At HDI, we are always talking about The Income Method. It is an investing strategy focused on creating and growing an income stream for a portfolio. In doing research for this week's Market Outlook, I ended up looking into 2014, and I read Warren Buffett's annual letter. A thousand Warren Buffett quotes float around investing sites, but often, the things he says don't make it to a meme are the most insightful.
In his 2013 Letter to Shareholders, Warren Buffett compared a farm he bought to stocks:
After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state – how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.
His point is that investors shouldn't be wrapped up in the short-term volatility in the market. Just because the price changes every day doesn't change Buffett's investment. He buys businesses that he believes are good at an attractive price. Knowing that he will reap the rewards in the long-term, even if the price movement isn't favorable in the near term. Even when a particular investment doesn't work out, he knows that overall the majority of them will, and the gains from the winners will be much larger than the losses of the losers. What his neighbor's opinion of value at any given moment doesn't matter. The price your neighbor is willing to pay for your farm doesn't change how much food it yields.
This is the ideal mentality for investing. It is shared by many of the all-time greats. You don't see billionaires day trading, jumping in and out of stocks based on temporary price changes.
We all know I can't pass up a good farming reference, and I often think of my portfolio in terms of a cash farm. I invest in dividend stocks, the plants that will produce my dividends. Every year, I take a portion of my crop and reinvest it, planting new seeds for the future, just like a farmer setting some corn kernels aside to replant next year. And ultimately, the number I keep my eye on is not what my neighbor is willing to pay me for my farm - the family farm is NOT for sale - what matters is what my farm is producing.
People scoff when I say it doesn't matter to me whether my portfolio's price was up 20% or down 20% in a given year. What matters to me is whether my portfolio produced more or less income than it did last year. I know that as long as my portfolio is producing more, then the price my neighbor is shouting at me every morning will increase on average too.
When you reach the point where you are truly focused on the income, you will find that your emotional reactions to the market are much more controlled. Your decisions will be better and in the long run, you will be more successful.
I was researching 2014 because I see some similarities between 2014 and 2022 from a psychological standpoint. Many investors are starting to feel that the bull market is reaching a top, that the recovery is over, and they think they are being smart by sitting on large amounts of cash. Instead of relying on their farm to produce tasty results, they sold when their neighbor shouted and are now sitting in cash, hoping that the price of farms will come down. Thanks to these investors, we have an opportunity to continue building our income by opportunistically buying undervalued equities.