Investing In Cryptocurrency

Cryptocurrencies are digital assets or “tokens” – akin to the idea of money – specifically designed to take advantage of the architecture of the Internet. Unlike traditional currency they have value not because of the guarantee of a financial institution or government. Instead, they have value for three reasons: their ability to be accurately “confirmed” by the computers on a particular network, the value that is placed (or misplaced) on them by the market, and as a consistent way to measure the price of goods within a blockchain network.

Cryptocurrency versus traditional currency

In some ways, cryptocurrency works very similarly to a traditional currency or a precious metal like gold. The worth of the US dollar, for example, as a means of exchange, is valued not only in term of what a dollar can buy in real terms, but also by its relative worth against other currencies.

A key difference, however, between traditional currency and cryptocurrency, despite Bitcoin’s recognition as an “asset” by the IRS and as an accepted currency by the EU, is that the supply of cryptocurrency is not controlled by a central bank, but rather reflects the actions and perceptions of many independent individuals across a large number of jurisdictions. This has the potential to upend basic models of political economy of the last century (if not the last several hundred years of Western history).

Bitcoins, for example, are mined at a predetermined rate each time a user of the network discovers a new block (currently 12.5 bitcoins are created approximately every ten minutes) and the number of bitcoins generated per block decreases over time. Ultimately, the total number of bitcoins in existence is never supposed to exceed 21 million.

The real impact of Bitcoin beyond the hype is that it has the potential to diminish the need for central banks. It also has the potential to reduce the role of financial intermediaries like retail banks. Cryptocurrency was designed as a form of electronic cash to allow individuals to transact without going through a financial institution. This is likely to have a profound impact on the global financial system, financial markets, and the banking industry.

When it comes to buying other kinds of cryptocurrency, such as Ether, which was not created as a traditional “currency” but rather to pay for computations along the Ethereum network, the investment analysis becomes more complicated. In a very real sense, the “value” of Ether is more like the cost of a barrel of oil, a watt of electricity or any other mineral that must be “mined” or processed in some way, and then used to make a piece of machinery function – in this case a computer.

Cryptocurrencies are not immune from market forces or monetary policy, starting with the fact that you still need traditional currency to buy them. Ultimately, the buying power and inherent value of a cryptocurrency will be affected by the real economy including by things like inflation, exchange rates, global electricity prices, and the speed of the computing networks through which the cryptocurrency is created, traded and transferred. In the case of Bitcoin, for example, a market price is created against traditional currencies like the US dollar and renminbi because the main buyers of Bitcoin do so in dollars and yuan. To the extent that the value of these traditional currencies continue to fall with inflation, the price of Bitcoin will continue to rise over time.

Investment risks

The value of cryptocurrencies are not controlled the same way that fiat currencies are, for example by a decision of a central bank to increase the money supply. However, the cost of the resources that are used to create, price and transfer cryptocurrency may still be controlled on a national basis.

Potential investors should carefully consider the risks of cryptocurrency investing, some of which are listed below:

  1. Lack of Adoption: There are many cryptocurrencies in existence. The more people that use a particular cryptocurrency, the more likely it is that other people will be willing to use it also. In short, this means that cryptocurrencies benefit from “network effects”. Investors need to be aware that if a cryptocurrency fails to gain critical mass, or if it is superseded by a technically superior or more popular cryptocurrency, then its value may decline rapidly.
  2. Market Volatility: Potential investors in bitcoin would be wise to tread cautiously given the high levels of volatility in bitcoin’s market price over the last few years. This means that even if you are correct about the long term direction of bitcoin’s market price, you could still lose money in the short run. As John Maynard Keynes noted “the market can remain irrational longer than you can remain solvent.” Potential investors should keep in mind that purchasing bitcoin with the hope of achieving short term capital gains is a form of high risk speculation, similar to gambling. Professional traders manage this kind of market risk by following the “2% rule”; a trading practice which suggests that an investor should never commit more than 2% of her total capital to any one trade. Further, manipulations of the price and supply of bitcoin have occurred regularly.
  3. Security Risk: Cryptocurrency is digital, and so there are risks posed by hackers, malware, or system failures. For example, anyone who has the private key to a bitcoin account can transfer bitcoins in that account to any other account. This poses a significant risk since all bitcoin transactions are permanent and irreversible. Many experts recommend storing bitcoin in a digital wallet that is not connected to the Internet.
  4. Increased Regulation: Cryptocurrency could be a competitor to traditional currency, and may be used for black market transactions, capital flight or tax evasion. There is also no reason why a government could not move to control the supply of a cryptocurrency in the future either by passing legislating, buying up enough of it to change the rules, or by incentivising programmers to change them.
  5. Lack of Liquidity: Liquidity refers to how easy it is to quickly convert an asset into cash without a significant drop in the market price. The more difficult it is to buy and sell a cryptocurrency, the greater the risk for an investor if they need to sell in a hurry. Bitcoin can be traded on various bitcoin exchanges, which makes it easier to buy and sell, however it has still not achieved mainstream adoption.

So, where should you invest?

The question of what cryptocurrency to invest in is a loaded one. It depends what one’s goals are. If the aim in buying cryptocurrency is to use it to buy specific goods and services, or to transfer money from one place to another, then the purpose is very different from someone who is merely trying to make money by speculating in the short term volatility of a cryptocurrency’s market price.

As the above discussion indicates, there are many issues to consider. For that reason, investing in a cryptocurrency is a far more complicated decision than investing in other kinds of assets – and the risks of the same are also not yet fully and widely understood. Tread cautiously.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

Image: Pexel

The Great Reset?

This past week there has been fear circulating among founders and private investors who hold stock in certain early stage startups that have achieved sky-high valuations.

Why the fear?

The startups in question are privately held, meaning that the founders and early stage investors own shares in the companies, but shares have not yet been offered for sale to members of the public.

Many of these startups have achieved record valuations, based largely on a hope among investors that they will be able to sell shares in these companies to members of the public at even more inflated prices when the companies are eventually sold via IPO.

Early stage investors are willing to bet big because they are desperately searching for the next big win, the next Facebook, Airbnb or Whatsapp.  And they have been comforted by the fact that, if their optimistic expectations don’t come to pass, they should still be able to break even or turn a small profit by passing the buck onto a hapless public.

This form of aggressive investing has produced a record number of unicorns (that is, startups with a valuation of more than $1 billion). Unfortunately for all the Venture Capitalist cowboys, though, prices for tech companies in the public markets have been falling, and this has started to make unicorns that are yet to float on the stock market look over valued. Business Insider reports that “[o]ver the past year, LinkedIn shares have fallen by about 52%.”

Falling prices in the public markets means that a fear of missing out on the next big thing appears to have morphed into a fear of losing money. Early stage investors will need to reset their expectations, ignore the startup hype and return to investing basics by looking for companies with a proven business model.

How to Thrive in Hard Times

Invest for the future, reduce your debts, and insure your income

How to Thrive in Hard Times

TODAY’S economy is vastly different compared with our parents’ generation, and even those of us in ‘stable’ jobs should be prepared for increasingly rapid technological change and a continued downturn.

The competitive landscape can change at any time and in ways that you may not have expected. If you are unexpectedly laid off or demand for your company’s products suddenly plummets (think Blackberry), then you will want to have a healthy financial buffer to buy you time to recover.

If you want to thrive during hard economic times, then consider adopting the following three remedies for an empty purse:

1. Invest for the Future

Regardless of your current financial position, it is wise to save a fraction of your current income and invest for the future. George Clason, in his best-selling novel The Richest Man in Babylon, provides the following advice:

  1. Save: save at least 10% of your income each time you get paid,
  2. Invest: put your savings to work by investing in sound investment opportunities which offer safety of principal and a fair return, and
  3. Grow Your Earnings Potential: pursue a life of continuous learning and constant improvement; invest in yourself with the aim of increasing your earnings potential.

2. Reduce your Debts

As you know, debt is a form of financial leverage which can enable you to spend more than you earn.

Debt needs to be used with extreme caution because, while defaulting on your debts may be possible (hat tip to Greece), bankruptcy is a sure path to conflict, instability, and personal suffering. In earlier times, bankruptcy was punishable by death. And while this may no longer be the case, bankruptcy will still expose you to social stigma, personal difficulties, and make it difficult to borrow money in the future.

You should keep your investment debts within reasonable limits, and eliminate consumer debt as far as possible.

Consumer debt includes things like credit cards, purchases on deferred payment terms, and fixed payment contracts like rental agreements and cell phone plans. The largest consumer debt for most people is their rental or mortgage payment obligations, and so a good way to significantly reduce your consumer debt is to work towards owning your own home.

3. Insure Your Income

Clason advises in The Richest Man in Babylon that you should “provide in advance for the needs of thy growing age and the protection of thy family.”

If you are not adequately prepared for hard times, then setbacks in your health, the economy, or a tougher than expected competitive landscape could have a long term impact on your family and your quality of life.

One way to protect your lifestyle and your family is to take out insurance: life insurance, income protection insurance, and property insurance.

Although Income Protection Insurance is an often overlooked option, it may be a sensible one since it can buy you time to recover in the event of an unexpected illness or injury. Income Protection Insurance is probably not appropriate for everyone but, if you are interested to explore the available coverage options, your best bet would be to speak with a specialist income protection provider in Australia or where ever you are currently living.

Don’t Be Seduced

By sweet sounding lies

RISK taking is important. Entrepreneurs are in the business of taking risks in the pursuit of profit and are the engine room of the capitalist market economy. Risk taking makes sense where the likely consequences of action have been well considered and are deemed acceptable.

The quote above though states that “we only regret the chances we didn’t take”.

While missed opportunities can be regrettable, this is only one side of the story. The quote ignores the possibility of regretting the things we have actually done. For example, when asked by Businessweek about achievements of which he was most proud, the late Steve Jobs did not mention the iPod, the iPhone, or the iPad. Instead he stated, “I’m as proud of what we don’t do as I am of what we do.”

“Take a chance and live without regrets” is the mantra of charlatans, philanderers and unscrupulous financiers everywhere. However, it is not just the unscrupulous operators who are to blame. The sales pitch appeals to the people who are looking to be convinced (Dan Kahneman would call this confirmation bias). You probably have a friend who, despite any evidence to the contrary, desperately believes that they are uniquely lucky, that true love can be found in a night club, or that fast money is possible for them.

Some people want to be seduced by sweet sounding lies, and the results can sometimes be quite regrettable.

ModelOff 2012 – Financial Modeling World Championships

MODELOFF is a fun, innovative and professional competition for students and young professionals to develop and test their financial modeling skills against their friends, colleagues and top modelers from around the world.

With $25,000 cash from S&P Capital IQ for the overall ModelOff Champion and more than $65,000 of prizes in total from Microsoft and many others, ModelOff is the world’s largest Financial Modeling contest!

Participants from over 100 countries will compete in two online rounds (starting 13th October) with a finals event held in New York.

Modeloff was founded by John Persico, chief executive of Vumero, a Melbourne-based finance contracting company and board member of the Australia Israel Chamber of Commerce Young Business Forum. The competition seeks to increase awareness among finance students, young professionals and their teachers of the need for modelling skills.

ModelOff is put on in conjunction with Bloomberg, Microsoft, S&P Capital IQ, Deloitte CFE, AMT Training, Vumero and a number of other leading global finance businesses. Professor Simon Benninga, one of the worlds leading authorities on financial modeling, will be heading up the judging panel for the finals event in New York.

To enter, you need to act quickly! Purchase a ticket for Round 1 (online) held on the 13th October at 5pm New York time. Successful competitors will then progress through to Round 2 and then the Finals.

To register, please visit the website now:

5 Principles for Value Investing

WARREN Buffett is the world’s most successful value investor.

Very few people have ever managed to achieve his level of investment success.  The interesting thing about that fact is that there are only a few simple principles that you need to know if you want to be a successful value investor.

  1. Stick to your Circle of Competence – only invest in companies that you understand.
  2. Value Stocks as the Part Ownership of a Business
  3. Focus on Intrinsic Value – determine the underlying value of a business rather than looking at how much the market might be will to pay. Factors to bear in mind when figuring out the value of the business:
    • Business Drivers – what is the company’s business model? How do they make money?
    • Low Leverage – how much debt does the company have? You want to see as little cash going out of the business as possible.
    • Cash Flow – how much cash flow does the company generate? You want to see more and more cash coming into a business over the years.
    • Sustainable Competitive Advantage – what kind of natural advantages does the business have? To sustain and grow earnings the company needs a large moat with alligators in it. Large moats might come from (1) strong brand, (2) patented technology, or (3) incumbent low cost position in a market with economies of scale.
    • Prospects for Growth – what kind of profitable opportunities are available to the business?
    • Quality Management – the company needs honest and able management because an investor should not need to keep checking whether management is doing its job.
  4. Invest with a Margin of Safety – there is always investment uncertainty, so the price should be low enough to ensure that you have a “Margin of Safety”.
  5. Think Independently – it is difficult to outperform the market if you follow the market. Think independently and “be greedy when others are fearful”.

Madoff made off with $65 billion

ON 29 June 2009, Bernard Madoff pleaded guilty to defauding investors and was sentenced to 150 years in prison. The 71 year-old swindler is due to be released in 2159.

Madoff’s $65 billion investment fraud has been referred to as a gigantic Ponzi scheme “dating at least as far back as the 1980s” (The Economist).

A Ponzi scheme is any kind of fraudulent investment operation that pays returns to investors from their own money or money paid by subsequent investors rather than from any profits earned. The scheme is named after Charles Ponzi who used the technique in 1920 to attract so much money that his operation became infamous throughout America.

Given the enormity of Madoff’s investment fraud, perhaps we should start referring to this kind of fraudulent operation as a “Madoff scheme”.

Warren Buffett on hard work

WARREN Buffett‘s 2006 letter to shareholders makes for very interesting reading.

One of the sentiments that Buffett expresses in the very first page of his letter is one of gratitude to the managers who have run his companies over the last 42 (now 44) years. Buffett indicates that he and Charlie Munger, Berkshire’s vice chairman, run a company that has turned out to be a very big business; one with 217,000 employees and annual revenues approaching $100 billion.

We certainly didn’t plan it that way. Charlie began as a lawyer, and I thought of myself as a security analyst. Sitting in those seats, we both grew skeptical about the ability of big entities of any type to function well. Size seems to make many organizations slow-thinking, resistant to change and smug. In Churchill’s words: “We shape our buildings, and afterwards our buildings shape us.” Here’s a telling fact: Of the ten non-oil companies having the largest market capitalization in 1965 – titans such as General Motors, Sears, DuPont and Eastman Kodak – only one made the 2006 list.

Instead of taking personal credit for Berkshire’s successes, Buffett pays tribute to the managers who have successfully led his companies over the years, and says he knows that he wouldn’t have enjoyed many of the duties that come with their positions – meetings, speeches, foreign travel, the charity circuit and governmental relations.

Buffett claims to have taken the easy route.

My only tasks are to cheer [my managers] on, sculpt and harden our corporate culture, and make major capital-allocation decisions.

If Buffett has taken the easy route, then it is a path that no-one else has cared or managed to follow. From 1964 to 2007, Buffett and his team have managed to grow the net worth of Berkshire Hathaway by 400,863%, no small feat.

Whether or not Buffett has taken the ‘easy’ route, one thing is clear, he hasn’t lost his sense of humour. Buffett says that he has allowed each of his trusted managers to run their own show over the years. Having a self-effacing sense of humour and, not wanting to miss an opportunity, he quips:

For me, Ronald Reagan had it right: “It’s probably true that hard work never killed anyone – but why take the chance?”

To live in a world full of people as lazy as Buffett, if only we should be so lucky.

Understanding financial statements 101

UNDERSTANDING financial statements is very important if you are looking to invest, become a consultant, work as a CEO or in upper management, or want to start and run your own business. Understanding financial statements will allow you to assess a company’s current financial strength, and determine its profitability and creditworthiness. This article provides an overview of the four key financial statements that you need to understand.

There are four basic financial statements that you need to understand in order to evaluate a company, including the:

  1. Balance Sheet;
  2. Profit and Loss Statement;
  3. Cashflow Statement; and
  4. Statement of Retained Earnings (Owner’s Equity).

1. Balance Sheet

The Balance Sheet presents the financial position of a company at a given point in time. It is made up of three parts: Assets, Liabilities and Equity.

Assets are the economic resources that a company uses to operate its business: e.g. cash, inventories, and equipment.

Liabilities represent the debts of the company, the claims that creditors have on the company’s resources.

Equity represents the net worth of a company, and equals Assets minus Liabilities. Equity holders are the owners of the business.

It is important to notice that Equity is defined as a residual amount. As a rule, companies do not promise to pay back Equity holders. An Equity holder’s investment is more risky than a loan given by a bank because their investment is not guaranteed. In the event of insolvency, bank loans and other debts are repaid before Equity; Equity holders receive the residual amount after all the debts of the company have been paid.

2. Profit and Loss Statement

The Profit and Loss Statement measures the success of a company’s operations; it provides investors and creditors with information to determine the profitability and creditworthiness of the enterprise.

The Profit and Loss Statement presents the results of operations of a business over a specified period of time (e.g. one year, one quarter, one month); it is comprised of Revenues, Expenses, and Net Profit (Loss).

Revenue is the income that is generated from trading, i.e. when the company sells goods or services. Although, it might also come from other sources, for example, selling off a piece of the business or a piece of equipment. It is important to note that, revenue is recorded when the sale is made as opposed to when the cash is received.

Expenses are the costs incurred by a business over a specified period of time to generate the revenues earned during the same period. It is important to distinguish Assets from Expenses. A purchase is considered an asset if it provides future economic benefit to the company, while expenses only relate to the current period. For example, monthly salaries paid to employees for services that have already been provided are expenses. On the other hand, the purchase of a piece of manufacturing equipment would normally be classified as an asset.

Net Profit (Loss) is equal to the revenue a company earns minus its expenses during a specified period of time.

3. Cashflow Statement

The Profit and Loss Statement does not provide information about the actual receipt and use of cash generated during a company’s operations.

The Cashflow Statement presents a detailed summary of all of the cash inflows and outflows over a specified period of time; it is divided into three sections based on three types of activity:

1. Cash flows from operating activities: includes the cash effects of transactions involved in calculating net profit (loss).

2. Cash flows from investing activities: involves items classified as assets in the Balance Sheet; it includes the purchase and sale of equipment and investments.

3. Cash flows from financing activities: involves items classified as liabilities and equity in the Balance Sheet; it includes the payment of dividends as well as the issuing and payment of debt or equity.

4. Statement of Retained Earnings (Owner’s Equity)

The Statement of Retained Earnings shows the retained earnings at the beginning and end of the accounting period. It breaks down changes affecting retained earnings such as profits or losses from operations, dividends paid, and any other items charged or credited to retained earnings.

The Statement of Retained Earnings uses the net income information from the Profit and Loss Statement and provides information to the Balance Sheet. Retained earnings are part of the Balance Sheet under Owner’s Equity.

The general equation for calculating Retained Earnings can be expressed as following:

Retained Earnings (year end) = Retained Earnings (beginning of the year) + Net Income – Dividends Paid

What is an asset? What does it mean to be wealthy?

What is an asset?

THE question, “What is an asset?” seems like an absurdly simple question. But if you understand the answer to that simple question, and act on it, you have started down the path that leads to riches. Few people become rich, so clearly then, few people understand the answer to this question. Let’s have a closer look.

The Oxford English Dictionarydefines an asset as “a useful or valuable thing or person; [or as] property owned by a person or company.” This is the strict dictionary definition of the word ‘asset’. However, if I use this definition of ‘asset’ when deciding how to spend my money then I am likely to make mistakes. That is, I am likely to make decisions that I would not have made had I really understood what an asset is.

Using the Oxford dictionary definition of ‘asset’, I could be mistaken for thinking that my Mercedes that I have parked out the front is an asset. I own it, it is very useful and it is definitely valuable. This satisfies the dictionary definition of an asset. In addition, the bank will usually be willing to count my Mercedes as an asset when I ask for a personal loan.

In Rich Dad Poor Dad, Robert Kiyosaki makes the insightful point that, “what defines an asset is not words but numbers”. Let’s consider the numbers relating to my Mercedes. Every month I have a series of expenses that I incur because I own my Mercedes. My expenses might include: fuel $400, on-road maintenance costs $50, and insurance $200. So, every month my Mercedes costs me $650 in expenses. This doesn’t sound much like an asset.

According to Robert Kiyosaki, an asset is “something that puts money in my pocket every month.” By this definition, my Mercedes is not an asset but a liability. It costs me $650 each and every month, and that’s not including depreciation.

But, what about my house, is that an asset? The conventional wisdom is that you’re house is an asset, and the bank will certainly let you count it as an asset when you ask to borrow money. Let’s apply Kiyosaki’s definition to see whether a house is an asset. Every month you might have to pay: property taxes $200, loans $3000, utilities $200, and maintenance $100. In this example, your house costs you $3,500 each and every month. This doesn’t sound much like an asset.

It is true that, unlike my Mercedes, houses usually appreciate in value. However, there are three problems with this:

  1. Property does not always appreciate in value. The recent sub-prime mortgage crisis in the United States has taught us all that lesson, if we didn’t know it already;
  2. Tying up all of your money in your house comes at a high opportunity cost. So, while the value of your house may be rising and you are managing to pay off your mortgage, you may be unable to take advantage of great opportunities that are presented to you. “I would, but I have to make mortgage payments”;
  3. Your home does not put money in your pocket every month. The only time that you can obtain money from your house is when you sell it. For one reason or another, people are often reluctant to sell their homes. This fact remains true even when people are in tight financial circumstances.

The kind of assets that I’m talking about come in various forms, five examples include:

  1. Businesses that do not require your presence. If you need to be there to run the business it is a job and not a business;
  2. Stocks;
  3. Bonds;
  4. Income-generating real estate; and
  5. Royalties from intellectual property such as books or music.

Once you understand the difference between assets and liabilities, it is a good idea to concentrate your efforts on only buying income-generating assets. This is the path to wealth and riches.

What does it mean to be wealthy?

If the main game is to become wealthy, it would pay to stop for a second and consider what it would mean to be wealthy.

I am inclined to accept the definition of wealth that Kiyosaki puts forward, borrowed from Buckminster Fuller.

Wealth is a person’s ability to survive so many number of days forward into the future if they were to stop working today. So, I have become wealthy when my income each month, which is generated from my assets, fully covers my monthly expenses. If I want to increase my monthly expenses, I must increase my cash flow obtained from my assets in order to maintain my wealth.

To say that someone is wealthy, then, is to say nothing about whether that person is rich. I can be wealthy without being rich.

How much income do I need each month, generated from my assets, before I can consider myself rich? The answer to that question is up to you. The definition of ‘rich’ is in the eye of the beholder.

Warren Buffett on long term value investing

BACK IN 1998, Warren Buffett gave an inspirational talk to a group of MBA students at the University of Florida, College of Business. In the speech, Buffett gives his perspective on investing, in which he outlines the need to understand the underlying economics of the businesses that you invest in, and the need to stick to disciplined principles of business evaluation without being swayed by passing investment fads.

Here are 15 of the most interesting and insightful points made by Buffett in his speech about successful long term investing, as follows:

1. Return on equity is key

Return on equity is fundamental. In general, there is no point to investing, just because of the availability of cheap financing, if a business has a low return on equity. It’s hard to earn much as an investor when the business you’re in doesn’t earn very much money. Buffett elaborates that when he started out as an investor he would sometimes purchase very ordinary stocks at prices way below the value of working capital. This is what Buffett calls the ‘Cigar Butt’ approach to investing. You look around for a cigar butt (i.e. really cheap company), you find one that is old and soggy. You get one free puff out of it, and then you throw it away and try to find another one. If you’re looking for a free puff then this approach to investing works, but these are very low return businesses. By investing in a wonderful business with a high return on equity then, even if you initially pay a little too much, you’ll do well if you stay in for a long time.

2. Ownership of a stock is partownership of a business

Ownership of a stock is part ownership of a business.  With that in mind, the investors should not pay attention to the day to day stock fluctuations.

3. Invest in businesses that you understand

As Buffer jokes, this significantly narrows down the number of companies that he has to look at. You need to look for a simple business which is easy to understand, and which has honest and able management. Buffett says that this lets him understand where a company is going to be in ten years time. If he can’t see where the company will be in ten years, he won’t buy it. Buffett says that “investing is putting out money now, to be sure of getting more money back later at an appropriate rate. To do that you need to understand the business.” Buffett says that he wouldn’t invest money in a new internet business because he doesn’t understand that business and couldn’t say where it would be in ten years time. In his early years he would conduct extensive industry research. For example, by asking every CEO in an industry “if you could buy the stock of one other company in the industry, which one would it be and why?”

4. Invest within your circle of competence

The nice thing about investing is you don’t need to learn anything very new. Buffett says that he learnt about Wrigley’s chewing gum 40 years ago, and still understands that industry today. As a result, you will develop a pool of knowledge about different industries that builds up over time. Interestingly, Buffett says that most of his deals get completed in a matter of hours. If you don’t know enough about a business instantly, you won’t know enough in a month or two.

5. Invest based on solid reasoning

If someone told you about a company at a cocktail party or the charts look good, that’s not good enough. Paying a little too much for a wonderful business, you’ll do well if you stay in for a long time. You buy a lousy business for a good price; you stay in for a long time you’ll get a lousy result. If you’re right about the business, you’ll make a lot of money.

6. Invest for the long term

Buffett recommends buying businesses that you would be happy to own forever. It may happen that you have to sell for one reason or another, but you should, at the time you buy, want to be buying a company that you’ll own forever.

7. Strong businesses need a durable competitive advantage

A strong business needs a durable competitive advantage. Buffett says that although he wants to understand the businesses he goes into, he doesn’t want a business that is easy. You want a business with a moat around it with a duke defending the castle. That moat might be low cost operations, quality of products, service, patents, real estate location, or share of mind (Buffett explains that thirty years ago, Kodak’s moat was as wide as Coke’s moat. Kodak had share of mind, forget about share of market. They had something in everybody’s mind that said, “Kodak is the best”).

8. Feel strongly about the products

You want a business that has products that are not price dependant. Disney and Coca-Cola have developed a favourable impression in the mind of consumers that allows these companies to charge more for their products and sell more of them than other companies in the same industry.

9. Don’t borrow money that you don’t need

Buffett says that he never borrows money. He loves his job and was doing the same thing when he had $10,000 and when making $1,000 was a big deal. He recommends taking a job that if you were independently wealthy you would take. “If you think you’re going to be a lot happier if you have 2X instead of X, then you’re probably making a mistake.”

10. You only have to get rich once

Risking what you have and need to get what you don’t have and don’t need is foolish. Buffett gives the example of Long Term Capital Management. This hedge fund was run by smart people, with extensive experience and with their own money invested. To make money they didn’t have and didn’t need, they risked money they did have and did need. Buffett says, “if you risk something that is important to you for something that is unimportant to you, that decision just doesn’t make sense.”

11. Be patient, think carefully and avoid over stimulation

Buffett says that, in his opinion, the best way to think about investments is to sit in a room and just think. The problem with being in a market environment is that you get the feeling that you have to do something everyday, you get over stimulated. You want to be away from any environment that stimulates activity. Get one good idea a year, and ride it to its full potential.

12. Professional investors should not diversify

Buffett believes that if you are not a professional investor, which is ninety nine percent of people, then you should extensively diversify your investments and not trade. However, once you decide that you are going to bring an intensity to the game and start evaluating businesses and bring the effort, intensity and time involved to get that job done, then Buffett believes that diversification is a terrible mistake. In his opinion, if you really know businesses then you shouldn’t own more than 6 of them. “Very few people have got rich on their seventh best idea.”

13. Business size is not the important consideration

When investing, business size is not the important consideration. Small, medium and large cap stocks can all represent good investment opportunities. It doesn’t matter about the size of the business; it’s the certainty of the returns that counts. The relevant questions are:

  1. Can we understand the business?
  2. Do we like the people running it?
  3. Does it sell for a price that is attractive?

14. Only worry about what is important and knowable

Anything that is unimportant or unknowable, you should forget about it. Buffett outlines that market predictions do not affect his investment decisions. “I have no idea where the market is going to go.”

15. Make investment mistakes

Buffett says that the mistakes that he has actively made have been far less costly than his mistakes of omission. He reflected that the times where he understood a business, saw an opportunity and sat on his hands and did nothing have cost him tens of billions of dollars.