

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=121776&newpost=1781884

The topic at hand isn’t all that important—it was a bunch of guys debating the get-the-party-started question of international allocation within a portfolio—but I wanted to point out an example of the dumbest way to approach personal finance or any other topic: the constant appeal to authority.

When one of the writers asked what percentage of his portfolio should be international stocks, the first reply was this:

“Why not hold 20-30 international instead? Most of the experts seem to suggest this as the ‘going allocation’ for international.”

That’s a terrible, terrible way to think, and it’s a terrible, terrible way to argue. The only way you can improve as a person is if you understand why you are doing something. It doesn’t particularly matter what road you take—someone might want to own all American large-caps because they don’t want to deal with the profit volatility that is typical with most third-world regimes, or someone might want to own a bunch of third-world funds because they have more room to industrialize and grow—but the only way you can get better is by getting in the habit of trying to figure out why something makes sense. The notion “you should do this because the experts say so” is a way to outsource your thinking and abdicate your own responsibility for your actions because it easily leads to the cop-out “He told me to do it.” But mostly, that kind of thinking stunts your ability to improve.

I’ll give an example of how it can make you a better investor if you regularly engage in the topic of thinking critically by looking to the ultimate investment authority figure himself, Warren Buffett. Anytime Warren Buffett buys something, you will see a chorus of commenters say something to the effect of “If Coca-Cola is good enough for Warren Buffett, it is good enough for me” or “If IBM is good enough for Buffett, I’m in, too.” The problem with that kind of thinking is that it discounts the difference in opportunity costs between Warren Buffett and yourself.

A great example is Warren Buffett’s recent foray into newspapers. Most news outlets are lazy in their reporting of Buffett’s maneuvers and publish the obligatory “Buffett Bought Newspapers—Should You?” articles in response to the news. The problem with those kinds of news stories is that they neglect to mention that Buffett is making a killing on private debt arrangements he put together in these deals.

For an excellent piece on the details behind Buffett’s newspaper investments, check out this article by Rick Edmonds that came out in June:

http://www.poynter.org/latest-news/business-news/the-biz-blog/215580/notes-on-media-generals-merger-with-young/

He points out that Buffett isn’t some guy initiating a common stock position in Media General. He was charging them 10.5% to refinance their huge debt obligations. He’s receiving warrants that only cost $0.01 to buy 19.9% of the company. Buffett picked up a tidy $44 million premium to help Media General refinance its debt. Stuff like that. If you only look to most newspaper headlines and fall for the appeals to authority, you could easily find yourself buying the common stocks of newspapers that catch Buffett’s attention.

But if you have that “why, why, why” gene, you’re going to be asking yourself “What the heck is Buffett doing here?” and you’ll realize that Buffett is buying debt that happens to have a newspaper arm, rather than making a plain vanilla common stock investment like he did with IBM, Wells Fargo, and Coca-Cola.

Right now, IBM trades at $184 per share. Buffett paid about $167 per share for his stake. He’s got a 10% or so lead on you as of this moment in time, but if you have a 20+ year time horizon, you can come pretty close to mimicking Buffett’s returns if you buy IBM stock today.

That’s not true with Buffett’s recent newspaper investments. They’ve been loaded with so many special private debt deals and arrangements unique to Berkshire that you cannot even come close to being on an equal plane with the Oracle of Omaha. That’s why I love the Benjamin Graham quote that encourages us to ask “On what terms, and at what price?” about every financial decision we make. That question cuts through all the BS and gets you on the path to thinking clearly.

If you want to improve as an investor, don’t be like the guy that says “most experts think” and then assumes a closed matter. Be more like this guy:

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=111947&newpost=1781756

He wants to know why most conservative investors have a kneejerk reaction against leverage. I guarantee you that ten years from now, that guy is going to be a more intelligent investor than the guy who says “Because the experts said so.”