It’s Time to Take Buffett’s Millionaire Challenge

Warren Buffett and his geeky, bridge-playing sidekick Bill Gates have talked 40 billionaires, including some of the business world’s marquee names, into giving half their fortunes to charity.
It’s an interesting scenario: If the avuncular Buffett showed up at your house and asked you to donate half your assets, what would you do?

Well, I’ll tell you exactly what I would do. I’d throw Buffett out. And his little buddy, too.

I will do whatever I like with whatever assets I have. Condescending public displays of noblesse oblige don’t impress me. They strike me as new-money gauche, like some parvenu dentist who gives a few bucks to the local art museum and then sends a news release about it to the local paper. I mean, c’mon. Barf. 

If you want to give money away, then do it. I applaud that. But do it for the sake of true charity, with the aim of helping those in need. Don’t do it for the sake of justifying your wealth or inflating your own terrific-ness.  My parents and grandparents taught me that in polite society that means quietly sending a check and saying absolutely nothing other than “Glad to help. You’re welcome.”
The bottom line is I feel guilty about exactly none of the dollars I have been able to amass, and what I do with it is between my wife and I. The only thing I even remotely respect about Buffett’s move is that he’s keeping Uncle Sam at bay: Functionally all of his $40 billion wealth is in Berkshire Hathaway (NYSE: BRK-B) stock, which he has never realized a profit on and, thus, never paid taxes for. So Buffett is keeping the folks at the IRS (Proud motto: “Always here to help”) from sending what may be one of the largest tax bills in history. Good for him.
I’m not impressed with Saint Buffett’s Billionaire Challenge. Not at all. But I am impressed with the uber-investor’s ongoing multimillionaire challenge. Never has one man tried so hard to make so many people so much money. 
And never gotten a dime for it.
Buffett is, at his core, a teacher. Early in his career as a stock broker in Omaha, he taught investing classes. Now he is involved in helping children learn about personal finance. He also speaks about complex financial topics in clear, understandable terms, both when he speaks to the media and at Berkshire Hathaway’s annual shareholder’s meeting, which consists of him answering questions for six hours.

What’s more, his annual letters to shareholders are among the best business writing ever. Any investor who sits down and reads even one year’s letter will be enriched by it. Reading five or 10 years of annual letters is the equivalent of going to graduate business school. And Buffett, who could publish a bestselling investment book every year, gives it all away for free.
Are you prepared for the Buffett Multimillionaire Challenge? He’s been offering it for years. Here are the five elements of it:

1. Learn about what you’re investing in.
Like all of Buffett’s truisms, this one seems glaringly obvious. But most investors do no research into the areas they’re investing in. Buffett, on the other hand, is obsessed. He loves industry publications, research reports, newsletters and anything else that can help him analyze and contextualize what is going on.

Buffett, as one of America’s most respected businessmen, can arrange a sit-down with anyone he wants. When he does, he’s prepared. Dozens of chief executives — and managers of businesses Buffett owns — have all said, “I was amazed at how much he knew about my business.”

The corollary to this element of the Buffett challenge is that people should never invest in something they don’t understand. If you can’t teach an 11 year-old about the company, its products, its prospects and how it makes money — then you do not understand the business adequately. If you’ve never looked at the income statement or taken a long-term study of the balance sheet, then you have no business owning the stock. You might as well go to Las Vegas. Buffett might well tell you your chances would be better there, though he would probably suggest an S&P 500 index fund instead.

2. Look at your investment from an ownership perspective.
Fact: People drive more aggressively in rental cars than they do in their own vehicles. No trick to understanding that: We’re inclined to take better care of something we own and must be responsible for than we are of something we rent and will never see again.

That’s Buffett’s message about his investments. He doesn’t consider himself an investor. Rather, he looks at his role as the owner. When he looks at a huge holding like Mid-American, Berkshire’s utility business, he doesn’t look at it just for the free cash flow. He examines the financials and consults with the managers as a steward of the business, concerned not with short-term performance but with long-term health.

Rare is the individual investor who does this. We see a security we own that gains or loses and the first thought we have is whether we should sell it. The owner, on the other hand, sees every dip as a chance to buy and every gain as another step toward realizing an asset’s intrinsic value. Buying or selling is always an option, just never the first reflex. The first step is to learn about your investments. The second is to begin to treat them as if you were the owner of the entire company.

3. Hunker down for the long haul.
Buffett says he operates on the premise that the New York Stock Exchange could be shut down and not reopen for five years and it wouldn’t hurt Berkshire at all. That’s because short-term gains don’t have a key place in the Berkshire model.

The entire company is built on achieving predictable, sustainable growth over the long haul. And over the long haul, from 1965 to the end of 2009, Buffett has achieved a compound rate of growth in the book value of Berkshire’s stock of +20.3%, more than twice the total annualized return of the S&P during that time, +9.3%. Overall, Berkshire has gained +434,057% to the benchmark‘s +5,430% advance during that time.

Now, it’s a myth that Buffett never sells. He does. But it should be pointed out that those sales are just as likely to be because the company has disappointed its owner rather than simply because Berkshire wanted to harvest some capital gains. Buffett occasionally takes gains, but only if he can prove that he earned an outstanding rate of return — and that further gains are unlikely.

Pick stocks you can live with, and hang on to them as long as the reason you bought them remains valid. If the company, its management or underlying conditions undergo a material change, then there’s nothing wrong with selling.
4. Choose leading companies with sustainable competitive advantages and minimal capital requirements — and try to get them cheap. 
Outstanding businesses will always grow and attract a disproportionate share of their respective markets. If they can do that without taking too much cash, all the better. (That’s the owner perspective again — no one wants to buy something that’s just going to eat cash year after year.)  

And yet this is the part of the Buffett challenge where most investors fail. It’s not the selection of companies, it’s the pricing.

The fact is, investors as a class behave as a herd. They buy when everyone buys and they sell when everyone sells. This, of course, is absolutely counterintuitive when one has a clear head. But under the panic of the constantly moving and unpredictable market, 99 investors out of 100 don’t have the intestinal fortitude to buy when everyone else is selling and to sell when everyone else is buying. There’s some element of human nature that makes the concept of “value” investing very difficult to stomach.

This is what has made Buffett his billions. He didn’t get uber-rich by earning a predictable +8% a year. That’s how he maintains Berkshire now because of its size. But in the early years, Buffett bought stocks cheap and held them dear, patiently waiting until the right moment to sell came along.

Sometimes a broker would call offering shares of a company at a certain low price. Buffett’s answer was always the same: “Unthinkable.” He’d keep waiting, sometimes for a dime and sometimes for a dollar. This combination of discipline, patience and courage is the hardest part of the Buffett challenge. It is also the most critical part because, unlike the others, it cannot be easily taught. It’s a function of character as much as of intellect.  
5. Seek to outperform in bad years rather than good years.
“We have done a lot of stupid things,” Berkshire Vice Chairman Charlie Munger said at this year’s shareholder meeting. “But we have done less stupid things than many others.”

Munger always gets laughs. His sense of humor is very dry, his delivery is deadpan. But there’s just one thing: Munger wasn’t kidding. He could have passed a polygraph with that line. He absolutely believes it.

Outperforming the market in good years is only half the trick. To be ultra-successful, an investor also has to outperform the market in bad years. Breaking even in a bad year is some trick, but do it only a couple of times in a long course of able management and you look almost god-like. In 2008, when the S&P tanked -37%, Berkshire receded only -9.6%. The next year, the company started way ahead, with far less ground to make up. Buffett has beaten the S&P in all but six years since he took over in 1965, including a spectacular string from 1981 to 1999 where he twice posted strongly positive results as the broader market slipped.

One key element of this is Berkshire’s longstanding practice to keep plenty of cash on hand in case opportunity arises. When the financial crisis came, Berkshire was one of the few companies with significant cash on hand to lend, and Buffett cut some sweet deals, including multibillion-dollar loans to General Electric (NYSE: GE) and Goldman Sachs (NYSE: GS). If Buffett didn’t have the cash on hand, he would have likely been unable to do those deals. The trick is to keep some dry powder on hand and to orient your portfolio to generate positive results even when the broader market and the economy are in tatters.
Action to Take –> These are the five elements of the Buffett Multimillionaire Challenge. Find good companies you understand, buy them at a good price for the long haul and seek to outperform in bad years as well as good, always keeping plenty of cash on hand.

The Oracle of Omaha has been espousing these exact same tenets for more than 40 years. Those who have listened to his sage advice and been able to mirror Buffett’s discipline have seen their fortunes increase almost boundlessly, some to an astounding multimillion or even billion-dollar net worth.

After all that, if they see fit to give it away — then I guess that’s up to them.