Warren Buffett's Secret Sauce

By John F. Wasik

Warren Buffett knows more about investing than a room full of celebrity chefs know about cooking. But he has secret sauce that has worked for him over the course of a half century that he’s not entirely sharing.

In a recent Fortune blog, the oracle of Omaha shared some of his advice on long-term investing. He bought a farm and some real estate near New York University and held onto them. Surprise! They rose in value.

 

Yet what Buffett rarely acknowledges these days is a prime source for his long-term strategy: John Maynard Keynes.

Yet when I asked him (through his assistant) how Keynes influenced his investment philosophy when I was researching my book Keynes’s Way to Wealth, Buffett’s reply was that Keynes had no influence on his strategy. This surprised me, since Buffett has quoted Keynes over the years and told people to read Keynes to get a grounding in fundamental investing. He said this in an interview with Business Wire (which is owned by his company Berkshire Hathaway):

“Mr. Buffett said if you understand chapters 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of the General Theory (John Maynard Keynes, 1936) ‘you don’t need to read anything else and you can turn off your TV.’”

And Buffett said in 1991 that Keynes was a man “whose brilliance as a practicing investor matched his brilliance in thought.”

The Graham-Keynes-Buffett Connection

Buffett’s reference to Graham’s book, originally published in 1949, is understandable since Graham was Buffett’s mentor and was a giant in investment methodology and the “value school” of investing, which Buffett has championed his entire career.

But where does Keynes fit into the Buffett worldview? Although Buffett has not acknowledged as much in recent years, Keynes’s prosaic chapter 12 in his otherwise turgid 1936 “General Theory” must have made a significant impression.

Keynes may have been the original value investor who realized in the late 1920s that chasing the market with grandiose theories was a fool’s errand. Like Graham, Keynes lost a fortune in the crash of 1929 after losing a smaller sum in 1920 while speculating on European currencies. Yet Keynes learned his lesson and changed his thinking at a time when most investors thought holding stocks was like throwing a match in a gasoline can.

Here’s Keynes, in a letter to insurance executive F.C. Scott in 1934:

“As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence… One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.”

Here’s Buffett from his Fortune blog:

 

“You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick `no…’ Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”

Keynes again on making long-term investments (from 1934):

“Investing is an activity of forecasting the yield over the life of the asset; speculation is the activity of forecasting the psychology of the market.”

Buffett from his blog:

“If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so.”

Whatever source is moving Buffett, as you can see, the intellectual groundwork had been laid by Keynes — and Graham. It’s not known if Graham connected with Keynes during the time that both investment savants developed their value investing theories.

I tried to find correspondence between Keynes and Graham when I was researching my Keynes book at Cambridge University. I didn’t find anything, although that doesn’t mean that they didn’t know of each other’s activities.

Keynes was a celebrity during the 1920s and 1930s. His talks on investing were well attended during the time he managed The King’s College/Cambridge fund, two insurance company portfolios and money for himself and famous Bloomsbury Group friends.

 

Although his fame as an economist is global, Keynes’s stunning success as a professional investor is not well known, even among economists.

When I asked Prof. Paul Krugman after a Chicago talk last year if he was familiar with Keynes’s investment record, he replied that he wasn’t familiar with that part of his life. And this coming from a Nobel Prize winner who is one of the world’s leading Keynesians!

Utlimately, it doesn’t matter who takes the credit for long-term investing principles that build wealth without churning your stomach at every market turn.

If you seek long-term value in businesses that will be around in every market cycle, generate cash and dividends, you will probably make money. The key to success is not only holding onto those stocks through thick and thin, but holding onto the idea of selecting those investments with great care.


John F. Wasik is the author of Keynes’s Way to Wealth: Timeless Investment Lessons from the Great Economist and 13 other books.  An investor protection advocate, he speaks and writes regularly on investing, economics and personal finance.