I want to make another distinction between investing in things like horses real

I want to make another distinction between investing

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I want to make another distinction between investing in things like
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horses, real estate, and art versus investing in businesses. The former have no real “floor” to their price. Their value is based on nothing more than fashion, history, and the greater-fool theory. (The greater-fool theory is the basis of all investment price bubbles: that a greater fool will come along who will pay more for this thing than you paid.) Therefore, it’s difficult to determine the value. A Picasso might sell for $20 million one year and $10 million the next. Which was the true value? Who knows? Businesses, on the other hand, have real value based on future cash. We’ll talk about that more in a later chapter as well. The point here is this: You don’t know exactly when you’ll make money, because you have to wait for the price to come up to the value. But because it’s a business that produces cash, it inevitably will someday. So that’s pretty cool, huh? But it raises an important issue: How long might it take before the price gets back to the value? What good is “someday” if we can’t cash out when we need to? Well, here’s where my 10–10 Rule comes into play: We don’t buy a business for even ten minutes unless we are willing to own it for the next ten years. We do the 10–10 Rule for two reasons: 1. It forces us to think long-term. 2. We may be in such a bad stock market that we actually don’t expect to see the price come back up to the value for ten years, and we want to be totally okay with that. This puts quite a strong requirement on us that we know our businesses the way Melissa knows horses. You’ll learn what to look for in Chapter 3 . In the meantime, in case all this is scaring you, just remember: I’ve done valuations with both businesses and horses, and businesses are a lot easier. When you find a business with the price lower than the value, you can’t lose if you don’t have to sell. That’s just for openers. But it gets way better than that. The Secret to Riches Is Compounding Returns by Stockpiling If you know the value of the business and you’re intending to keep investing your money, then the more the price goes down, the better it is
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for you. If you keep buying as the price goes down, the average cost of your investment per share goes down, too. When the price goes back up to the value, stockpiling the stock at ever lower prices will massively increase your overall return. Stockpiling accelerates your compounded return. According to Albert Einstein, one of the hardest things in the universe to understand is the power of compounding returns. So don’t feel bad if the fact that you can become a millionaire simply by buying something as its price goes down doesn’t seem to make sense. I told you before that stockpiling is not intuitive. It’s easy and it’s intensely rational but it’s not something that just leaps out at you with a big YES. So let’s take this compounding thing slowly.
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  • Spring '20
  • Warren Buffett

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