Warren Buffett's 20-Slot Punch Card
A Mental Technique to Help Investors Be More Selective in Building a Portfolio
It's no secret that billionaire investor Warren Buffett has one of the best investing track records in history. From starting a handful of investment partnerships that were early versions of a modern-day hybrid hedge fund and private equity fund, to building an old textile mill into one of the world's largest holding companies—Buffett and his business partner, Vice Chairman Charlie Munger, have often talked about how they made most of their money in a handful of really great businesses.
Being so successful, people often ask Buffett for wealth advice. Anyone relatively new to investing would do well to consider some of the tips he's shared.
Diversifying Income Sources
Buffett and Munger didn't seek diversification for the sake of diversification, even though they were always attempting to diversify their income sources. Rather, they exercised extraordinarily levels of patience, sometimes sitting on large cash reserves in their portfolios for extended periods until something intelligent came along for them to buy.
Buffett's General Advice
Buffett and Munger's best investments, such as their stake in The Coca-Cola Company or Wells Fargo & Company, have sat on the balance sheet for decades. These sorts of long-term holdings take advantage of the power of compounding and deferred taxes. When asked about their investing strategy, Buffett often has a handful of key pieces of advice he shares. These include:
- Insist upon a margin of safety between the purchase price you are paying for a business and the intrinsic value of what that business would be worth to a long-term private buyer—as measured by the net present value of the discounted cash flows. This means avoiding things like value traps or dividend traps. If in doubt, calculate your share of a firm's look-through earnings.
- Avoid using large amounts of leverage to buy stocks or speculate in the capital markets. If you're smart, you don't need it. If you're dumb, it can hurt you.
- Only buy things you understand (or, as legendary investor Peter Lynch put it, "invest in what you know"). Dive into the Form 10-K and annual report to learn about the company.
- "KISS," or "Keep It Simple, Stupid."
- Look for signs you're dealing with shareholder-friendly management.
- Focus on the long-term. Warren Buffett says that you should be perfectly fine if the stock market closed for years after you acquired a stake in a company. You should be content to focus on the net income applicable to common shares and the dividends you receive as an owner—not on your opportunities to buy and sell.
20-Slot Punch Card
Aside from this, there is something that Warren Buffett repeats that doesn't get a lot of coverage in the press, despite its extraordinarily profound implications. Since at least the 1990s, when giving college students advice on how to get rich, Buffett has often said, "I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it—so that you had 20 punches representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd think really carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."
So what exactly is Buffett driving at here? Too often, investors throw money around like scattering seed across a wide field. They say to themselves, "I'll throw a little here and little there to see what happens." Instead, Buffett advocates a policy of finding the best and richest soil, planting a substantial amount of seed in that small spot, and protecting it. This policy may sound simple, and it is, but it also can be life-changing. Lou Simpson, one of the best investors in the world and former head of Geico's equity portfolio, once said that this particular Buffett strategy helped him achieve enormous success on the stock market.