Friday, September 26, 2008

Know Thy Gut

The word did not come from Delphi, but Omaha. It did not come from Apollo, but from Warren Buffett.

In the midst of the current financial uncertainty Warren Buffett stepped forth to offer a vote of confidence in the system. He took a large stake in Goldman Sachs.

I will not comment on the wisdom of the investment but on the way Buffett made his decision. As he puts it, he trusted his gut and made a quick judgment.

When I first read this, I thought that it was surely bad advice. In my coaching practice-- a place where questions of decision-making are often crucial-- any time anyone tells me that he has decided to go with his gut, my own starts to feel queasy.

If he adds that he is simply following the counsel and example of Warren Buffett he does not calm my disquiet. I start thinking that he has misunderstood the oracle.

There is a Buffett mystique. The world's richest investor makes occasional pronouncements, just like Apollo's oracle at Delphi. And just as the god's message was communicated by a young woman sitting on a stool, so too Buffett's wisdom is offered to us by Becky Quick and Liz Claman.

What does it mean to follow your gut? Is it simply an affectation, a form of down-home folksiness that Buffett puts on to lure unsuspecting bankers into selling their assets as fire-sale prices? Or is there more to it?

How did Warren Buffett decide to take a major position in Goldman Sachs? (See link for the larger story.) One day he was sitting in his office in Omaha, feet on his desk, sipping Cherry Coke, nibbling on some nuts, when some guy called him and asked him if he wanted to invest in Goldman Sachs. A few conversations later Buffett owned $5 billion worth of preferred stock, paying 10%, along with a ton of warrants that could net him untold profits.

Not a bad deal for a country boy.

It was not the first time one of New York's major financial institutions had put in such a call. But, it was the first time there had been a deal.

As Buffett told the story, he did not enlist an army of lawyers and did not comb through the Goldman books: a chat between friends, a few meetings on the phone... and, bingo... a deal was struck.

His gut was saying yes, so he said yes.

Does this mean that the next time you are facing a difficult decision you should be reading the signs welling up from your digestive tract? It all depends on how you understand the oracle.

Buffett's is not just any old gut. It possesses a mind of its own, a mind that has been trained by decades of experience and considerable investing success, to say nothing of a few failures. Saying that Buffett can follow his gut does not mean that you and I should grant quite as much credence in our respective guts.

Any time you are thinking about making a decision-- saying investing in something-- you will have some anxiety over the risk. That much is normal. But, it might also happen that you feel anxious because there is something wrong with the investment, something that you do not fully understand. Sometimes your gut thinks faster than your mind. Sometimes it knows more than you do.

Knowing your gut means knowing which is which, whether your gut is telling you that you are taking a risk or that you should not take the risk.

All of this assumes that you know something about businesses. The phone call last week was not the first time Buffett had heard of Goldman Sachs. It was not his initiation into the world of financial services companies. He knew the principals of the company, had studied its annual report, and had examined its balance sheet. The result was that he could size up a deal for Goldman Sachs stock much quicker and with more accuracy than you or I could.

Had he already mulled over the possibility of investing in that company? Surely,he had. Was he already thinking of where and how he was going to invest in the newly-available financial assets? Surely, he had.

His decision was not an impulse buy. His quick judgment was more like what happens when suddenly you grasp something that you have been working on and working on. It's like a mental tipping point.

But why does he dumb in down by saying that he is just following his gut? Is it an affectation, or is something else involved.

Obviously, Buffett likes to present himself as an ordinary guy. He has a ribald sense of humor, and never touts his own brilliance. By giving credit to his gut, he ensures that success does not go to his head.

But how does he maintain the right attitude and the right frame of mind? Strangely enough, he does it through lifestyle, not through self-knowledge. And he does it through disciplined restraint, not just in his investing, but in the way he lives his life.

Buffett famously lives on Cherry Coke and cheeseburgers, not caviar and champagne. He has always lived in the same suburban house in Omaha, and has never aspired to a palatial triplex on Park Avenue or a mega-mansion in Greenwich. He buys his suits off the rack, not on Savile Row. And he still drives a Cadillac, not a Maybach.

He seems to have known that abrupt changes in status and lifestyle are difficult to handle. You cannot just bounce from one community and one lifestyle to another without putting in a great deal of work to readjust and acclimatize yourself. All the time that that takes is time you will not be using to work on your investments.

Besides, what is your mega-mansion really worth if it merely gives you a severe case of anomie.

Buffett's lifestyle keeps him from getting too full of himself. It is one reason why, as the Masters of the Universe quiver in fear as they watch their empires fall apart, this country boy is standing ready to pick up the juiciest pieces, at fire-sale prices.

So, if you want to invest like Warren Buffett, start with Cherry Cokes and cheeseburgers, trade in your Maybach for a Cadillac, and downsize your living quarters. Remember, the best time to do it is before you have to.

[Added note: If you have read this far I would recommend that you also check out Adam's remarks in the comments section.]

1 comment:

Adam said...

An excellent post with valuable insights, to which this reader would like to add:

Warren Buffett isn’t an oracle; neither Becky Quick nor Liz Claman is Pythia. They aren’t speaking in riddles; they’re reading scripts. Quick and Claman are financial entertainers inserted to interrupt commercials.

Behind the scrim of myth, Buffett is a stress-tested, high-performance player with skills honed by decades of diligently plying his craft in every sort of market condition.

He knows that if you don’t know what your edge is, you don’t have one.

Part of Buffett’s edge is his “aw shucks, who me?” persona that deflects attention from his true brilliance: acute skill in financial statement analysis.

Buffett’s high-performance analytic skill was learned by doing what most of us won’t: reading, by his own estimate, a quarter million corporate reports from back to front, and retaining the knowledge.

That’s nearly six decades of deliberate, dedicated high-quality practice. Some would call such behavior a symptom. This blog’s author would call it discipline. Berkshire Hathaway shareholders call it profitable.

One must make conscious decisions about what one wants to know and how it’s going to be learned, and then spend years diligently practicing one’s craft before gut-level decisions are trustworthy.

Extensive research has repeatedly confirmed that it takes 10 years of deliberate, dedicated high-quality practice to achieve excellence in any chosen domain.

For this reason Dr Schneiderman is justifiably concerned when a client “tells me that he has decided to go with his gut.” Absent years of discipline, the client is saying he plans to act out the oracular myth.

We are all better off replacing such behavior with deliberate, dedicated high-quality practice. Should you doubt this, ask a navy aviator what was required before he first landed his aircraft on a moving carrier deck at night in a gale ~ a decent analogy for many life decisions made under stress.

Look at Tiger Woods’ short game. Look at Ted Williams’ career as baseball’s most robustly successful batter. Look at Warren Buffett’s investment returns.

Don’t just look at the numbers, look at the process, how the work was done. These experts are setting examples worth following.

In each example, high-performance was achieved by repeating the same exercise over and over and over in ever more complex environments until sustainable levels of excellence were achieved.

To demonstrate sustainable excellence in a chosen domain, a person must be able to perform under conditions testing survival. Today’s financial markets are testing survival. Players are getting kicked off the island.

Those players who survive in, or thrive in this environment will be ones who don’t flinch when their guts tell them to. The survivors will be those who work diligently like Tiger Woods and Ted Williams, systematically expanding their knowledge and skill at execution.

In the best of times, navigating financial markets is like landing an aircraft on a moving carrier deck at night in a gale. Many nervous investors are blinded and deafened by tuning in to financial entertainers.

If you want to develop an edge you can define, first turn off your TV.