The irony is that Buffett is known as one of the greatest stock pickers ever. His nose for a good business has made him one of the richest men on the world — revered by Wall Street and the public alike.
So why is he telling people to buy index funds?
“Because most people don’t know how to pick stocks,” Buffett said of index funds in a recent interview with CNBC’s Becky Quick. “Most of the time, I don’t know how to pick stocks. It is not an easy game.”
Buffett knows firsthand. Berkshire Hathaway, his conglomerate, has earned an annual return of 20.5 percent since he gained control in 1965. That’s better than twice the annual return of the Standard & Poor 500-stock index’s 9.7 percent total annual return.
Over the past 16 years, Berkshire Hathaway and the S&P are neck-and-neck.
“Investing in index funds works probably better than ever,” said Whitney Tilson, a Berkshire shareholder for more than two decades and a close follower of Buffett and his longtime business partner and sidekick, Charlie Munger, 95. “Even the greatest stock pickers like Warren Buffett are finding businesses that once seemed stable now vulnerable to disruption. Indexing, where you own a piece of everything and you don’t have to predict who’s going to get disrupted and by how much, makes more sense.”
If Buffett can’t beat the S&P 500, I am sure I can’t, either.
“His great days are well behind him,” said Daniel P. Wiener, chairman of Adviser Investments, which manages $5.5 billion.
Just look at December, when trillions of dollars in shares were sold over concerns about the economy and interest rates. Christmas Eve was one of the worst market crashes on record. And the day after Christmas was one of the best climbs back.
People would have been better off staying in the market. But a lot of them panic. They sell, thinking they will see the bottom coming and get back in.
Even though I write about this stuff, I have trained myself to ignore the noise and look at the long term. But it’s kind of like telling myself to eat less and exercise more. You don’t always do what is good for you.
I invest in mutual funds through payroll deductions in my 401(k) and in a taxable mutual fund on a regular schedule. That’s called dollar-cost averaging. You buy the highs, the lows and everything in between.
“Investing is laying out a dollar of purchasing power and getting more back in the future,” Buffett told Quick. “You try and figure out how much you’re willing to pay for that bird in the bush, compared to the bird in the hand.”
Non-stock-pickers like you and me need constant reminders that we cannot beat the market, especially when a dominant company such as Apple takes a 25 percent drop, as it has in recent months. (Buffett said he is waiting for it to get even cheaper). I don’t own any Apple directly.
Buffett — whose fans call him the Oracle of Omaha — gave us a reminder of the basics last month. Buried deep in the 88-year-old’s letter to Berkshire Hathaway shareholders that was published Feb. 23, under a section called “The American Tailwind,” is this:
“On March 11th, it will be 77 years since I first invested in an American business. The year was 1942, I was 11, and I went all in, investing $114.75. What I bought was three shares of CitiesService preferred stock. I had become a capitalist, and it felt good.
“If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019.
“That is a gain of 5,288 for 1. Meanwhile, a $1 million investment by a tax-free institution of that time — say, a pension fund or college endowment — would have grown to about $5.3 billion.
“Let me add one additional calculation that I believe will shock you,” Buffett wrote. “If that hypothetical institution had paid only 1 percent of assets annually to investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8 percent annual return actually achieved by the S&P 500 is recalculated at a 10.8 percent rate.”
Investing is about keeping life simple. Riding the wind. Put your money in inexpensive index funds that mirror the U.S. economy. Let the American Tailwind do the work.
I watched Buffett’s three-hour interview with Quick on Monday, when he riffed on the simplicity of investing in index funds.
“You didn’t have to know accounting, you just had to believe in America. And you didn’t have to pick the right stock, you just picked America,” Buffett said. “That isn’t a tail wind. It’s more like a hurricane. American business has done incredibly well, and America’s done incredibly well.
“We didn’t have to read the newspapers. You didn’t have to pick a stock.”
My wife, Polly, and I aren’t aggressive investors, but we are very aggressive savers. And, we’ve put most of our savings into boring bond and stock index funds. We do have some money in managed mutual funds, which means the manager is picking stocks and trying to beat the S&P index.
We also own a handful of large-cap individual stocks that I have had for more than two decades. I bought them as much to learn about stocks as I did to invest. It was more fun to have some bets on the table, but I didn’t confuse that with serious investing. Even so, I left those shares to compound, reinvesting the dividends and letting them grow. The account is now worth about 12 times my investment, although some of those have done better than others.
Lastly, we keep enough cash in the bank to bridge a market downturn so we don’t have to sell our stocks at a cheap price.
Why? I am no match for the thousands of math geniuses with their heads buried in Bloomberg machines and Excel spreadsheets, figuring out how to get the upper hand.
“You would be foolish not to allocate a good portion of your investment portfolio in public U.S. companies,” Wiener said. “You can’t go wrong betting on U.S. innovations, U.S. manufacturing advances and U.S. entrepreneurism.”
I agree. Barring a nuclear war, invasion of the mainland or repeat of the American Revolution, I am betting on the American wealth creation machine. Buffett does, too. He has lived through 15 presidents, a world war, cold war, a nuclear missile crisis in Cuba, Vietnam, a presidential assassination, a presidential resignation, Sept. 11, and, well, Donald Trump.
The Oracle said he is unfazed.
“We’ve got something that works,” Buffett said. It “wasn’t that we were working harder. Wasn’t that we were smarter. But we had a framework that unleashed human potential.”