Why Warren Buffett Stopped Investing the 'Warren Buffett Way'

The Oracle of Omaha got out of personal investing as fast as he could. Follow this logic and you could become a supreme success too.

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Warren Buffett and Alice Schroeder, author of The Snowball.

 

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It's hard to believe that so many personal investors swear by Warren Buffett's stock-picking methods. Why? Because when you look back at Buffett's early career, none of his best and biggest moves required placing stock market bets with his own money.

The secret to Warren Buffett's wealth is that he works like an entrepreneur. Sure, he uses the principles of value-investing to identify companies to invest in. But then he extracts wealth from those companies by pulling off entrepreneurial deals and executing on complex boardroom strategies.

If Buffett were a little more forthcoming, he just might cite the following reasons why you should stop trying to get rich by value investing your own money:

1. You don't have enough capital.

When Buffett was in his mid-20s, he tried investing his own money and found it incredibly frustrating. He'd invest all his holdings in stocks he'd identified through Benjamin Graham's buy-low-sell-high value-investing philosophies. But once those under-the-radar stocks started picking up steam, Buffett would discover some other undervalued stock that was much more promising. With his cash all tied up, he continually faced the miserable choice of either selling one stock before its value had peaked or letting a great opportunity pass by. Buffett came to realize he'd never get anywhere this way, and he reluctantly raised money from other people through investment partnerships so he could get his hands on more capital. In a sense, Buffett didn't start getting rich until he quit doing what most personal investors now regard as "investing the Warren Buffett way"!

2. You're risking what little capital you have.

Buffett was kind of a shy guy, and he didn't like the process of fundraising required to get his hands on other people's money. But he also recognized that other people's money would enable him to play a game called "heads I win, tails I don't lose." Under the rules of his early investment partnerships, Buffett enjoyed a big percentage of the gains if his stock-picking was good, and very limited losses if his stock-picking was bad. When people ask Buffett about his worst investment, he always points to his very first at age 21. It was a "heads-I-win-tails-I-lose" deal in which he lost everything on a failed gas station. Warren Buffett hasn't used his own money to go "all-in" on a deal since.

3. You don't need money to make money. You need people.

In some of his early investment partnerships, Buffett didn't just make clever bets on undervalued stocks and then wait for those stocks to appreciate. Instead, he pulled off boardroom maneuvers that often benefited his partnership at the expense of individual stockholders. Buffett organized alliances of other big investors who would follow his lead when he demanded that management take steps to raise the stock price. Sometimes management would buy out Buffett's alliances instead, helping make Buffett and his partners rich, but leaving all the little individual value-investors out in the cold. Buffett relied on his "know-how" to identify opportunities, but it was his "know-who" that made him rich.

All these details are plain to see in both of the definitive Buffett biographies: Alice Schroeder’s The Snowball, and Roger Lowenstein's Buffett. So why do so many personal investors remain under the spell of the mythical "Warren Buffett Way"?

The survey research I did for Business Brilliant, my new book, offers a clue. About 90 percent of people surveyed simply believe that it's necessary to put your own capital at risk in order to be successful, while fewer than 20 percent believe that it's necessary to get others to invest with you. Meanwhile, people who know better, those who've already become extremely successful, believe the opposite. Among this group, just 40 percent think you should only invest your own capital in order to succeed financially. And about 6 in 10 say it's important to get others to invest with you.

Successful entrepreneurs are more familiar with the real Warren Buffett because most of them have succeeded the real Warren Buffett Way, with more "know-who," than "know-how.