How to Become a Billionaire by Being “Approximately Right”
Have you ever confidently stated something you were absolutely sure of… that turned out to be flat-out wrong?
As I’ve gotten older, I’ve had more and more opportunities to look back on the things I was “absolutely sure of” as a youth—things that I later (hours or years) discovered were actually false.
A Lesson in Arrogance
Like the evening I gathered about 18 friends in my living room to tell them about my exciting new business venture. (Yes, I was trying to recruit them to help. And no, it wasn’t multi-level.)
I stood up with a confident smile, raising my right index finger to the ceiling, and said, “My friends, this cannot fail.”
I had a mountain of data to prove my idea would work. And I was, well, a little arrogant. (OK, not a little.)
Eighteen months later I shut down that business after only making a handful of sales and losing a whole lot of precious time—and one friendship. My business partner with eight kids had even quit a good job to launch this. (Thankfully, we’re still good friends.)
There are plenty of “bulletproof” business opportunities that result in nothing more than bullet holes. Most successful entrepreneurs and investors have survived a bout with over-confidence at least a time or two in the past.
We all make decisions with our gut (a technical term for our “wanters”). Then we consult our analytical center for the data (the reasons we tell our spouse). So whether we really utilize it or not, we believe that detailed data is useful for our process.
Sometimes, the bigger the decision, the more data we gather, analyze, and ponder to back up our initial decision. And we think that more in-depth data lends more valid proof to our argument.
Learning From Warren Buffet
I’ve shared that I’m remotely mentoring under Warren Buffett. Sort of. He’s never heard of me, but I’ve joined my BiggerPockets friends Bryan Taylor and John Jacobus to analyze Buffett’s investment theses to apply them to real estate. You’ll only get this analysis on BiggerPockets, so if you love real estate and want to learn from the world’s greatest investor, you’re in the right place.
So, does Mr. Buffett have anything to say about our obsession with data and precision and our desire for endless analysis? Why of course he does.
From Buffett’s 1993 annual letter to shareholders:
“Academics, however, like to define investment ‘risk’ differently, averring that it is the relative volatility of a stock or portfolio of stocks — that is, their volatility as compared to that of a large universe of stocks. Employing databases and statistical skills, these academics compute with precision the ‘beta’ of a stock — its relative volatility in the past — and then build arcane investment and capital-allocation theories around this calculation. In their hunger for a single statistic to measure risk, however, they forget a fundamental principle: It is better to be approximately right than precisely wrong.”
“For owners of a business — and that’s the way we think of shareholders — the academics’ definition of risk is far off the mark, so much so that it produces absurdities.”
And from a 2012 interview with Charlie Rose:
“I only get into situations where I know the value. There are thousands of companies whose value I don’t know. But I know the ones that I know. And incidentally, you don’t pinpoint things. If somebody walks in this door and they weigh between 300 and 350 pounds, I don’t need to say they weigh 327 to say that they’re fat.”
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What Does Buffett Mean?
Warren Buffett recommends that investors discover the one or two critical items in an investment that make all the difference. Then, focus on those items relentlessly. Understand them thoroughly and do not compromise on them.
“It’s better to be approximately right than precisely wrong.” There’s no need to spend all your time and effort on every detailed aspect of an investment. Focus on the one or two critical items of importance and get them right.
A Personal Example
I received my undergraduate degree in petroleum engineering. One summer, I interned for an oil company in the lovely city of Denver. I ran detailed projections to calculate the amount and value of oil we could produce in a particular Rocky Mountain oilfield.
These calculations were based on one assumption piled on top of another. When I was done, I believed the calculation was no more accurate than throwing a dart against a dartboard in the dark dead of night.
I shared my frustrations with my boss, but he encouraged me to keep going. He asked me to put it all together for my big presentation to the vice president of the company.
Then he wanted me to carry out my calculations to another decimal point or two.
I did it. But I was disgusted inside. My assumptions and guesses caused my calculations to be questionable by a factor of 100 times or more. But hey, the presentation looked great—right down to the hundredth decimal place.
My heart sank as I realized that my summer of hard work wasn’t worth the transparency plastic I presented it on. And I felt sick knowing that the company could spend a fortune acting on my data. I was glad to get out of town and back to college.
How Does This Buffet Nugget Apply to Real Estate?
Do you do this with your real estate calculations? Do you project IRR, ROI, and breakeven occupancy twenty years from now out to the tenths or hundredths? Why do you do this when it is based on so many assumptions about the future?
“It’s better to be approximately right than precisely wrong.”
This is not an excuse to avoid detailed underwriting. Rather, I’m saying to use your underwriting to inform the one or two key items about a real estate investment that will allow you to make a shrewd decision.
In real estate, the key items that make the difference are often things like purchase price, location, your business partners/vendors, and the economics of the local area. Get these things right and often the rest will follow to create a successful investment.
What Are Your Main Investment Drivers?
I’ve shared this often: My firm believes that the location plus the choice of a professional property manager drive about two-thirds of the success of our multifamily real estate acquisitions.
The locations we are seeking have:
- Positive net population migration
- Low unemployment
- A diverse and growing economy
- Affordable rents compared with home prices
- Low crime, average schools, and average incomes over 3 times our projected rents
The property management firm we’re seeking:
- Doesn’t own competing properties
- Has a regional or national presence with upward mobility for employees
- Uses top tier property management software
- Has strict policies and accountability they enforce at all multifamily assets
- Integrates well with our Apartment Life (or similar) programs to care for our tenants
As a multifamily syndicator, author, and BiggerPockets blogger, I talk to a lot of people each week. I’ve spoken with more than one or two people with analysis paralysis. I hope that’s not you.
Could taking Buffett’s advice to relentlessly pursue being right about a few critical things cure you of analysis paralysis forever?
What about you? What are your critical success factors? How do you approach them?