Buffet Masterclass (Using reason): 3 – Learning from mistakes

Buffett's attitude to error is among the most important aspects of his teaching. Expect to make mistakes sometimes and, if they occur, analyze the reason for them. Use the analysis to avoid the worse mistake: doing it again.

Accepting error

True rationality accepts that mistakes will happen, and it is deeply irrational to suppose that you have been, ever will be, or ever can be without fault. Every time you buy a share, for example, you make a mistake; there is always another investment that will perform better than your choice. Buffett's avoidance of high technology stocks, for instance, sounds reasonable because it is rational to invest only in businesses that you understand. But, ironically, Berkshire Hathaway's amazing record would actually have been better if Buffet had invested in Microsoft, and nothing else.

Analyzing your mistakes

The irrational response to error is to try to rewrite history; "if only I had..." is a familiar cry - instead of being defeatist, analyze your mistakes. Once you have established the reasons why something has gone wrong, it is relatively easy to make sure you do not repeat the mistakes. Ask yourself the following seven questions:

* Did I lack adequate information about the present?

* Did I make an inaccurate prediction?

* Is this a mistake I have made before?

* Did I ignore logical lessons that I already knew?

* Does what happened teach me a new lesson?

* Did I do the wrong thing?

* Did I do the right thing in the wrong way?

Buffett's mistaken sale of shares in McDonald's in 1998, for example, was based on an inaccurate reading of the company's poor US sales figures, from which he predicted, possibly incorrectly, that its growth prospects had fallen below his requirements. Such mistakes have been rare in Berkshire's history because of Buffett's logical insistence on keeping shares indefinitely, knowing that bad short-term patches do not invalidate good long-term analysis.

Stick to your principles

In other words, Buffett ignored his own teaching. The advice given by Polonius to Laertes in Hamlet is particularly sound: "To thine own self be true."

Many mistakes flow from aberrations that override this principle. The aberrations often stem from following conventional wisdom rather than your own (or, indeed, Buffett's). As an investor, have the courage to obey at all times the five rational principles expounded by Buffett:

Analyzing your successes

You can learn from your successes as well as your failures. Subject them to the same scrutiny as your mistakes, and learn from them. People tend to pride themselves on their success and take it as proof of their brilliance. But success is often accompanied by serious mistakes that might have proved fatal. Ask yourself:

* Did you succeed in spite of your ignorance about the present and the future?

* Did success flow from repeating previous experience, or breaking into new ground?

* Did you do the right thing in the wrong way, but succeed because the thing was so right that your mistakes did not affect the outcome?

Reason is a hard master, but one whose lessons, like Buffett's, always repay intelligent obedience.