The punch card strategy, which Warren Buffett (Trades, Portfolio) has highlighted several times throughout his career when giving general investing advice, recommends investors to concentrate their investments on a limited number of well-known, high-quality businesses. During a talk at Georgetown University on Sept. 19, 2013, Buffett described this approach as follows:
“You only have an opinion on a few things. In fact, I've told students if when they got out of school, they got a punch card with 20 punches on it, and that's all the investment decisions they got to make in their entire life, they would get very rich because they would think very hard about each one."
Quite simply, with a 20 slot punch card, every time you make an investment, you punch one of the holes. According to Buffett, you don't need 20 right decisions to get very rich. Four or five will probably do it over time. The punch card helps you focus on this principle.
Invest as if you had only 20 investing possibilities in your lifetime
Fundamentally, the punch card approach means that you should approach your investing career as though you were holding a single ticket with 20 slots for each time you decide to make an investment. This strategy is based on the notion that picking too many businesses to invest in might result in diluted rewards and a lack of concentration.
In the HBO film "Becoming Warren Buffett (Trades, Portfolio)," the billionaire also draws parallels between his investment approach and the nation's pastime by quoting Ted Williams' book "The Science of Hitting," in which the All-Star hitter stressed the significance of understanding your sweet spot. You do not have to swing at every pitch, according to Buffett:
“The key to investing is to just wait for the pitch that is exactly in your sweet spot while you sit and watch pitch after pitch pass by. Also, disregard anyone shouting, 'Swing, you bum!'"
In order for the punch card approach to work, you have to invest for the long run
The punch card strategy involves more than just making investments in a select few businesses. It also involves keeping such investments for the long run. Buffett frequently cites "forever" as his preferred holding duration. He thinks that making investments in reputable businesses and holding onto them over the long haul may provide more impressive profits.
The key to this technique is to concentrate your investments on a small number of reputable, high-caliber businesses that you have done a lot of research on and are confident you understand. Investors may achieve significant returns by sticking to these investments for a long time while resisting the urge to trade regularly.
Maximize outcomes by simplifying life and investing
By restricting the number of investments that you may make throughout the course of your investing career, in Buffett's opinion, the chances of financial success can be enhanced because you won't make hasty, poorly-considered investments. Diversification is nice to limit risk, but you shouldn't need to limit risk if you're not investing in stocks you are unsure about.
The punch card method has the benefit of preventing investors from succumbing to the urge to trade excessively. Too much trading will increase your overall transaction costs and could encourage irrational decision-making. Therefore, investors should resist the urge to trade often and concentrate on producing long-term profits by making a modest number of long-term investments in high-quality companies.
The approach also assists investors in avoiding the pitfall of trying to make predictions about the future. Buffett frequently asserts that he does not attempt to forecast the direction of the stock market or the economy. Instead, he concentrates on businesses that have long-term potential and can remain steady throughout any market conditions.
Mitigate the risk of missing good opportunities
The largest danger involved with the punch card method is that investors might pass up chances in promising businesses or sectors due to fear of meeting their punch quarter quota too early. Investors that focus on a limited number of businesses might risk missing out on chances due to overthinking things.
In order to identify great companies and avoid the pitfall of missing out on them due to fear, Charlie Munger (Trades, Portfolio) stated at the 1988 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual meeting:
“I’ve heard Warren say since very early in his life that the difference between a good business and a bad business is usually the good business just throws up one easy decision after another, whereas the bad business gives you a horrible choice where the decision is hard to make and, is this really going to work? And is it worth the money?
If you want a system for determining which is a good business and which is a bad business, just see which one is throwing the management bloopers time after time after time.
Easy decisions. It’s not very hard for us to decide to open a new See’s store in a new shopping center in California that’s obviously going to succeed. It’s a blooper.
On the other hand, there are plenty of businesses where the decisions that come across your desk are just awful. And those businesses, by and large, don’t work very well.”
