The investment management industry loves its legends and there is none bigger than the nonagenarian ‘Oracle of Omaha’ Warren Buffett, CEO of the US-listed firm Berkshire Hathaway. Over the years in that role Buffett has built a portfolio of directly held companies alongside a portfolio of listed stocks. Today, he is worth over US$100 billion and is the world’s fifth wealthiest person. In anyone’s eyes, he is a highly successful investor and is often held up as a beacon in support of an active, judgmental approach to investing.
Paradoxically, Warren Buffett’s legendary status as an active investor provides some useful lessons in support of adopting a systematic, low-cost approach to investing
Lesson 1: believe in the power of capitalism and compounding over time
Buffet understands capitalism and the powerful wealth generation that it can bring. He started investing in 1941 when he was 11 years old, and now at 92 years old, has over 80 years of compounding returns from the predominantly US companies he has owned. By the age of 39 he was worth US$25 million. His life story is fascinating.
‘The genius of the American economy, our emphasis on a meritocracy and a market system and a rule of law has enabled generation after generation to live better than their parents did.’
Lesson 2: patience and emotional fortitude are key
Buffett expects to hold the companies for the long-term, much like an index fund.
‘Our favourite holding period is forever.’
He strives to avoid making decisions driven by emotions in response to short-term market pressures, such as the poor relative performance of value stocks from 2018-20 or equity market falls.
‘The most important quality for an investor is temperament, not intellect.’
Lesson 3: active management is not easy
Despite his incredible business acumen, and consequent track record, it is not easy to continue to beat the market over time. He has always been a value oriented investor and was notorious in the run up to the tech crash of 2000-3, stating that he did not get it. He was to some extent proved right. As Berkshire has grown, finding deals that will make a material difference to performance has become harder. His early years were spent trawling for individual investment opportunities. In those post-war years, information was scarce, professional investors represented a far lower part of the investor base, and markets were probably less efficient. If he was starting out again, would he be as successful? Who knows? And there’s the rub.
Take a look at the chart below, which illustrates 20-year rolling windows of Berkshire’s performance relative to a US equity index fund. It is evident that the huge success of the early days, has given way to far more trying times. Over the past 20 years, you could have achieved virtually the same return by investing in an S&P 500 index fund.
Whilst these types of study imply a binary approach to being invested in equities or cash, which is a somewhat unreal scenario, it is evident that a few good days, weeks or months drive the bulk of market returns and missing them can be costly. Missing the best 30 days in this 30-year period deliver only 17% of the rewards that the market delivered.
Likewise missing the worst 30 days would be highly beneficial, yet the ability to pick them does not seem to show up in the data. The October 2022 Liz Truss/Kwasi Kwarteng ‘mini-budget’ in the UK provided evidence of just how quickly new information can impact markets, in that case the bond market. Being right is quite a challenge. Being wrong can be very costly. The odds of success in market timing are slim.
A seminal piece of UK research (Cuthbertson et al., 2006) concluded that only around 1.5 % of UK equity funds demonstrate positive market timing ability.
‘An [investor] who keeps assets in stocks at all times is like an optimistic market timer. His actions are consistent with a policy of predicting a good year every year. While such a manager may know that such predictions will be wrong roughly one year out of three, such an attitude is nonetheless likely to lead to results superior to those achieved by most active market timers.’
Lesson 4: you need an investment approach for your lifetime
Warren Buffett may be a legend, but he is not immortal. At 92, Warren Buffett’s reign at Berkshire is in a late innings. Will his successor be able to deliver market beating returns? What impact will Berkshire’s concentrated, sector-skewed and US centric portfolio of companies have on performance? Will it miss out on some of the - as yet unknown - global winners of the future? You can simply avoid this dilemma by owning a well-diversified index fund. Buffett agrees.
‘The goal of the nonprofessional should not be to pick winners – neither he nor his 'helpers' can do that – but should rather be to own a cross section of businesses that in aggregate are bound to do well.’ ‘Consistently buy an S&P 500 low-cost index fund. I think it's the thing that makes the most sense practically all of the time.’
Lesson 5: humility and using wealth well
His legendary status also relates to his humility as a person and his humble lifestyle. No superyachts, private jets, multiple homes and international staff for him. He lives in the same house he bought in 1958 in Nebraska, eats McDonald’s burgers, sucks on See’s Candies and famously drinks Coke. He intends to give away all of his wealth when he dies, of which 85% will be passed to the Bill and Melinda Gates Foundation. He explained:
‘I don't have a use for the money. It just makes you feel good to do it.’
Perhaps that is his greatest lesson of all.
