Warren Buffet's Advice

In the last post I presented Warren Buffet's often repeated advice to the average investor to invest in low cost index funds. He simplifies and recommends an index fund tracking the S&P 500.

This got me to recalling a recent post on LinkedIn about an Uber Driver who got advice from his passengers. He asks his passengers for the one message in life that they would suggest and then he asks them to write it down for him. He then says he plans to publish the "life suggestions" in a book.

Well, as you might imagine this got a terrific response with many people stating they couldn't wait to read the book! Many responders thought this a novel idea.

To be clear I am all for sharing life living advice especially from those with the experience  of decades manuevering  the pitfalls of the free market capitalistic  hyper-charged consumer driven U.S. economy.

Circling back it is interesting to recall Buffet's advice. After all, this is the advice from the premier investor of our age and has embedded in it the key to a successful retirement for the last 25 to 35 years of our life! You would think that every high school in the country would present this as worthy of consideration for young people. Good luck finding it in a single economics curriculum.

But, given Buffet's investment prowess, why wouldn't better advice be to invest in his company? Well, let's take a look at his record:

                                   YTD     1-yr     5-yr     10-yr     15-yr     20yr
Berkshire Hathaway   4.1%    7.9%   10.8%  13.7%    8.5%    7.7%
S&P500                     17.5%   13.1%  11.7%  15.3%    8.7%    5.9%
(reported in Barron's  from Bloomberg, 4/29/2019, p.16)

As shown he has underperformed from 15 years on in,  weighed down by the tremendous size of Berkshire Hathaway and the significant cash position he holds.

So, to me the bottom line is this: few know as well as Buffett how difficult it is for the average investor to beat the market. His advice to stick with a low cost index fund is worth heeding. That's what I would tell the Uber driver.

Inside Buffett's Brain

Here is an article that Warren Buffett fans will enjoy:

"Inside Buffett's Brain" by Pat Regnier in Money magazine,

It describes an attempt to create a formula that not just matches Warren Buffett's performance but exceeds it.

Trying to duplicate Buffett's success or at least discover his secrets has, of course, become something of a national pasttime.  Many people who become charmed by his folksy, common sense investment stories are convinced that they can do what he has done.

This reminds me of a presentation I went to many years ago at the National Press Club in Washington DC where the presenter was a money manager who had exceptional success in investing in so-called "fallen angels" - stocks that for some reason or other had fallen on difficult times and consequently had seen their stock price drop significantly.  I watched as the crowd nodded in response to the money manager's description of superior performance.  I watched as the crowd scribbled notes in response to his listing of things he looked for.

Finally, he got to the point where he named his fund's largest holding.  It was General Public Utilities which had gotten pounded as a result of the Three Mile Island nuclear accident.  At this point, there was a gasp and the scribbling stopped.  The crowd morphed in an instant from anticipating discovering the golden goose to understanding they weren't nearly on the same plane as a serious value investor.

According to the article, Buffett earned 19.7%/year, compared to 9.8% on the S&P 500, over the past 49 years!  Using the rule of 72, we can divide 72 by 19.7 and find that Buffett's portfolio was doubling every 3.65 years, on average!  And he did this with what most people would consider to be boring stocks--Geico, Coca Cola, American Express.

I think it is possible that, like the crowd that learned about General Public Utilities, many Buffett wanabees, formula or no formula, will be frustrated for two reasons.  First the world is different today. It is changing much, much faster because of technological advances, globalization, and general information flow making the identification of solid, basic companies that will be leading brands over a 30- to 40-year period considerably more difficult.  In today's world, products are produced with practically zero marginal cost and many times fixed costs are not that substantive.  Industries are disrupted by talented kids with computer power in the proverbial garage.  Secondly, few people in Warren Buffett's heyday had anywhere near his patience and staying power; and they are surely fewer and farther between today.

I think he knows this, and this is why he pushes index fund investing even to the point of recommending it to his heirs.

What Buffett Didn't Say

OK, so there is a buzz going around about Warren Buffett's advice in his will to the trustee on how his money should be invested.  See

The Warren Buffett Guide to Retirement Investing by Robert Berger.

Some seem to express surprise that Buffett suggests his assets be invested in a low-cost index fund.

All I can say is those who are surprised haven't been paying attention because Buffett has consistently said  over the years on numerous occasions that most investors, including those that invest for the nation's largest pension funds, should invest in low-cost well-diversified funds.

To be perfectly clear, it is worth emphasizing what he didn't say.  He didn't say that the trustee should do a meticulous search and hire a consultant to analyze investment performance and methodology of the top investment managers, including the much-touted hedge fund gurus.  He didn't say that the search should include the top stock pickers, market timers, and chartists who loudly proclaim that their analytical powers are akin to a crystal ball that clearly divines future prices better than the millions of investors setting prices today.
 
His prowess in the market has come from a deep understanding of value, unrivalled patience, and, yes, a willingness to bailout sticky situations on extreme penalty terms.  It has come from being in a position to restructure boards of companies bought to cut out the deadwood and enable value to flourish.

Again, why not find someone of the same ilk?  Along the same lines, I wondered why, when Michael Jordan came to the Washington Wizards, he didn't try to bring in someone who could take off from the foul line and dunk a basketball, hit a 25-foot jump shot with a championship on the line when all 5 players on the other team knew he was going to take the shot, and break his record 10 seasons of achieving the NBA scoring record.

Legends know how hard it is to do what they have done.

Buffett Ahead of the Hedge Funds

When I set about convincing non-investment people on the efficacy of low-cost indexed investing, I usually face a challenge.  Many of them have had a bad experience with their investments.  That's why they are talking to me.

I am up against the suits and the resources of well-heeled firms that have honed their sales pitches to the nth degree.  I'm against the hard thought-out processes of cleverly hiding fees and poor performance.  I'm against the presenters of carefully selected funds that have outperformed in the past.

It is easy for me to empathize with the 3rd runner up in some of today's presidential primaries.

But I bring heavy hitters to the plate.  These include Burton Malkiel, Dan Solin, John Bogel, Andrew Hallam, Jack Meyer, and many others.  The most powerful, though, is Warren Buffett who states that professionals even should follow the low-cost index approach.

Warren Buffett says:

Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees.  Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.

All of this, of course, is more than an academic exercise.  Many of the above mentioned people spent lifetimes studying and analyzing data on market performance before they arrived at their conclusion. Warren Buffett went a step further.

The Bet

On Jan. 1, 2008, Warren Buffett bet Protégé Partners LLC, a New York fund of hedge funds co-founded by Ted Seides and Jeffrey Tarrant, $1.0 million they couldn't pick an index of five funds that would outperform  the Standard & Poor’s 500 Index over the 10-year period ending Dec. 31, 2017.  These funds are funds of funds.

The fund of funds hedge fund pitch is interesting.  Hedge funds are for the wealthy.  To get in them, you have to put up a lot.  Everybody knows, however, that diversification is important.  Thus, you want your investment dollars to spread among several hedge funds.  Not easy unless you are ultra rich.  Enter the "fund of funds."  Now you are diversified and getting management from the best of the best - at least, that's the pitch.  All of this and you are investing like the ultra rich!  You are ready to head to the neighbor's barbecue and brag that you are invested in hedge funds.

I once listened to a pitch to a group of do-it-yourself investors that presented impressive graphs as part of a power point that showed the exceptional performance of hedge funds over the past 20 years.  I asked if Long Term Capital Management was included in the results.  The presenter didn't know - at least, that's what he said.  Long Term Capital Management was the largest hedge fund in the world - before it went broke.

As of the most recent calculation on the bet, Buffett has a return of 2.2% (using Vanguard's Admiral funds) and the hedge funds are down 4.5%.

Brad Alford, head of Alpha Capital Management LLC in Atlanta, says "hedge funds of funds have underperformed because of high fees and mediocre manager selection."  Interesting.  It seems that with $1.0 million on the line and, even more importantly, pride, that the hedge fund manager made his best picks.

The fees part of it we definitely get.

The details of the bet can be seen at http://longbets.org/ .

Bonds versus Stocks: Buffett versus Gross

The media is playing up the differing views of Buffett and Gross on stocks and bonds.  Buffett recently previewed his much-anticipated shareholder letter and called bonds "dangerous investments."  At the other end of the spectrum, Bill Gross, manager of the world's largest bond fund, at PIMCO, has recently increased exposure to Treasury issues.

Five years from now, we will look back and see that one of these icons of the investment world will be right and the other probably very wrong.  With the yield on the 10-year Treasury below 2%, the Fed and other world central banks on an inflation mission, and the yield on the S&P 500, for the first time in decades, yielding more than the 10-year Treasury, I have to side with Buffett - up to a point.

Some, in fact, like Laurence Fink, CEO of BlackRock Inc. (the world's largest investor), are pounding the table and arguing that investors should be 100% in equities.



I have to say that I believe Buffett is right but wouldn't go 100% into stocks.  I could sketch out a scenario where 10 years from now the S&P 500 is 10% lower than today (think Medicare, U.S. dysfunctional  government, Southern Europe, nutcase in Iran, etc., etc.) and the 10-year Treasury note is at 1.50%, say, where, in fact, Buffett followers would not have done well.  It is why my clients are diversified.

One comment that Fink made got a chuckle out of me.  He said he was sitting with Buffett one time and the market was falling off a cliff.  He said Buffett got up 3 times and bought stock.  This impressed him. It doesn't me.  Buffett is a multi-billionaire.  He has, for all practical purposes, unlimited capacity to take risk.  If the market fell 50% tomorrow, it would not make one bit of difference to Buffett's economic well-being.

I would suggest that  Fink sit with a couple who are 3 years into retirement, have a "nest egg" of $600,000, and are trying to generate an income from the nest egg and social security that will last.  See how often they are jumping up and down to buy stocks in a market that's falling sharply!

To me, the disagreement on the most important investment decision of all--asset allocation--by these extremely bright, successful long-term investors is the strongest argument for diversification.  Although I agree that long-term Treasuries should be avoided today, bonds in general should not.

Disclosure:  This post is for educational purposes only.  Individuals should do their own research or consult an investment professional before making investment decisions.

An Interview With An Investment Guru

Seth Klarman is a legend in a league with Warren Buffett. In this interview with Charlie Rose I found on The Biz of Life site, he first talks about his non-profit organization and then gets into his investment approach.

No matter what style an investor chooses, it is always valuable, I think, to listen to those who have mastered the game. He notes that it takes a certain, rare gene to invest in line with the Benjamin Graham style. He talks about his book Margin of Safety. He lists the 3 stages of investing followed by Buffett. Interestingly, he humbly claims that he is only good at the first: "buying cigar butts at good prices."



You can follow Seth Klarman and his holdings as derived from 13f filings at guru focus.

As shown,CLICK IMAGE TO ENLARGE, he takes some big positions.

As readers of this blog know, I believe investors should index at least 80% of their retirement assets and invest at most 20% in individual stocks. I would also argue that one should be careful following the top hedge fund managers. You may find you don't have that "special gene" at exactly the wrong time ;)

Disclosure: This post is for educational purposes only. Investors should do their own research before investing. I may hold stocks mentioned in this post.

Jury Duty, Investing, and Warren Buffett

At some point in a jury trial, you get to credentials.  In the jury trial I was on, a "first responder" was getting equipment off a firetruck in a cordoned-off area when he was sideswiped by an elderly lady whose car had somehow made it into the area.  He rolled down an embankment and damaged his knee.

I was hoping the trial would go into analyzing how the lady got her car into the area, but instead it veered off into discussing the problem knee.

With a damaged knee, the defendant couldn't do his second job - roofing.  After some background in what roofers go through, we took a much-needed break.  Next, they brought the credentialed experts in - in this case, the knee specialists.  As Warner Wolf used to say, "Let's go to the tape!"

Both sides took 20 minutes to present the credentials of their experts.  They have gone to prestigious schools, written the most widely-used text books on knee surgeries and reconstruction, invented a knee brace or two, and performed one zillion surgeries.  They have been on Presidential Commissions and one even performed knee surgery on the moon, if I remember correctly.  After a while, it all started to blend together.

All of this, and time to be a professional expert witness!  You can't help but be impressed.

The testimony on each side took 20 seconds.  "I examined the x-rays and with this knee injury the defendant can do/can't do roofing."  

When you think about it, though, expert witness is many times the best.  Especially when it comes uncompensated.  Many people understand that this isn't the case in the world of financial services.

In this world, it is easy to impress with colored graphs and fancy promotional materials.  It is not uncommon to find prospective clients overwhelmed by bulky analysis and jargon.

This is exactly where  the best approach is to put all of that aside and ask the uncompensated expert witness.  We go to the tape and see what Warren Buffett has to say about the best way to invest:



Better yet, I like to go to a direct quote from  his 1996 annual report:

Most investors, both institutional and individual, will find that the best way to own common stocks  is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals.  

This sentence is worth parsing.  He mentions both "...institutional and individual...."  Institutional includes the large pension funds and others whom hire the best and the brightest from the nation's best business schools.  If anyone could beat the market by stock picking, timing or voodoo even, it would certainly be this group.  Yet Buffett says they, too, should use low-cost index funds.  And, they do to a surprising extent; but that is the subject of a future post. 

Should You Follow Buffett?

MoneyCone has written a must read analysis, "Following Buffett Blindly Can Be Injurious to Your Wealth,"  from the perspective of the investor who might consider jumping on the coattails of some of his deals.  Be sure to note the very apt art on the article showing a pack of "SMOKEME" cigarettes.

It is not easy for me to write objectively about Buffett's latest deal, Bank of America, because formerly I was a managing director at an investment subsidiary of theirs and saw first hand and experienced how they operate.  I have to say that I just don't understand why someone of Buffett's stature would deal with them (or Goldman Sachs for that matter) even with the outrageous terms he obtains.  I, for one, would grab my wallet and be sure to never let the likes of Hugh McColl or Ken Lewis get behind me. Dealing with their top management reminds me of Indiana Jones in the snake pit.

Many times I like to start a presentation by quoting Buffett to the effect that most investors are better off investing in low-cost index funds.  This is met with the question of why would Buffett recommend this when he invests in individual stocks?  The answer I jokingly give is that, if the questioner looks in the mirror and sees Buffett looking back, he can forget the recommendation to use index funds.  The more serious answer is that Buffett doesn't invest in individual stocks like most investors.  Even from the beginning, he visited companies and jumped right into their finances.  This morphed into an approach where he controlled companies and literally replaced the dead wood.  Today his stature enables him to rescue or semi-rescue firms by providing capital at terms that make even seasoned investors gasp.

The investment markets attract many people who are looking for an easy way to get rich.  Naturally the thought crosses their mind to follow the likes of Buffett.  In fact, there are generally a couple of shelves of books in most bookstore business sections devoted  to Buffett's investment approach.  After al,l how can you go wrong following a man with the performance record of Warren Buffett?

MoneyCone answers this question with the numbers.  His article is worth reading more than once by every DIY investor.

3 Quotes to Understand

When I give presentations, and even when I talk with potential clients, I like to start off with quotes. The reason is simple. Numbers and graphs can easily be manipulated. I learned this years ago when I picked up a copy of "How to Lie With Statistics" by Huff. Instead of the numbers, I like to start by bringing  the experienced, wise people right to the table and discussion.

Warren Buffett: "Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees.  Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Notice that he is talking about institutions as well as individuals. He is not just talking about you and me using index funds; he is also talking about the huge state pension funds like CALPERS and the state of New York fund, the large union funds, and so forth. Think about this:  these funds have staffs comprised of Harvard and Wharton Business School graduates. They are paid big bucks. And Buffett is saying that still these institutions should use index funds. And they do!

I don't know about you, but this tells me a lot.

Benjamin Graham, coauthor of Security Analysis : "If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."

The first thing that jumps out here is the "...60 years..." This is a lot of years watching the stock market. Appreciate that Security Analysis is considered a bible by value stock investors, and Graham himself was Buffett's mentor. His statement boils down to this:  if your advisor is trotting out all kinds of fancy charts and talking about getting into and out of the market on the basis of an economic forecast, he/she will not likely earn better than the market return. Graham doesn't say it, but you can take this to the bank:  they will charge you a lot for making the attempt and leave you with a smaller nest egg in the bargain.

Jack Meyer, head of Harvard University's endowment fund: "The investment business is a giant scam.  Most people think they can find fund managers who can outperform, but most people are wrong.  You should simply hold index funds. No doubt about it."

Meyer doesn't mince words. He is heading up one of the institutions Buffett was talking about. Imagine the investment managers who have made presentations about their investment approach to him over the years. Why is the business a scam? Simply, it over-promises and under-delivers.

Want to be Warren Buffett But Too Lazy?

Not that many years ago, it seemed that every kid on the basketball court wanted to be Michael Jordan. They worked hard, in their imagination, at recreating his game-winning shots. But, as many basketball coaches/motivators were fond of pointing out, not one-in-a million were willing to do what it takes to be a Michael Jordan. His work ethic in the weight room and at practices was legendary. At practice, he insisted that the best defender on the team (Scottie Pippen) be on the side that he was scrimmaging against. He always wanted to go against the best.




In the same way in the investment field, there are many who want to be the next Warren Buffett. But how many are willing to do what it takes to be a Warren Buffett? Buffett talked his way into Columbia Business School to study under the legendary Benjamin Graham. Classmates said he knew Graham and Dodd's "Security Analysis" classic better than the authors did. Question:  How many are willing to do what it takes to be Warren Buffett? How many of you know the text better than the authors?

Since I don't see any hands up, consider an easier approach - sort of the video game version, I guess, of recreating a Michael Jordan game winner.

According to Russel Kinnel, Morningstar's Director of Mutual Fund Research, as listed on page 59 in "FundSpy," the following funds  are "Buffet followers:"  the Sequoia fund (SEQUX), Fairholme Fund (FAIRX), Dreyfus Appreciation(DGAGX), Oakmark (OAKMX). Returns over the past 5 years on these funds have ranged from 3.36% to 9.08%. Interestingly, the fund with the highest turnover (71%) (I know...don't ask me how a "Buffett follower" would have a 71% turnover rate)  had the highest return.

Kinnel points out that, as many do, you can always buy Berkshire Hathaway shares.

All of this is out of my "there is more than one way to skin a cat" file. I am a proponent of low-cost index funds as the way to invest for DIY investors for at least 80% of their  retirement funds. The easiest thing in the world is to pick out past winners. As a point of fact, Buffett himself has said,

"Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Disclosure:  I hold none of the funds mentioned here and do not endorse or recommend them. The information is solely for educational purposes. Individuals should do their own research or consult an advisor before making investment decisions.

Do As I Say - Not As I Do

Warren Buffett recommends that individual investors diversify and use low-cost index funds. But that is not what he does. It's not even close. He takes big positions. Early in his career, a few positions comprised his entire invested assets for himself and his partnerships.

What gives? Actually, it's pretty simple, I believe. Few people understand the management of risk better than Warren Buffett. What he understands, and what most people don't get, is what is glibly referred to as "firm specific risk" in the investment texts. Think of it like this: when you buy a stock, you can do a lot of research by cranking the numbers, reading the reports, analyzing the competition, and even taking into account the macroeconomic environment. But, no matter how much research you do, if you are on the outside of the company, there is still a lot you don't know.

As you get ready to click "buy," the CEO and CFO could be having lunch and talking about the phone calls they got yesterday from their two biggest customers and how they were thinking of moving to a competitor. They may be discussing that internal research report that found customers were reporting a surprising increase in company product related injuries. They may be discussing the surprising announcement that the top salesman is considering a competing offer. They may be fleshing out an idea that involves selling barges to Merrill Lynch and then buying them back after the quarter ends, to get the revenue numbers Wall Street is expecting.

This is partly what "firm specific" risk is about. And, again, if you are on the outside, it can blindside you and you have no Michael Oher to protect you.

Unless, you are on the inside and at the top levels on the inside. Even the employees of Enron didn't know what was going on.

But Warren Buffett and Charlie Munger get on the inside. They get appointed to the board. They bring their own people in, if necessary, and make it their job to minimize firm specific risk. They get to know the key people in the companies in which they invest.

Thus, his admonition to diversify is appropriate, despite his approach, because he realizes the firm specific risk the typical investor faces in buying individual companies. If you must buy individual companies, limit your buy in a single name to 5% of total assets. That's my recommendation.