investing

Book Summary of The Psychology of Money by Morgan Housel

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Finance expert Morgan Housel suggests that financial success is not solely dependent on education and intelligence, but rather understanding human behavior. By recognizing how emotions and beliefs impact financial decisions, individuals can make better choices.

This guide explains why people struggle to achieve financial success, the reasons behind wanting money, and provides strategies for creating and following a long-term financial plan, while staying informed.

Why People Fail to Achieve Financial Success

According to Housel, the reason why individuals find it difficult to manage their finances is because they overestimate the importance of luck and conflate prosperity with poverty.

Lesson #1: Chance Plays a Bigger Role in Our Financial Lives Than We Give It Credit

Housel warns that we often overlook chance in financial success. For instance, Bill Gates was not only intelligent but also fortunate to have had access to a school computer in 1968.

Therefore, imitating the success of exceptionally lucky people can be misleading. Instead, Housel advises that we look for patterns among successful individuals to increase our likelihood of success.

Lesson #2: Being Wealthy And Being Rich Are The Same Things

Housel says we fail financially by confusing wealth with being rich, which leads us to imitate the spending habits of the latter. It’s challenging to learn self-control from the wealthy, so understanding the difference helps protect and preserve your money.

Understand Why You Want Money

Housel believes two key mindsets are crucial for a healthy attitude toward money: first, recognizing that money gives you control over your time, and second, acknowledging that having enough money is achievable.

Lesson #3: Money Buys Us Control Over Our Time

Housel says money’s value is in controlling your time for happiness. Americans often lack this control, leading to unhappiness. Having more control over time will make you happier, according to end-of-life interviews.

Lesson #4: Be Happy With Enough

Housel advises that being content with enough is crucial for financial success, as wanting more than necessary can lead to losing all your wealth. To achieve this, he suggests avoiding constantly increasing lifestyle standards and deciding to be happy with your current lifestyle.

What to Include In Your Financial Strategy

Housel identifies three key elements for a successful financial strategy: compounding, saving, and contingency planning.

Lesson #5: Take Advantage of Compounding

Housel stresses the significance of compounding in investing, recommending finding steady-return investments for maximum profit. He believes the duration of investment is more crucial than annual returns and cites Warren Buffet as an example of compounding’s benefits. According to Housel, people neglect compounding’s power because it seems counterintuitive and opt for less efficient methods.

Lesson #6: Prioritize Saving Money

Saving money is crucial, according to Housel, since it is the money, you don’t use. Because it is completely within your control and very simple, it is also the most dependable approach to accumulate wealth. To ensure you save money, Housel recommends ignoring others’ opinions and wanting less. Less wants means less spending and greater savings.

Lesson #7: Plan for Things to Go Wrong

Housel stresses the importance of planning for setbacks to secure your financial future and benefit from compounding. He advises against being overly optimistic and suggests preparing for a range of possible futures. To do this, he recommends diversifying investments and keeping a portion in safer options to cover potential losses.

How to Create a Financial Strategy You Can Stick To

To ensure you follow through with your financial strategy, Housel suggests two principles: Firstly, expect your future goals to change. Secondly, prioritize common sense over logic.

Lesson #8: Expect Your Future Goals to Change

Housel advises against extreme financial plans and suggests expecting future goals to change when developing a long-term financial strategy to avoid regret and missed opportunities due to the end-of-history illusion.

Lesson #9: Be Sensible, Not Logical

Housel advises prioritizing sense over logic and being flexible about goals for a successful long-term financial strategy. By investing in companies, you love and considering non-financial elements like peace of mind, you’re more likely to stick to your strategy and accumulate more wealth.

How to Counter Negative Thinking

To handle bad times in the market, Housel offers two lessons: Don’t let uncertainty deter you and keep in mind that frequent failure doesn’t mean you can’t ultimately succeed.

Lesson #10: Don’t Be Put Off by Uncertainty

Housel advises accepting uncertainty in the market to achieve long-term investing success. Rather than trying to avoid it by timing the market, he suggests embracing it and focusing on potential long-term gains.

Lesson #11: Even if You Fail Frequently, You Can Still Succeed

Housel advises staying optimistic in the face of setbacks and failures by acknowledging the role of luck in successful financial ventures. Outlier events can offset numerous smaller setbacks, so focus on overall financial health rather than individual failures.

How to Pay Attention to the Right Financial Information

To maintain a long-term financial strategy, it’s important to be aware of how the information you encounter affects your decisions. Housel suggests that knowing your personal financial goals is one way to ensure you focus on the right information.

Lesson #12: Know Your Personal Financial Goals

Housel advises setting personal financial goals and avoiding irrelevant information to make better financial decisions. He recommends creating a mission statement for your finances to discover your goals and avoid following herd mentalities in investing.

Book Summary of Rich Dad Poor Dad by Robert Kiyosaki

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Robert Kiyosaki grew up with two dads: his biological father, a financially illiterate PhD who valued job stability, and his best friend’s father, a high school dropout who built a business empire worth millions. Kiyosaki calls them Poor Dad and Rich Dad, respectively.

Poor Dad believed in the traditional view of work and money, which is to get a good education, a secure job, and buy a house without a clear long-term plan. In contrast, Rich Dad had a contrarian view of finances and life, focusing on achieving financial independence, having money generate more money, and taking calculated risks.

Kiyosaki argues that most people adopt the Poor Dad view and let money control their lives, leading them to get stuck in jobs they dislike for the sake of money, trapped in a cycle of working to make ends meet.

Lesson 1: The Rich Don’t Work For Money – Money Works for Them

To become wealthy, it’s not enough to just earn a high salary – owning income-generating assets is crucial. The rich buy assets that generate income and limit spending on expenses and liabilities. Those who are not wealthy either spend all of their money on spending or acquire non-income producing obligations. The objective is to amass enough assets that produce income so that you may stop working.

Lesson 2: Buy Assets, Not Liabilities

To build wealth, focus on buying income-generating assets, not liabilities that drain your money. Assets create more money for you, while expenses reduce it. However, beware of deceptive investments that look like assets but are liabilities in disguise, such as overpriced houses.

Real assets include businesses, stocks, bonds, income-generating real estate, and intellectual property. Treat each dollar as an employee working for you 24/7 to create more wealth. Remember, every dollar you spend today is a missed opportunity to generate future income.

Lesson 3: Reduce Taxes through Corporations

Kiyosaki suggests setting up corporations to deduct business expenses pre-tax instead of paying with post-tax dollars.

Lesson 4: Overcome Your Mental Obstacles

To achieve your Rich Dad goals, you need to overcome common mental obstacles:

  • Self-doubt: Success requires more than intelligence and grades. Guts, chutzpah, balls, and tenacity play a big role.
  • Fear: Courage is needed to pursue great opportunities, and failure is an opportunity to learn and grow. Don’t let fear of failure or others’ opinions hold you back.
  • Laziness: Busy people can be the laziest, using busyness as an excuse to avoid investing in their future.
  • Guilt for feeling greedy: Embrace your desire for wealth and the power it brings.
  • Arrogance: Be open to new ideas and don’t dismiss anything as beneath you. Even sales techniques can be valuable.

Lesson 5: Build Your Economic Intelligence. Continue To Learn

Understanding accounting, investment, markets, and legislation is a prerequisite for having financial intelligence, which entails applying that knowledge to problem-solve ingeniously. Incremental improvements in knowledge can have a significant impact over time, and the faster you can learn and apply your knowledge, the greater the rewards.

Book Summary of I Will Teach You to Be Rich by Ramit Sethi

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Take small steps towards solid personal finance and free yourself from money worries. Ramit Sethi, author of “Will Teach You to Be Rich,” provides clear and actionable advice to help you navigate the confusing world of personal finance.

Learn how to use credit cards effectively, choose the right bank and investment accounts, plan your spending, and create a system that automates your financial growth. With Sethi’s guidance, you can achieve your vision of a “rich life” without being overwhelmed by technical jargon or conflicting advice.

Credit Cards

Using credit cards responsibly can benefit your credit history and future loan eligibility.

Follow these six essential rules: pay your bills on time and in full, avoid fees, negotiate a lower APR, keep accounts open and active for longer credit history, and use card perks like extended warranties and travel insurance.

One late payment can hurt your credit score, raise your APR, and incur fees. By making smart choices and utilizing card benefits, you can improve your financial standing and save money in the long run.

Paying Off Debt

Eliminating debt is a smart financial move that can boost your credit score and save you thousands of dollars.

Here are five steps to help you pay off your debt:

  • First, calculate the total amount of debt you owe.
  • Second, decide which card to focus on paying off first, either by starting with the highest APR or the lowest balance.
  • Third, negotiate a lower APR to reduce interest payments.
  • Fourth, review your expenses to find ways to increase your monthly payments.
  • Finally, get started with your plan, even if it’s not perfect. Don’t delay your progress by striving for perfection.

Choosing the Best Banks

Your credit cards and bank accounts are crucial to your financial system. To ensure a strong foundation, choose accounts with low fees. Banks profit from fees, so selecting a bank that charges minimal fees is a good indication that they aren’t trying to take advantage of you.

When searching for a new bank, consider three essential factors.

  • First, trust is critical. Ask your friends which banks they trust, then check the bank’s website for any red flags like high fees or misleading account descriptions.
  • Second, convenience is essential. If the bank’s services aren’t user-friendly, you’re unlikely to use them.
  • Lastly, make sure the bank offers important features like competitive interest rates, free transfers to external accounts, and free bill pay.

Choosing Your Accounts

To get started, you’ll need a checking and savings account. Here are Sethi’s recommended accounts:

  • Charles Schwab Bank offers Schwab Bank Investor Checking for usage.
  • Using Capital One 360 Savings, you may set up sub-accounts for particular objectives.
  • Once your bank accounts are set up, you can shift your attention to opening investment accounts.

The Power of Compounding

Investing beats saving because it offers a higher rate of return; the stock market averages about 8% annually, after accounting for inflation. This rate is crucial because of compound interest, where you earn interest on the interest earned in previous years. For example, a $100 investment earning 8% annually would become $108 after the first year and $116.64 after the second year.

The longer you leave your money in the market, the more you earn. Therefore, the earlier you start investing, the more money you’ll have at retirement.

Start by Opening Your 401(k)

A 401(k) is a retirement investment account that allows employers to automatically deduct a percentage of an employee’s paycheck. It offers several advantages:

  • Your contributions are made pre-tax, giving you a higher principal investment amount and potential compound growth of 25 to 40%.
  • Employers may match your contributions, providing you with free money.
  • Investing is automatic, without any additional effort.
  • The downside is that early withdrawal before age 59.5 will result in a 10% penalty and income tax. Therefore, 401(k) investments should be made for long-term financial planning.

Roth IRAs

A Roth IRA is a retirement account that doesn’t require an employer sponsor and is available to people with lower incomes. Unlike a 401(k), you can choose how to invest in a Roth IRA.

Also, the money you invest in a Roth IRA has already been taxed, which means you won’t pay taxes on the returns you earn. This gives you an advantage over a regular taxable investment account where you pay taxes on both your contributions and your returns.

Choosing a Brokerage Firm

Open a Roth IRA by signing up with an investment brokerage like Vanguard, Schwab, or Fidelity. Choose a discount brokerage that requires lower minimum investing fees than “full service” ones.

Spending Mindfully

To determine how much you can contribute to your savings and investment accounts each month, create a personalized budget that aligns with your goals, values, and lifestyle. This approach will enable you to be confident that you’re saving enough while also allowing you to spend any remaining money without feeling guilty.

Deciding How You’ll Spend Your Money

Sethi recommends dividing your take-home pay into four categories:

  • Fixed costs (50-60%): Your necessary monthly expenses, plus 15% for unexpected expenses.
  • Investments (10%): Contributions to your long-term investment accounts.
  • Savings goals (5-10%): For both short-term and long-term goals.
  • Guilt-free spending (20-35%): Any money left over after accounting for the other categories.

Automating Your Financial System

Automating finances means establishing automatic transfers between accounts to distribute funds each month without manual intervention. It avoids budgeting errors and saves mental energy. Spend a few hours setting up the transfers between checking, credit cards, bills, savings, and investment accounts. The checking account will be the central node and automatically transfer funds to other accounts according to the allocated percentages.

Getting Ready to Invest

After setting up automated transfers to your investment accounts, it’s important to actually invest that money instead of letting it sit idle.

Asset classes, such as stocks and bonds, are the building blocks of investing. Stocks are unpredictable as their value is determined by shareholders, while bonds are a more stable investment with a predetermined payback period.

Asset allocation is the division of assets in your portfolio and helps control the amount of risk you take on. As you age, your risk tolerance decreases, so your asset allocation should change accordingly.

Target Date Funds

Investing can be made easy with target date funds. These funds automatically adjust your asset allocation based on your retirement timeline, providing automatic diversification and eliminating the need for managing individual stocks and bonds.

As retirement approaches, the fund will reallocate your investments into safer options like bonds. Additionally, it’s important to plan for major financial milestones such as paying for a wedding. To save for a wedding, estimate the desired date and total cost, divide the cost by the number of months, and save accordingly.

Negotiating a Higher Salary

To negotiate a higher salary, take advantage of your leverage when you get hired. Follow these tips from Sethi:

  • Emphasize the value you’ll add to the company, not how much your salary will cost them.
  • Use other job offers to show you’re not afraid to walk away if the offer isn’t fair.
  • Negotiate total compensation, including vacation days and stock options.
  • Be friendly and aim for a win-win agreement.
  • Let them make the first offer and don’t reveal your salary.
  • Practice with friends playing the role of the hiring manager.

Big-Ticket Purchases

Young people often have two major financial milestones: buying a car or a house. To buy a car, the first step is to figure out your budget and include all the costs associated with owning a car. Look for a reliable car and be ready to invest in preventative maintenance to save money. To get a good deal, wait until the end of the month and ask for quotes from multiple dealerships to start a bidding war.

When it comes to buying a house, start by deciding on a budget and save up 20% of the price for a down payment. The total monthly cost of owning a house should be no more than 30% of your monthly income. Don’t forget to account for closing costs, insurance, property taxes, and any needed renovations. Owning a home is more expensive than renting, so be prepared for the extra costs.

Book Summary of The Intelligent Investor by Benjamin Graham

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Investing success comes from rational decision-making and emotional control, not exceptional intelligence. A stock represents ownership in a business with fundamental value beyond its price, and you should buy from pessimists and sell to optimists.

Keep a margin of safety to avoid overpaying and incurring losses during downturns. The book covers Graham’s concepts of Mr. Market and Margin of Safety, advising both defensive and aggressive investors on investment principles and market behavior.

Let’s start by defining investment.

Investors vs. Speculators

Investors, according to Graham, are those who analyze investments and prioritize safety of principal and adequate return. Speculators, on the other hand, trade on market movements and ignore fundamental value.

Investors buy when the market is down, while speculators follow popular opinion. Investors use a dependable system for decision-making and prioritize the fundamental value of the stock, while speculators are swayed by emotions and optimistic estimates.

Don’t Believe the Active Trading Hype

Beware of brokerages that push low fees and easy trading. They profit from trades, not your gains, and may lure you into risky speculation. Excessive trading can hurt your returns – a study shows that the busiest traders lagged the market by 6.4% annually, while the least active kept pace.

Defensive vs. Aggressive Investors

Graham classifies intelligent investors into defensive and aggressive types based on their approach to investing. Defensive investors prefer simplicity and aim for average market returns, while aggressive investors seek higher returns through in-depth research.

Both approaches can be successful if aligned with the investor’s temperament and goals, while maintaining emotional control.

The Defensive Investor

Graham advises defensive investors to allocate 50% to stocks and 50% to bonds, with a 75-25 imbalance limit. This balance helps to manage risks and exposure to market conditions. A 100% stock portfolio can be challenging due to high fluctuations.

Dollar-Cost Averaging

Graham advises against market timing and recommends dollar-cost averaging for investing lump sums. Splitting the sum into equal investments over time helps avoid emotional attachment to market fluctuations and the false belief in predicting the market.

Low-Cost Index Funds are the Default Option

Graham’s advice on selecting individual stocks and bonds is outdated. Nowadays, low-cost index funds like Vanguard offer easy diversification across assets. Graham eventually recommended index funds as the default choice for most investors, and even Warren Buffett agrees.

Choosing Individual Stocks

To choose your own stocks, Graham advises a defensive investor to look for high-quality companies at reasonable prices and use these seven criteria: size, strong financials, continuous dividends, positive earnings over 10 years, earnings growth of at least 33% in the past 10 years, a P/E ratio no more than 15 times past 3-year earnings, and a price-to-book value ratio no more than 150%.

However, many companies today have more intangible assets, so a higher price-to-book ratio may be acceptable. These criteria are strict and filter out most stocks, but this is intentional as most stocks are not suitable for the defensive investor. For most everyday investors, Graham recommended low-cost index funds.

The Aggressive Investor

Defensive investors seek low-effort results, while aggressive investors aim for high returns via research. But Graham warns against impulsivity, advising methodical valuation, patience, and calmness.

Expectations for the Aggressive Investor

Aggressive investors aim for better returns by methodically valuing potential investments and maintaining level-headedness. Graham advises that an additional 5% annual gain, before taxes, is necessary for the effort to be worthwhile.

However, beating the market is difficult and even most professional money managers cannot do so in the long term, after fees are deducted. Graham suggests aiming for modest and consistent returns instead of stratospheric ones.

Find Bargain Stocks

Graham’s strategy is to buy undervalued companies and purchase a dollar for less than its actual worth. This strategy works because of human psychology, which can cause irrational fluctuations in stock prices. When a company falls out of favor, its stock price drops below its actual value, making it a bargain.

A bargain stock is one that is priced below two-thirds of its value, which can happen when a large company faces a temporary setback or when an entire industry becomes unpopular.

Aggressive Investor Criteria

To filter stocks, start with statistical criteria like the defensive investor. But as an aggressive investor, you can be more flexible with your criteria, such as not requiring a minimum company size. To determine if a stock is a good investment, you must conduct your own analysis. Good and bad stocks don’t exist, only cheap and overpriced ones.

Market Fluctuations and Mr. Market

J.P. Morgan famously said that the market “will fluctuate.” While it’s impossible to predict when and how these fluctuations will occur, there are two important ways to respond to them.

First, prepare yourself mentally for potential declines and avoid emotional reactions. Second, watch patiently for opportunities that arise when the market overreacts to negative news about a company, which can lead to bargain buying opportunities.

Mr. Market

You don’t have to trade and sell with the market. Market prices should only serve as indicators for whether a stock is over- or under-priced. Graham’s Mr. Market concept shows that following the whims of other traders is irrational.

You should maintain your rationality and transact only when it’s in your favor, using market prices to your advantage. Don’t blindly follow Mr. Market, but also don’t ignore him entirely. You have no obligation to trade with him.

Margin of Safety

Graham believed in the importance of margin of safety when making investments. This refers to the amount that can go wrong before the investment goes bad. By choosing investments with a larger margin of safety, you increase your chances of success.

For example, Graham’s criteria for interest coverage ratio, price to book value, and asset to liabilities ratio all incorporate margin of safety. A larger margin of safety means you don’t need to predict market downturns or be overly clever to succeed. Warren Buffett summed up the idea of value investing as “if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me.”

Book Summary of The Essays of Warren Buffett

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A collection of Buffett’s yearly reports to Berkshire Hathaway shareholders is available as The Essays of Warren Buffett. In addition to his commercial savvy, Buffett, CEO of Berkshire Hathaway, is renowned for his success across a variety of sectors and his reputation as a teacher.

He views shareholders as partners and uses his annual report to educate them on Berkshire’s operations and his investment decisions. Buffett’s essays provide valuable insights into his investment philosophy and principles, which contrast with typical Wall Street culture. He also sheds light on the ethical landscape of the wider business world. Though his ideas on investing are easy to understand, they are difficult to put into practice.

This guide covers Buffett’s writings on investment practices and the inner workings of high finance. The part on investments looks at Buffett’s suggestions, his critiques of flawed economic theories, and the kinds of investments to steer clear of.

The book illustrates Buffett’s beliefs by contrasting Berkshire Hathaway’s values with the conventional culture and principles of Wall Street corporations. It also presents the ideas of other financial experts, both in agreement with and in opposition to Buffett’s philosophy. The guide places Buffett’s career and essays in their historical context and evaluates how well his ideas hold up in modern investment.

How to Invest

Buffett’s most valuable insights for both casual and professional investors relate to his ideas on the dos and don’ts of the stock market. His fundamental philosophy is that owning a stock means owning a piece of a real-world business. He advises investors to identify and invest in well-run businesses that are undervalued, and to hold onto their stocks indefinitely as long as the business continues to be well-managed and profitable.

This strategy goes against the widely held belief on Wall Street that stock prices and company valuations are generally unrelated. Buffett warns against trading based on the market’s mood swings, instead endorsing long-term investments as the best way to maximize returns. Buffett doesn’t make forecasts, unlike other traders who can foresee the future with accuracy; instead, he concentrates on buying good companies at bargain prices.

Best Practices

Individual investors might benefit from Warren Buffett’s writings, which primarily provide an explanation of his investing approaches for Berkshire Hathaway shareholders. One of his main points is to invest in industries that you understand and have knowledge about, which can give you an advantage in identifying companies with good future prospects. In order to profit from the market’s rising momentum, he also stresses the significance of understanding the value of market volatility and investing in straightforward index funds.

Buffett emphasizes the idea of purchasing stocks as a form of business ownership rather than just a short-term investment, and advises investors to concentrate on businesses that effectively utilize capital to generate consistent profits, particularly in sectors where future prospects are straightforward to predict.Buffett’s strategy is based on “hedgehog thinking,” which entails concentrating on one’s “circle of competence,” or area of expertise, to make wise investment decisions.

The Upside of Volatility

Warren Buffett believes that market volatility is good for investors, as it offers great deals when the market’s behavior is irrational. While high stock prices may be pleasing to owners, investors want stock prices to be low. Buffett recommends investing in industries that you understand, and if you don’t have time or resources for thorough research, he suggests putting your money into a simple S&P index fund.

This way, gains will match the overall market with minimal loss to brokerage trading fees, rather than trying to “beat the market” through day trading or individual stock picking.

Mindful Investing

Benjamin Graham, the mentor of Warren Buffett, distinguishes between thoughtful investors who make rational decisions and speculators who are driven by emotions and irrational optimism. For those who want to make money simply and safely without much effort, low-cost index funds are recommended.

Yet diligent but aggressive investors like Buffett devote their time and efforts to well-researched investments, turning investing into a full-time career. On the other hand, Ramit Sethi recommends starting with retirement accounts, such as your employer’s 401(k), if available, then opening a Roth IRA. Sethi also advises automating payments into your investment accounts, exploring index and mutual funds, and gradually learning about other types of equities.

Economic Nonsense

Buffett’s financial ideas may seem like common sense, but they often contradict the views of many financial professionals. He concedes that there are several topics where his opinions and those of other investors diverge, such as the efficacy of diversified portfolios, efficient market theory, and the importance of financial advisors.

Efficient Market Theory

Deeper study is unimportant according to the Efficient Market Theory (EMT), which contends that because financial markets are naturally intelligent and logical, stock prices always represent the true worth of their respective enterprises. According to Buffett, study into a firm shows its underlying value, and stock swings are generally worthless until they present possibilities.

He finds it frustrating that EMT is still taught in business schools despite being discredited. EMT’s underlying implication that investors are rational actors was challenged by psychologists Daniel Kahneman and Amos Tversky, who proved that humans are fundamentally irrational, undermining much of the economic research of their day.

Diversification

Buffett challenges the idea that diversification of a portfolio protects against risk, which he believes originates from academic models that equate risk with volatility. Instead, he defines risk as the odds of suffering financial harm and recommends investing in a few safe bets such as companies with good management and excellent long-term economics.

Although Berkshire Hathaway’s diversified holdings may appear to contradict this approach, most of its investments are in majority shares in the businesses it owns, committing a significant amount of capital, and Buffett’s personal holdings are not diversified. Nassim Nicholas Taleb, a mathematician, endorses this strategy in his book Skin in the Game, where he makes the case for focused investing rather than diversification.

Financial Advisers

Buffett criticizes the culture of brokers and advisers who create and sell complex financial products, encourage frequent trades, and obfuscate market clarity to convince investors of their need for their services. These professionals skim off the top in the form of service fees and transfer wealth away from investors. Although they claim to outperform the overall market, the vast majority of them fail.

Buffett’s portfolio has outperformed the S&P 500 by 3,000% since transitioning Berkshire Hathaway into a holding company. Brokers and advisers feed off fear and optimism in the market, incentivizing them to recommend more trades and products even when it would be wiser for investors to let their money sit in an index fund with minimal fees. Advisers bear none of the risk as their clients’ fortunes rise or fall.

What to Avoid

Buffett favors equities but discusses other forms of investment and explains why they’re problematic. He advises against investing in ineffective goods like jewelry, collectibles, and gold since they are only worth what others are willing to pay for them. He also cautions against trash bonds, which are issued by failing businesses and carry a significant default risk. Investing in money market funds and bonds may seem safe, but their interest doesn’t keep pace with inflation, causing money invested in them to lose value over time.

Despite diversification minimizing risk, investing in junk bonds is like buying a lot of lottery tickets. Junk bonds exacerbate financial crises, and the market for them was particularly active in the 1980s until a series of defaults in 1989 led to a downturn in the stock market and the bankruptcy of investment firm Drexel Burnham.

Financial Derivatives

Derivatives are complex financial products that are essentially bets on how a portion of the market will behave. They are instruments of pure speculation and their value depends entirely on the financial strength of the parties involved. While both parties to the wager can assert that their derivatives yield genuine earnings up until the derivative actually comes due, Warren Buffett contends that derivatives are tools of deception. Derivative contracts are designed to be so complex that their true risks and false earnings claims are hard for portfolio auditors to spot.

Buffett also emphasizes the importance of avoiding borrowing money to invest, as it can lead to financial ruin. Debt is often sugar-coated as “leverage,” but eventually, all debts come due, and if your investments have dropped in value, you won’t be able to pay off your debts. It is important to be debt-free before investing.

How to Run an Investment Business

In the article, Warren Buffett’s opinions on Berkshire Hathaway’s internal operations are discussed. Buffett thinks Berkshire Hathaway distinguishes itself from other investment firms via openness, sane investing, and delivering wealth for shareholders. Buffett, on the other hand, criticizes the shortcomings of Wall Street’s business practices, including their use of financial derivatives, dubious accounting practices, and expensive acquisitions.

Buffett believes that CEOs lack true accountability, and many are rewarded for mediocrity. By withholding funds from investors, boards and CEOs frequently fudge profit figures, and if the business collapses, they flee with golden parachute payouts. Buffett is particularly skeptical of giving stock options to CEOs as pay since he thinks that doing so is a genuine expenditure that is unrelated to the success of the CEO. Yet CEOs frequently bargain for stock options, which have none of the risk that shareholders have but nonetheless yield the same benefits. Buffett lobbied for a change in accounting rules to list stock options as an expense, but he lost.

The Trouble With Stock Options

Stock options might encourage CEOs to take dangerous actions to increase the value of the stock, even when such actions could cause the stock price to fall and harm shareholders. Notwithstanding this problem, many companies continue to give stock options to CEOs as a strategy to increase remuneration, even when there is no connection between CEO pay and a company’s success.

In a recent study, over 70% of CEO pay comes from stock awards and options, 20% from bonuses, and less than 10% from their actual salary. Yet according to a 2021 Harvard Business Review research, stock options are only useful when CEOs may otherwise misappropriate business resources for their own benefit.

Takeovers, Debt, and Danger

Buffett’s investment strategy involves buying interests in companies he admires, but other corporations often engage in buyouts and takeovers that harm shareholders. CEOs and acquisitions managers often prioritize corporate growth without adding meaningful value, resulting in paying too high a price for another company and issuing new stock, which reduces the value of existing shareholders’ stock.

Instead of issuing new stock, bonds can be used to raise quick capital without impacting stock value, but investors should be cautious of bonds issued by companies in financial trouble. Leveraged buyouts, in which one business borrows money to acquire another, hurt whole industries and jeopardize the livelihoods of workers. Derivatives are used to hedge against debt risk, but they can pose a danger to the larger economy if a wave of defaults occurs, potentially causing the economy to collapse.

The Financial and Social Cost of Leveraged Buyouts

Leveraged buyouts transfer the burden of debt onto the company being bought, not the acquiring company. This means that if the loan defaults, the bought company goes bankrupt, not the buyer. Elon Musk’s purchase of Twitter is an example of this, as he put $33 billion of his own money into the purchase, but Twitter was left with $13 billion in debt.

The potential consequences of Twitter’s insolvency highlight the societal impact of corporate insolvency, as it could affect the information landscape and cost thousands of jobs. This illustrates Buffett’s thesis regarding the risks associated with leveraged buyouts.

The Berkshire Way

The article discusses Warren Buffett’s unique approach to running his holding company, Berkshire Hathaway, and the business philosophies that guide his decisions as CEO. Buffett favors boosting Berkshire Hathaway’s overall value per share over merely the number of its assets, in contrast to typical Wall Street practices. He values transparency and accountability to shareholders, providing them with comprehensive information about the company’s financial and managerial standing.

He thinks that a company with a reasonable price will draw long-term investors who respect and embrace Berkshire Hathaway’s culture. Buffett views his investors as partners and requires board members to own at least $4 million in Berkshire stock outright to avoid conflicts of interest. CEO compensation is judged on performance and real returns generated, not just the company’s stock price.

Growing the Berkshire Family of Businesses

Warren Buffett’s favorite part of his job is acquiring new businesses. In his youth, he looked for mid-range businesses available for cheap, but with Berkshire, he seeks out high-quality companies that he can buy for fair prices. For every opportunity that arises, he compares the potential value of an acquisition to other, more conservative ways to invest.

Buffett doesn’t intervene much with his new businesses’ operations after Berkshire owns a majority share. As long as an acquisition can provide even a small return on investment, Berkshire don’t ever sells it off, understanding that a mid-tier company is still a crucial source of revenue for its employees and their families. Buffett’s investment philosophies dictate that Berkshire never takes on debt to buy new businesses. Instead, it has a ready pool of capital from its numerous subsidiaries available for acquisitions. This owner-centric philosophy, which Buffett claims he deliberately fostered so that it will last long when he is gone, is at the core of Berkshire Hathaway’s culture.