From Mark Ford, editor, Creating Wealth: With a net worth of $73 billion, Warren Buffett is the second-richest man in America and No. 3 on the Forbes billionaires list.
Most people know Buffett as a great investor.
Why? Early in his investing career, he realized that there were certain businesses that had strategic advantages—advantages that allowed them to continue to grow bigger every decade, crushing their competition over time. He figured that if he could buy those businesses when the price was right, the market would guarantee him huge, long-term profits.
And that’s exactly what he did.
Berkshire Hathaway, the company Buffett took control of in 1965 to buy such companies, has produced an average 19.4% annual return on investment (ROI) since then.
If Buffett’s system is so great, why doesn’t every investor—professional or private—follow it?
I believe I know the answer. It’s an answer that anyone who has been successful in business over several business cycles knows.
The investment advisory industry—at least the way it is practiced by more than 95% of the professional community—is not geared toward long-term wealth.
Why Doesn’t Everyone Do What Buffett Does?
Although most wouldn’t admit it, investment advisors (brokers or financial gurus) have an entirely different objective—one that runs contrary to the long-term acquisition of wealth.
That objective is yearly ROIs.
It is perhaps the greatest stupidity of the investing world, but the investment industry enslaves nearly everyone to yearly report cards. Investment bankers, brokers, financial planners, and advisors all have their performances rated annually. Once per year, the whole world gets to see how they did, compared with their colleagues.
This is just as true for the independent investment newsletter industry.
Our performances are calculated, rated, and reported every year by various industry “watchdogs.” These yearly report cards are open to the public. And they get a lot of press. The advisories with the best one-year track records enjoy big influxes of new customers.
The industry watchdogs report longer-term track records too, but no one pays much attention to them. Consumers are hardwired to focus on “who’s hot”—and that means who was hot last year.
This creates enormous pressure to produce short-term annual gains.
I was reminded of this when Agora’s founder and president sent out a memo to Agora’s publishers saying that he wanted them to spend more money on research and the quality of our writing. He then said that he would like to see all of our publications at the top of Mark Hulbert’s list—an annual list of the best-performing newsletters in the industry.
Hulbert tracks newsletters on a long-term basis, but the entire industry gives scant attention to that. The industry treats yearly winners like Academy Award winners. They get the attention and the spoils.
The irony here is that Agora’s founder, the man who wrote this memo, knows that short-term gains have nothing to do with long-term wealth. He has created a family office to protect his wealth over many generations, and one of the primary rules of that office is to invest for the long term. By that, I mean 50-year increments.
The point I’m making here can’t be understated. The bias toward short-term profits is antithetical to long-term wealth building.
You need to understand this if you want to develop long-term wealth.
I can hear some of you shouting already. “I don’t care about long-term wealth. I want to start making good money now. In fact, I want to get rich now!”
I hear you. But the fact is that you can’t get rich quickly in the stock market unless you are both extremely foolish and also extremely lucky. But what you can do, if you are smart, is generate a reasonable amount of short-term income while you are building up a retirement nest egg that will cover all of your lifestyle expenses after you stop working.
I’ve written on both of those subjects before and will do so again, but today I want to focus on Buffett’s secret: generating nearly guaranteed long-term wealth.
Putting My Money Where My Mouth Is
Since having my own, personal Warren Buffett insight, I made some personal decisions. I asked Tom Dyson to recommend Warren Buffett-like stocks. (Not the exact same stocks that Buffett owns, but ones that make sense for me at this particular time.)
One of the keys to this strategy, as I’ll explain in a moment, is a modest degree of diversification. You can’t do it with four or even six stocks. I’m thinking at least 10 stocks will be perfect.
That’s a good start for me, but it does you no good. So we decided to build a portfolio that would recommend Warren Buffett-type stocks to Palm Beach Research Group subscribers.
Before I explain exactly how this portfolio works and how it will all but guarantee long-term wealth, I want to restate clearly something that I have just implied.
Three Different Kinds of Investing
When it comes to investing in stocks, there are, basically, three goals most people have:
The production of current income
Saving for retirement
I’ve discussed each of these separately in other essays. You know from reading them (“The Secret of the Golden Buckets” essay, in particular) that I believe each requires a separate and distinct strategy.
The Palm Beach Letter has a very good strategy for current income. That is our options course and advisory, the Palm Beach Current Income program. For those readers who can’t invest at least $20,000, we offer our Wealth Builders Club, an intensive series of wealth-building strategies that I have used to increase my wealth.
To help Palm Beach Letter readers save for retirement (and other goals, such as college tuition), we have our Performance Portfolio, which is designed to produce solid, above-market returns year after year. This is the best yearly investment savings strategy I know of.
Introducing the Legacy Portfolio
This brings us to our long-term portfolio. We call it the Legacy Portfolio, because it will eventually be a fortune that you can retire on, or leave to your children, or give to the charity of your choice.
Of course, you might one day use the Legacy Portfolio to buy boats, houses, or any other unnecessary luxuries you want. But my hope is that you won’t. You can use our other portfolios to take care of your present needs.
Because it has a different purpose, the Legacy Portfolio also has a different investment time frame, a different buying-and-selling strategy, and a somewhat different selection of stocks.
The Five Benefits of an Extended Time Frame
To get the full benefit of the Legacy Portfolio, you need to follow the rules. You need to select only very safe and very protected businesses. And you need to stick with them regardless of yearly results.
If you do, you will benefit from the enormous advantages of Legacy investing.
The most important of these advantages is the power of compound interest. If you have ever looked at a compound interest chart, you’ve noticed that the upward curve of wealth accumulation begins slowly over the first 10 years and then increases rapidly after that. By year 30, the numbers are really enticing.
At 40 years, they are simply unbelievable. For investors with meager means, they will be in the millions. For mid-level investors, they will be in the tens of millions. And for affluent investors, they will be $100 million or more.
The second advantage of this long-term time frame is simplicity. As I’ll explain in a minute, you won’t have to regularly monitor the markets or even worry which way they are going. You can pretty much set up the Legacy Portfolio strategy and leave it be.
The third advantage is peace of mind. With this sort of strategy, you don’t worry about stock market fluctuations. Not even big ones like we’ve experienced in the last few years. (Buffett says that if they closed the market for five years, he wouldn’t care.) In fact, you are happy when the market declines—even when the stocks you are holding drop, as I’ll explain.
The fourth advantage is that the Legacy Portfolio prevents you from paying unnecessary fees to money managers, brokers, and financial planners. Over time, the fees siphoned away by these professionals erode your wealth significantly.
Fifth, investing in stocks in the Legacy Portfolio will keep you from being too conservative with your money. One of the greatest risks you run is losing money to inflation in overly conservative investments such as cash, CDs, money market funds, and bonds. By investing in the best companies in the world, you’ll grow your money at much higher rates of return. Rates that beat the pants off inflation’s wealth-eroding effects.
The Legacy Portfolio has a different buying-and-selling strategy. Like Warren Buffett, we won’t be selling our stocks if they dip down. Whereas a trailing stop loss is essential for the Performance Portfolio, it is unnecessary and even counterproductive for the Legacy Portfolio.
If and when the share price of any of our stocks goes down significantly, we’ll be buying more, not getting out.
The reason for this is that our objective is not yearly ROIs, which are the bane of the financial industry, as I explained above.
The objective of the Legacy Portfolio is to accumulate as many shares as we possibly can of the 10 (or so) companies we believe in. We will be getting richer by having progressively larger shares of those companies, not by trading them to optimize profits.
Respecting this different objective, we won’t be reporting on our performance in the usual way. We won’t be sending you a yearly report card based on 12-month results.
Instead, we will be using a new and unique program that projects forward the value of our investments over 10, 20, 30, and 40 years.
Looking for Enduring Strategic Advantages
Before I joined the Palm Beach Research Group, I worked as an entrepreneur for 30 years. I invested in and ran dozens of businesses whose revenues ranged from $5 million to $500 million.
I learned many lessons about investing. Among the most important was that it very rarely pays to invest in long shots. Building wealth is much easier if you buy into proven businesses that have distinct, competitive advantages.
Take Agora Inc. (the parent company of the Palm Beach Research Group) as an example. Agora has always attracted independent thinkers. This made it impossible to have a corporate-wide philosophy of publishing.
No sooner had one group succeeded with a certain type of product than another would splinter off and create a second group that would compete against it.
By providing a safe place to exercise this independence, Agora grew into a holding company of several-dozen independent publishing entities competing first against one another and then against the rest of the industry.
This was not only a competitive advantage, but also one that was very difficult to emulate. Other publishers were simply not interested in suffering through the chaos that such a free-market-based management system must allow for. This allowed Agora to grow during my tenure from a company with about 10% of the market to one that has more than half of the market today.
If you could have invested in any of Agora’s competitors 30 years ago, you might well have chosen any of a dozen that were bigger and more impressive at the time. But had you recognized the competitive advantage that Agora had back then, your investment would have turned out very nicely indeed.
In fact, when I entered the picture, there were two “outsiders” who had shares in Agora. One believed in the company’s prospects and held his shares continuously in the good times and the bad. The other sold his shares piecemeal when trouble seemed to be looming.
The first investor’s stake (an investment of less than $50,000) is worth tens of millions of dollars today. The second investor regrets what he did.
I can give you other examples, but I think you get the point. When you have an interest in a business that you believe in, you don’t sell your shares simply because of some temporary downturn. Instead, you will use that advantage to buy up more shares, as Agora’s founder did.
Since your goal is not yearly profits or even yearly cash flow but long-term asset appreciation, you buy more when the price dips down, and you don’t sell unless the competitive advantage disappears.
In constructing the Legacy Portfolio, we were seeking to replicate the lessons we have learned as private investors, as well as the lessons Buffett learned early in his career.
Most of the principles are the same. The Legacy Portfolio stocks we invest in must meet the following criteria:
Proven businesses: These are companies that have demonstrated consistent growth.
Cash-rich businesses: These are companies that regularly produce excess cash and have lots of cash on their balance sheets.
Profit-consistent businesses: These are companies that have track records of consistent profit margins.
Dominant businesses: These are companies that are leaders in their industries and have powerful brands.
Dividend-paying businesses: These are companies that return excess cash to shareholders in the form of ever-increasing dividends.
Well-positioned businesses: These are companies that have enduring competitive advantages.
Recession-resistant businesses: These are companies that stay profitable even during extended industry downturns.
Well-priced businesses: These are companies we can buy at price levels that are below their historic averages.
Tomorrow, I’ll expand more on the eight criteria we’re using and why it’s so important that Legacy businesses have them.