It sounds obvious, but at times, investors ignore a patently obvious basic tenet: buy quality investments. Why do we do this? Because we are reaching for something out of reach. We believe that the investment returns provided by quality companies are too low in comparison to other riskier opportunities. In an effort to earn a higher return, investors devote capital to low-quality investments. While Buffett is not infallible (he admits to his fair share of mistakes), he has enjoyed phenomenal success by staying disciplined and insisting upon quality investments. We must seek to maintain the same discipline.
Lessons for Phlox and Phlox Clients
1. We can learn a lot from Buffett, but we should not seek to fully replicate his strategy.
As stated in the paper, Buffett’s strategies result in higher investment returns, but also higher volatility, due to the use of leverage. Most investors do not have a stomach lined with iron as Buffett does. Such a gut is necessary in order to tolerate Buffett’s strategy. Phlox does not utilize borrowing/leverage in client portfolios.
2. Buffett understands the inherent value in his investments, so he does not allow market fluctuations to control his emotions.
With a few exceptions, nobody builds wealth by watching the market every minute of every day. Instead, we need to understand the inherent value in our investments. When the market is volatile, it is this understanding that helps us to avoid “buying high and selling low.” As the great investor Peter Lynch said, “it’s not a lottery ticket” (meaning the ownership of stocks). Quality stocks bought at reasonable prices are solid investments, not lottery tickets.
3. While Phlox does not advocate utilizing debt to buy stocks, Phlox does advocate judicious use of debt to buy a home.
Homes are where we live. They are where we raise our families and build our futures together. At a recent speech in Dallas, Buffett himself said that buying a home with a 30-year fixed rate mortgage is the single smartest investment a person can make. Note his reference to a 30-year fixed rate mortgage: he stipulates this type of financing because he knows that the phenomenon of inflation makes it a wise financial structure. Furthermore, mortgage interest is deductible for most tax payers, further lowering the cost of the debt.
4. Buffett creates wealth because he maintains high levels of liquidity
If I could give only one piece of advice from my study of Buffett and my work with many successful entrepreneurs, it is this: the 3 most important concepts in finance are 1) Liquidity, 2) Liquidity, and 3) Liquidity.
The reason Buffett is cool under pressure is because he has money in the bank and high-quality, liquid assets in the market that can be converted to cash when needed. He also has access to lines of credit and other forms of liquidity. When the storms roll in, Buffett is not looking for a loan. He has cash at the ready, and in fact, he’s looking to buy investments when others are in a state of panic.
5. Buy quality investments that pay cash dividends
Phlox favors a healthy allocation of U.S. blue chip stocks in client portfolios. These stable companies often pay cash dividends that increase on an annual basis. The dividends serve to increase investor liquidity and dampen the downside volatility in the stock.