There’s a funny thing my dog does around the same time every night, when I grab her bowl to feed her dinner. She runs over to the spot where I’ll eventually set it down, and she’ll sit, tail wagging, watching my every move until I bring the bowl over with her food – which gets eagerly and immediately devoured.
I tell this story not because I think you’d be interested in my dog’s eating habits, but because this is exactly how the whole of the investing community acts around this time each year as we await the release of Warren Buffett’s annual letter to Berkshire Hathaway shareholders.
The letter is more than your typical shareholders letter, it’s usually pretty entertaining and is always chock full of interesting insights and investing advice from Warren Buffett. Thankfully, this year is no different.
Not only did Buffett outline his fundamentals for investing, he once again got pretty specific on his thoughts on where the average investor should focus their investing dollars and time.
Warren Buffett’s 6 Fundamentals Of Investing
- “You don’t need to be an expert in order to achieve satisfactory investment returns.” Buffett goes on to say that you should keep things simple, know your limitations and don’t swing for the fences. He adds: “When promised with quick profits, respond with a quick ‘no’”. (More on this point later on)
- “Focus on the future productivity of the asset you are considering.” He says if you aren’t comfortable making a rough estimate of an assets future earnings you should forget it, and move on. This is a reiteration of sorts of his famous quote that you should “never invest in a business you don’t understand.” If you look at Berkshire Hathaway’s holdings you’ll see he puts this theory to work, as just about all of the top holdings have very easy business models to understand.
- “If you instead focus on the prospective price change of a contemplated purchase, you are speculating.” This is an important point. Know the difference between speculating and investing. As Buffett says, “half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if they continue…” Buying a stock because you think it will “go up” based on whatever factors you dream up, isn’t much better than walking into a casino and gambling.
- “Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.” This is Warren’s way of reminding us to focus on the long-run. Day to day movements in stock price are inconsequential. We should be focused on investing for the years ahead, not for the next quarter. (Related: How Often Do You Check On Your Investments?)
- “Listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.” In other words: Turn off CNBC and the rest of the 24 hour “news” networks, and don’t listen to the hundreds of talking heads that are out there (on any topic). The networks blow tiny things out of proportion because they have to fill 24 hours worth of programming with something. Likewise, Jim Cramer, Suze Orman or any other “expert” has no clue who you are or what your investing situation is. I’ve never once heard him say “This stock is a buy for Jay, because he’s in his early 30′s with no debt and wants to focus on building an income stream from the dividends in his portfolio” So until he does, I’ll be better off assuming his “buy” picks aren’t directed towards me.
- “What the economy, interest rates, or the stock market
might do in the years immediately following – 1987 and 1994 – was of no importance to me in making those investments. I can’t remember what the headlines or pundits were saying at the time.” Speaking of his farm purchase in Nebraska and his second real estate purchase of a property near NYU in New York City, Buffett reminds us to focus on the fundamentals of our investments. Not on whatever macro issues are big news at the moment. He goes on to say that no matter what, corn would grow in Nebraska and students would flock to NYU. It’s easy to get caught up in the “The market is up today because of ____” or “The S&P 500 fell today due to fears over _____”. Regardless of what those headlines are, Visa will still continue to collect fees on the swipe of every credit card and McDonald’s will continue to sell millions of hamburgers. These fundamentals are what’s important. Short-term changes in interest rates, inflation and other factors will have little effect over your investments in the long-term.
Where Warren Buffett Thinks You Should Invest
It’s not big news that Warren Buffett is a big fan of low-cost index funds. Over the long run there isn’t a fund manager on Wall St. who can consistently outperform a simple S&P 500 index fund. He’s even made headlines in recent years for his million dollar bet against Wall Street’s “expert” investors.
His first point above stated that you don’t need to be an expert to achieve satisfactory returns. In fact, your money would be better off by avoiding experts at all costs. Here’s Buffett’s plan for his own estate. (emphasis mine)
“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
I think this is the most powerful takeaway from Buffett’s letter. You don’t need expert help to invest, or invest well. All you need is an E*Trade account and you can construct a low cost portfolio of index funds that will beat the portfolio your friend with the fancy financial advisor has.
You can read this year’s Berkshire Hathaway Shareholder Letter here. I also HIGHLY recommend reading the Complete Berkshire Hathaway Letters To Shareholders 1965-2013. It has every single letter Warren Buffet has written during his time as Berkshire Hathaway CEO, and if that’s not considered a “must read” for your finances, I don’t know what is.
Photo Credit: DonkeyHotey