More Praise for The Warren Buffett Way, First Edition

It works to reduce transaction costs.
This is one of those com-
monsense dynamics that is so obvious it is easily overlooked.
Every time you buy or sell, you trigger brokerage costs that
lower your net returns.
2.
It increases aftertax returns.
When you sell a stock at a prof it,
you will be hit with capital gain taxes, eating into your prof it.
The solution: Leave it be. If you leave the gain in place (this is
referred to as unrealized gain), your money compounds more
forcefully. Overall, investors have too often underestimated the
enormous value of this unrealized gain—what Buffett calls an
“interest-free loan from the Treasury.”
To make his point, Buffett asks us to imagine what happens if you
buy a $1 investment that doubles in price each year. If you sell the in-
vestment at the end of the f irst year, you would have a net gain of $.66
(assuming you’re in the 34 percent tax bracket). Now you reinvest the
$1.66, and it doubles in value by year-end. If the investment continues
to double each year, and you continue to sell, pay the tax, and reinvest
the proceeds, at the end of twenty years you would have a net gain of
$25,200 after paying taxes of $13,000. If, on the other hand, you pur-
chased a $1 investment that doubled each year and 
never
sold it until the
end of twenty years, you would gain $692,000 after paying taxes of ap-
proximately $356,000.
The best strategy for achieving high aftertax returns is to keep your
average portfolio turnover ratio somewhere between 0 and 20 percent.
Two strategies lend themselves best to low turnover rates. One is to
stick with an index mutual fund; they are low turnover by def inition.
Those who prefer a more active style of investing will turn to the sec-
ond strategy: a focus portfolio.
T H E C H A L L E N G E O F F O C U S I N V E S T I N G
My goal so far has been to lay out the argument for adopting the focus
investing approach that Warren Buffett uses with such great success. I
would be doing you less than full service if I did not also make it plain
that an unavoidable consequence of this approach is heightened volatil-
ity. When your portfolio is focused on just a few companies, a price

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M a n a g i n g Yo u r P o r t f o l i o
1 7 5
change in any one of them is all the more noticeable and has greater
overall impact.
The ability to withstand that volatility without undue second-
guessing is crucial to your peace of mind, and ultimately to your
f inancial success. Coming to terms with it is largely a matter of un-
derstanding the emotional side effects of investing, which is the topic
of Chapter 11.
Money matters are about the most emotional issues of all, and that
will never change. But at the same time, you need not be constantly at
the mercy of those emotions, to the point that sensible action is handi-
capped. The key is to keep your emotions in appropriate perspective,
and that is much easier if you understand something of the basic psy-
chology involved.
T H E C H A L L E N G E O F S U C C E S S
Warren Buffett’s challenge is not psychology; he understands the emo-
tional side of investing as well as anyone and better than most. His chal-
lenge is maintaining the level of returns that others have come to expect
from him. Two factors are involved: First, in very recent years, Buffett
hasn’t found very many stocks that meet his price criteria. That’s a prob-
lem of the market. Second, when you’re driving a $100 billion company,
it takes a significant level of economic return to move the needle. That’s
a problem of size.
Buffett explains it this way: “Some years back, a good $10 million
idea could do wonders for us. Today, the combination of