The Warren Buffetts Next Door

I recently finished reading the book The Warren Buffetts Next Door: The World's Greatest Investors You've Never Heard Of and What You Can Learn From Them. Here's the summary from the book's back cover:

How 10 ordinary people consistently achieve extraordinary returns on their investments (and how you can, too).

There are the famous investors whose names you know—Buffett, Bogle, Soros, Lynch, and Templeton. And then there are the Warren Buffetts next door, those successful investors you've never heard of—Rees, Krebs, Koza, Petainen, and Weyland. The Warren Buffetts Next Door describes how these "regular" people—tractor-trailer drivers, radio DJs, and college dropouts—utilize an armament of online information, tools, and resources to routinely outperform professional brokers and Wall Street's Ivy League–educated investors.

So, the author found 10 "average Joes" who are investing geniuses and he profiles each of them -- telling their investment strategies, key metrics, performance stats, etc.

I love the fact that the book tells real-life stories of investors who are earning outstanding returns. It's a fascinating read -- and actually makes investing fun/interesting! ;-)

What I don't like is the implication (in some cases) or outright claims (in other cases) that because these 10 guys can do so well, so can anyone else (including you). If all it takes to "prove" something is to find 10 people who have done it, I can "prove" a lot of things that aren't actually true. And lest we forget, the Millionaires Next Door (where this book gets part of its title) was based on research, not on a very small sample of 10 people. Maybe it's true and maybe it isn't (I don't think it is) that anyone (or even most people) can become excellent investors, but please don't insult my intelligence by claiming that because 10 people can do something that anyone can.

Here's an example of what I'm talking about. It's the last paragraph of the book's introduction:

My hope is that you will read about my 10 Warren Buffetts Next Door and realize that the only real prerequisite to becoming a good investor is committing the time to do so. In other words, invest in yourself. You can achieve great investment returns, meet your financial goals, and beat the professional investors you would otherwise entrust your capital to.

Really? Is time (to educate yourself) the only requirement? If that was true, wouldn't the "professional investors" that the book claims everyone can beat be the best investors of all? After all, they have spent years (or even decades) trying to be better investors. And they have the added advantage of huge financial resources, staffs to help make/execute decisions, and so on. So simply by taking the time to learn about investing I can outperform them? Hmmm.

We have our own Warren Buffett Next Door who reads FMF. If you recall, I shared some of his thoughts on investing earlier this year. The summary: People can be excellent investors but the time, experience, and personality traits that are required to do so are held by very few. In other words, only a small percentage of people can hope to achieve stellar returns. For the vast majority, even investing the time (which is substantial) to be a great investor is not even close to guaranteeing a successful performance.

The book is balanced out a bit in the foreword written by Steve Forbes. Here's what he says about it:

The book both inspires and cautions. As always, there are no quick, easy roads to riches. But now people have unprecedented opportunities to create meaningful wealth over time -- if they have the stick-to-itiveness and the maturity to know there will be plenty of bumps along the way.

Forbes also gives a great summary of what can be learned from these ten investors. His thoughts:

• There is no one way to achieve success. Each of these people has developed his own particular approach.
• They do share two characteristics: hard work and iron discipline.
• These next-door Buffetts make mistakes -- but they actually learn from them.
• Every one of them has suffered a searing market setback.
• What also becomes clear here is how the Web allows individuals, regardless of their circumstances, to develop talents that otherwise would have lain dormant.

This is something I can believe. In particular, the "iron discipline" requirement alone will eliminate most wannabe Buffetts -- because when they start losing real money, especially their own real money, most people's "iron discipline" melts like wax in a hot flame.

All this said, I did enjoy the book and would recommend it to those of you who pick your own stocks (or those who want to.) Reading how these ten investors use their individual strategies to significantly outperform the market (and most of the rest of the world) is really quite compelling. Even if you don't learn anything that you will apply yourself, you'll still get an enjoyable read out of this book.

Tomorrow I'll share highlights about the ten investors so you can see for yourself the diverse ways these people became Warren Buffetts next door.

Comments

[Jackie]

I'm inclined to agree with your assessment that there's more to it than just education. I'm torn on whether or not I want to read this book though. Part of me is very curious -- I want to see how the people profiled did it. The other part of me is cautious though -- I don't want to be tempted to stray from my current methods since they seem to be working. I guess there's always room for improvement though!

[Apex]

Great summary FMF and I find your caution to be exactly what is needed.

I have always disliked the notion that no one can be the market. The index fund advocates and most long term investors posit this theory. I think this is almost certainly wrong and mostly is driven by people promoting what they believe to be true for them or what is in their own self interest (index fund mutual companies etc). The idea that the market is so efficient that there is no information that people can use to know a little more and profit from it than the herd of cattle who are all just throwing their money in (circa 1999) is just a little too facile for me to accept.

Then we have the other side. People who believe the market can be beat and it just takes the right formula, time, discipline etc. I certainly believe there are ways and people who can find ways to beat the market. But just like with a multi-level program, just because a few people at the top can make millions off of it doesn't mean everyone can quit their job today, join a multi-level and be rich. It doesn't work that way. And neither does beating the market. Only a certain few have the skills, abilities, personality, and perhaps even the right mix of past experience and circumstances to give them that edge. I believe it certainly can be done and the formula is not easy to define (perhaps undefinable entirely). But by definition, if everyone or most people could do this it would no longer be possible to beat the market. 50% of people are below average.

Both camps are biased in the views they present. The indexers and buy and holders and of the opinion that no one can beat the market and they beat that drum regularly. People writing books about beating the market want to tell you everyone can do it or if not everyone at least anyone can do it. That is not true either. But if they tell you most people can't do it but if you have the right knack you just me be the Michael Jordon of investing? Well that doesn't get too many people excited about buying that book.

[Valerie]

You've honed in on the big fallacy of this book, which in research we call "sampling on the dependent outcome". The (well proved) principle is that you cannot determine what leads to an outcome if you only examine people who succeeded on the outcome. In this case, take these ten folks: just because they all put in time to educate themselves does NOT mean that causes them to do well. There may be plenty of people who have failed at investing who also put in the time to educate themselves! The fact is that to determine what causes success you have to compare the successful and the non-successful to see what differentiates the two. You simply can't do that by looking at only the successes/winners/best investors.

[MonkeyMonk]

Reading about books like this just remind me of Warren Buffet's Graham-and-Doddsville coin-flipping contest.

[Michael Goode]

MonkeyMonk is right. This kind of book exists because of selection effects.

[DIY Investor]

It would be just as easy to write a book on 10 people who spent a lot of time educating themselves, used elaborate techniques etc. who lost it all. Write about what people want to believe and you'll have an audience.

[RJ]

I don't necessarily agree with the idea that committment and the investment of time towards becoming financially successful generally yields results. There have also been millions of "average Joes" who have attempted to outperform the market and have failed to do so. Yet their story is not revealed in this book.

[bkruptcy]

There is always someone next door who seems to always find a good way to make money, whether it is picking the right stock or not. But just like any stock transaction, there are always 2 parties involved. And chances are, most of the time someone always make out like a bandit while the other party has to suffer.

[MBTN]

Every year 50% of people beat the market and 50% of people don't. Some of the 50% who beat the market might be more skilled, but many might just be lucky to be in the upper tier. Let's assume that you are lucky one year, there is a 1 in 4 chance that you might be lucky two years in a row. 1 in 8 chance of being lucky three years in a row. After 10 years, 1 in 1024 will be lucky all ten years. Considering the millions of investors in the US alone, there are bound to be 10 that an author can find who have been wildly successful not because of any skill, but because of dumb luck. Like FMF points out, the folks who run mutual funds and hedge funds are educated, have lots of time, have computing power at their disposal, have teams of researchers and analysts. Basically, they have all of the advantages in the world. However, time and again, these professional funds are outperformed by the S&P 500.

I find it hard to believe that a radio DJ can educate himself/herself more than any professional, so I am inclined to think that his/her success was due to luck more than anything else. On the other hand, maybe this DJ's secret was investing in low cost index funds...

[08graduate]

MBTN - I agree that these people were likely successful investors by luck, but your probabilistic reasoning isn't sound.

First, investors as a whole cannot outperform the market, but this *does not mean* that every year 50% of people must lose to the market. It could be that 90% beat it by a little, while 10% lose big, or any other distribution you please. If you have data on the actual shape of this distribution, I would be interested to see it.

Second, your calculation assumes without proof that an individual's performance relative to the market each year is statistically independent of other years. I doubt that's the case, because the factors that make one underperform or outperform will persist somewhat year-to-year. For example, if someone has underperformed ten years running, your calculation gives him 50/50 odds of outperforming in Year 11, but I would not. Why? Because we can infer an underlying cause with some confidence. He is likely either a devoted index investor (and underperforming by a little), or skittish/emotional/gullible (and underperforming by a lot). Those features don't reset on January 1.

[Old Limey]

I am a successful private investor that has consistently beaten the market but I am certainly not "your Warren Buffett next door". For one thing I didn't start investing the bulk of our money myself until after I had retired. You cannot replicate what I achieved when you are very busy working in a job where you have lots of responsibilities and work long hours most days, as well as raising a family and taking care of your home. In my own case another vital factor was that I spent my life working as an engineer and first started using computers back in 1956 when they were giant vacuum tube IBM main frames surrounded by a host of fans that attempted to keep them cool. When I finished my career I was primarily writing software and submitting runs that ran all night on the fastest computer in the world which at that time was the Cray XMP4. I am also a very disciplined and logical person with a very strong mathematics background. When I retired I bought myself a few books, taught myself about the technical analysis of the market and started writing a variety of small programs to help me in my investing. After a couple of years the many small programs became one, easy to use large program that could access the database of funds to which I subscribed and I was off and running. At first I gave my software away for nothing to other database users and received many gifts in return. These users became my beta testers and finally I sold the software for several years until finally taking it off the market because of MS-DOS memory restrictions and because I was unwilling to spend my golden years learning how to program using the Windows system. It's one thing learning how to use new languages when you are a member of a group of very talented programmers and it's a whole different story when you are home every day, with no mentors and colleagues to consult with.

The following table was generated from some old MS-DOS software that I wrote many years ago but the data was produced using a proprietary mutual fund database and their software that came on the market in 9/1/1988 and to which I subscribe. The data contained shows my own performance and the next best five mutal funds out of 6,906 no-load mutual funds. The range of the data is between 12/28/92, the day I walked into a Fidelity Service Center, took charge of my IRA and consolidated the remainder of our investments. The ending date for the data is 11/6/2007 which is when I made the decision to stop taking large risks and become a very conservative investor. I became very conservative because large daily losses sere becoming too hard for me to take and our portfolio had reached the size where there was no point in taking large risks to try to keep it growing at the annual rate of return of 21.63% which I had achieved over the prior 15 years. My annual rate of return since 11/6/2007 has been 7.96% and since October 2008 when I became extremely conservative and moved into CDs amd municipal bonds my annual rate of return has been 4.54%. Funds that didn't exist on 12/28/92 were discarded from this study.

Full Name Ranking on: 11/06/07 - Family: TOP6 - Sorted by column: ANN%
--------------------------------------------------------------------------------------------------------
Symbol..... --------------------------------------------------------Ui%-------Ann%-----upI%-----Mdd%-----START
BEANS...... My Portfolio Bean counter........................4.97..... 21.63..... 3.27 .... -15.90 .... 12/28/92
FSESX...... Fidelity Sel Energy Service/43..............22.02..... 20.16..... 0.67 .... -62.21 .... 12/28/92
LDF............ CLOSED Latin American Discovery....27.79..... 19.34..... 0.50 .... -67.20 .... 12/28/92
VGENX...... Vanguard Energy/51............................. 10.24..... 19.01..... 1.33 .... -36.25 .... 12/28/92
FSDAX...... Fidelity Sel Defense & Aero/67...............8.88..... 17.91..... 1.41 .... -32.89 .... 12/28/92
FSLBX...... Fidelity Sel Brokerage & Investm...........14.39..... 17.77.... 0.86 .... -47.43 .... 12/28/92

In the table it is important to look at Ann%, Ui%, UPI%, and Mdd%. Ann% is the annual rate of return, Ui% is the Ulcer Index a measure of downside volatility, upI% is the Ulcer Performance Index a measure of the risk adjusted rate of return, and Mdd% is the maximum possible drawdown in the value of your portfolio between the starting and ending dates.
The most critical of these in my opinion is Mdd%. Just think about it. Let's assume you had a very large amount of your portfolio invested in FSESX. On 3/1/1999 you would be looking at an investment that was DOWN by 62.21% and you wouldn't have any idea whether it was going to continue going down or whether it has hit bottom and would soon start going up again. This is the big dilemma that Buy & Hold investors sometimes face. Most investors would throw in the towel long before their loss became 62.21%. I have owned FSESX many times in the days when I used to trade the Fidelity Select funds but I would follow every fund I owned on a daily basis and use a variety of technical indicators to guide my decisions. Sometimes the decision is to just get out of funds that your methods tell you to sell, other times I would sell everything I had and go into a MMF for a while until I sensed that the slide was over and that things were looking a lot better. The Fidelity Select funds were priced every hour at that time and on some stressful days I would follow the market from the opening bell.

[MBTN]

08graduate:

Thank you for your response. I re-read my post and in my haste I didn't not explain myself very well. Basically, what I was trying to say was that just because you have 10 years of above average (or median to be more precise) investment performance does not necessarily mean that you are a skilled investor. It could mean that you are just a lucky investor. If you assume that whether you are above the median or below the median is random, then you have a 1 in 1024 chance of being above the median in 10 straight years. In a population of millions of investors, it is quite easy for an author to identify 10 such lucky individuals. Just because 10 such individuals exists does not prove that they have skill as investors. It doesn't disprove it either, of course.

There is a lot of debate as to whether the stock market is random and unpredictable. Google "efficient market theory" to read more about this debate.

[Matt Schifrin]

I am the author of The Warren Buffetts Next Door and I am glad that the original poster enjoyed reading my book and found it fun and interesting.

There is a lot of criticism of my book on this site because I was selective in choosing my 10 great individual investors. Well of course I didnt choose to profile people who were investing losers. I didn't set out to take a valid statistical sample. My goal from the outset was to find outstanding investors, just as someone who writes a book about great hedge fund investors eliminates bad hedgefunds.
The point of the book is to showcase these self-directed investor's journey's to becoming outstanding investors. I dont ignore their failures either. In almost every chapter I talk about their big investing blunders. So these investors are not perfect. Several of my top guys lost 40% plus during the crash. It is all disclosed in the book.

Moreover, while I agree that ten years of above average results doesn't measure up to a Buffett or a Templeton, I will tell you that many pros are judged on much less (3 or 5 year results). 10 years can be life changing. Several of the people in my book have become multimillionaires during that time period. Moreover many of my investors have 25 plus of experience, but I could only verify 10 years of results. What my Warren Buffetts Next Door are doing is NOT coin flipping either. They are taping web resources doing serious time consuming research. They are also finding above average investments. Is it luck that one would buy into Anally mortgage,for example, a mortgage REIT that is effectively backed by the government because it buys FNMA and Freddie Mac mortgages and offers a yield of 15%. One of my profiled investors Bob Krebs bought in in mid 2008. Since that time the total return on that stocks, with dividends reinvested is about 50%. Moreover Krebs actually wrote out of the money calls and puts against Anally and magnified his returns. His ability to wring big returns out of this stock is NOT coin flipping. And he is mindful of losing money, because it is his own. If the stock or options go against him significantly, he is out. He has done this for years, so it is NOT luck.

The fact is, I am not seeking to definitively prove anything with the book. Rather I was hoping to provide and inspirational and educational read. I have a whole chapter on Legendary Investor Incubators, or web sites that can help you improve your investing skill.

Referring to the initial post no way meant to insult anyone’s intelligence saying in my intro that everyday people can achieve outstanding results..What I am saying that above average results are attainable by average Joe’s. I believe this.

I think many people give up before they even try to improve their investment skills and results. They are told that only professionals are suited to manage their money and then they become intimidated by the process. They also read that most mutual fund managers dont beat the averages. So why try? You should try because it is YOUR money and your future, not other people's.

The fact is most of the frontline pros seeking to manage people’s money are financial advisors and brokers and their core competency is NOT investing. Their skill is in acquiring new clients and establishing trust. They don’t spend hours per day on focusing on investing or stock picking. They are running client focused service businesses- that is a full time job.

I point out in my book that the gentlemen profiled spend at least four hours each day on their investments and portfolios. Most of us don’t do this and can’t do this. I believe if you do, and if you abide by prudent investing techniques- many of which are outlined in my book- you stand a good chance of beating the 6 to 8% average annual returns that most pros say you should expect over the long term. Even if one decides to stick with a financial advisor or index funds, I advocate spending the time to learn to invest better. In the long run it can only help, even if only to keep tabs on the pros.

Anyway I thank you all for reading my book or even considering reading my book. And if any of you want me to sign a copy, i'd be delighted to. I'll pay the postage.
Cheers, Matt Schifrin
ps. if you want to keep up to date on the Warren Buffetts Next Door, tune in to my Forbes blog http://blogs.forbes.com. If you want to see videos of the WBND check out http://mattschifrin.com

[FMF]

Matt --

Thanks for dropping by and sharing your thoughts.

We've discussed this issue before on this blog -- whether time/education is enough for someone to become a great investor. The general concensus is that it is not -- that there are also personal characteristics (I believe you note "sticking to a strategy" as one -- versus being swayed by emotions -- something many people can not do) that factor in. Taking a step back, many here believe that even with the time, education, and talent required that success is not guaranteed.

So the main issues being discussed are:

1. The fact that "anyone can do it". Really? ANYONE can do it? (If they put in the time.) That might be a great way to market a book, but it seems unrealistic.

2. The support for #1 is 10 people who have been great investors. The book hinges on the premise that because these 10 did it then anyone can. What would serve you better would be to do some sort of quantitative market research (like The Millionaire Next Door did) that would prove or disprove your hypothesis.

Like I said above, I found your book enjoyable. It was a pleasant read. I just don't think the idea of "they did it so you can do" comes from it.

[trev]

A bit harsh on the reviews, looks interesting, and the author took time to comment here. I see it on Amazon for $16, heck I've bought plenty of golf or other magazines for $8 each and don't expect the world. Maybe a few ideas to pickup on in there, ps no I don't know the author lol,

[Paul]

I am almost done reading this book now, and I'm really enjoying it. Its inspirational to see ordinary people put in the effort and have success investing their own money. I know the results aren't typical, but I do find it inspirational.