Warren Buffett (Trades, Portfolio) is arguably the greatest investor of all time. Anyone can learn a lot about investing from reading through this successful investor's letters to shareholders and his early letters to partners, as well as by listening to his interviews and reading any other correspondence he may have penned over the years.
However, while Buffett's advice can be tremendously helpful for individual investors, it can also be damaging if misinterpreted. Unfortunately, all too often, his advice is misquoted and misinterpreted to support someone else's point. With this being the case, I wanted to outline some Buffett quotes that could be downright dangerous for investors to misinterpret.
Diversification
Buffett has frequently warned investors that diversification can be damaging to returns in the long term. He once said, "Diversification may preserve wealth, but concentration builds wealth."
It is true that many of the most successful investors and business people in the world can trace the roots of their success back to one investment or business. Being concentrated worked for them, so why wouldn't it work for individual investors?
There are two reasons. Being concentrated works if you know what you are doing, but not if you have little to know knowledge of the company. Even if you do know the company and the industry, it often fails due to unforeseen circumstances. Looking back, we see the winners, but we don't see the losers.
Having a concentrated portfolio works for some people, but not for others. When Buffett says to concentrate on your best investment ideas, he means only if you have the knowledge and investing skills to outperform market averages. In fact, that is why Buffett recommends that the average investor buys a low-cost S&P 500 tracker fund.
Long-term investing
"If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes."
Buffett is a long-term investor, and he has always encouraged others to do the same. Unfortunately, buying and holding stocks is not a simple process. Many companies underperform in the long run, and deciding when to cut a position is challenging. It is not enough just to buy a position to hold it for a decade. One has to keep a constant eye on the company to see if it is still performing as expected.
Another Buffett quote relevant to this is:
"All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies."
How does one know when they stop being good companies? That is the hard part. As Buffett once said, "risk comes from not knowing what you are doing." Buying a stock for a long-term investment without understanding it inside out is highly risky. Investors should not keep clinging to bad companies just because long-term investing in general produces better results.
Jumping ship
This brings me on to another quote that can be misinterpreted:
"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be a more productive than energy devoted to patching leaks."
This seems to suggest that if one finds oneself in a losing investment, one should sell up and move on to a different opportunity. That may be the right decision, but if you are investing for the long-term, shouldn't you look past short-term market disruptions and focus on the company's potential in 10 years?
The challenge is knowing whether or not disruption is temporary or more permanent. If one sells a stock at the first sign of trouble every time, that is not long-term investing at all. It is the opposite of what Buffett has always recommended.
Buying low
Another quote that can be misinterpreted is:
"The best chance to deploy capital is when things are going down."
Yes, the right time to deploy capital is when things are going down, but averaging down into a losing position can also be a disastrous strategy, especially if the company is suffering from structural problems. In this situation, it may be better to change vessels. As with all things in investing, it all depends on how likely the company is to succeed, and how likely it is to fail.
As we can see, on their own, many of Buffett's best-known quotes can be easily misinterpreted. The best way to get around this problem is to read as many of his letters as possible and build a mental model of his investment style. Buffett's strategy cannot, and should not, be boiled down to one soundbite or quote.
