Be fearful when others are greedy, and be greedy when others are fearful

Warren Buffett has oft been quoted as saying: “Be fearful when others are greedy, and be greedy when others are fearful.”

In his annual letter for Year 2006 to Berkshire Hathaway shareholders on Feb 28, 2007, Mr Buffett said in a comment on super-cat (super-catastrophy) insurance: “…Rates have recently fallen because a flood of capital has entered the super-cat field. We have therefore sharply reduced our wind exposures.”

But to make clear his stand, Mr Buffett said: “Don’t think, however, that we have lost our taste for risk. We remain prepared to lose $6 billion in a single event, if we had been paid appropriately for assuming that risk. We are not willing, though, to take on even very small exposures at prices that don’t reflect our evaluation of loss probabilities. Appropriate prices don’t guarantee profits in any given year, but inappropriate prices most certainly guarantee eventual losses.”

Explaining why Berkshire Hathaway had then sharply reduced its wind exposures, Mr Buffett said: “Our behavior here parallels that which we employ in financial markets: Be fearful when others are greedy, and be greedy when others are fearful.”

Another occasion when he used the “greedy” quote was in his letter (February 28, 2005) for Year 2004 when, among other things, he said: “Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.”

Explaining the three primary causes, Mr Buffett said: “…first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

This “Be fearful when others are greedy, and be greedy when others are fearful” investment philosophy could be a factor explaining Berkshire Hathaway’s  third-quarter investment in 2011.

A Bloomberg report (Buffett Broadens Portfolio by Spending $23.9 Billion in Quarter) dated Nov 7, 2011, said that Warren Buffett’s Berkshire Hathaway Inc invested US$23.9 billion in the third-quarter, the most in at least 15 years, as he accelerated stock purchases and broadened the portfolio beyond consumer and financial-company holdings.

“Buffett, 81, drew down Berkshire’s cash as Europe’s debt crisis and Standard & Poor’s downgrade of the US pushed stocks to their worst quarterly performance since 2008. The investments disclosed Nov 4 include $6.9 billion of equities, $5 billion for preferred shares and warrants in Bank of America Corp and the acquisition of Lubrizol Corp for about $9 billion,” the report said.

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013