Warren Buffett is the richest financier in the world, his investments have brought him a fortune of $ 76 billion (at the moment). In the ranking of the richest financiers, he takes 1st place by a wide margin, and in 2008 he was the richest man in the world according to Forbes.
In one of his letters to the shareholders of his investment fund, he told how to invest money for a non-professional investor and revealed the investment strategy that he indicated for his wife in his will.
It turned out that Warren Buffett recommends passive investments.
Fragment of the letter:
Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.
I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional 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. A low-cost S&P 500 index fund will achieve this goal.
That’s the “what” of investing for the non-professional. The “when” is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs’ observation: “A bull market is like sex. It feels best just before it ends.”) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better longterm results than the knowledgeable professional who is blind to even a single weakness.
If “investors” frenetically bought and sold farmland to each other, neither the yields nor prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties. Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm. 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.
ACTIVE INVESTMENTS
It should be noted that Buffett himself is an active investor. He chooses stocks of individual companies for his fund, buys them, holds for a long time and surpasses the market average.
Few people know how to do this, so Buffett does not recommend looking for such managers. The chance to find a “new Buffett” is scanty, but to run into a manager who, taking into account the investor's costs, will lose to the market, is off scale.
Even Buffett himself is already doubted, because the competition has intensified and he does not show the same results as before (purple graph - Buffett fund, green - American stock market):
There is also a lot of money in his fund, and the number of opportunities where to “attach” it in the market is limited. And also Buffett is leaving the management, because he is 89.
TRADING
Buffett is even more wary of trading :
A quality investment allows your money to grow for 10, 20 or even 30 years. You can't make big money buying and selling stocks every day. I do not know how and I do not know a single person who could.
You yourself can draw a conclusion about the numerous courses and books on trading. If some unique person knows how to trade and overtake the market like Buffett, think it profitable for him to spend time on books, courses and reveal his secrets in them?
In the place of such a genius, I would not be teaching - I would not "shine" at all. I would make the maximum amount of money trading while I can. And when it stops working, release another like course would do something else.
PASSIVE INVESTMENT
With that said, it should come as no surprise that Warren Buffett supports passive investments.
He advises investing in the stocks of many companies through special passively managed funds with low costs, and he recommended to his wife to invest 10% of the money in a conservative asset - short-term government bonds.
You have to be careful here, because we are approaching the topic of diversification between different asset classes and the advice on allocation between stocks and bonds is very individual.
For example Benjamin Graham recommended more conservative 60/40 against Buffets 10/90 allocation in his famous book on investing which became classic - "The intelligent investor".
DIVERSIFICATION BY ASSET CLASS
Economist and Nobel laureate Paul Samuelson said that we cannot predict the future, so we diversify.
William Bernstein, one of the principal investigators of passive investment, says :
Only a fool does not own a certain number of bonds, domestic stocks and foreign stocks.
Here he is not 100% right, because in some situations it is possible to keep 100% in stocks or bonds, and also to refuse domestic stocks. But in the vast majority of cases, he is right: you need to diversify.
And the Buffett allocation of "90% stocks and 10% bonds" is not suitable for everyone. The distribution is determined depending on the timing of your investor investment and personal tolerance to risk.
Buffett also wrote that it is important for an investor not to sell in a downturn, because no one has yet been able to make money by buying high and selling low. Willpower alone is not enough for this.
Correct diversification helps a lot here. Because if an investor has a conservative asset allocation, then during crises his portfolio will fall less and cause less stress.
And now about the American market, which Buffett so much praised.
AMERICA VS OTHER COUNTRIES
In fact, not only American stocks are growing, but all developed countries (developing countries are also growing, but they have much more risks).
Take Russia. In 1995, the RTS index nominated in US dollars (consisting of the largest companies in the Russian Federation) was launched with a value of 100 points (in 1995), and now it is already over 1000 points. For 24 years, the value of shares has increased 10 times (which is equal to 9.5% percent a year growth).
The American market has grown ~5 times during the same period:
German ~4.5 times:
Chinese 4 times:
This change of valuation doesn't include dividends were paid on stocks during this time, which go as extra profit.
This is not an advertisement for the Russian market, because no one can predict the future. Moreover, such income is unlikely to repeat itself.
This is an illustration of the fact that business is developing not only in the United States, but all over the world. And this must be understood when we read how Warren Buffett praises investments in the American market.
Although there are crises in some countries, even “lost decades”, when investments in stocks give zero profit or loss for 10 years. But the world economy is growing globally. Therefore, Bernstein recommends investing not only in domestic stocks, but also in foreign ones.
FINDINGS
Warren Buffett recommends passive investments to the lay investor (of whom the vast majority). In general terms, these are:
- Do not select stocks of specific companies and do not trade frequently. Buy “the whole market” (diversified funds from tens and hundreds of companies) and hold.
- Do not panic in a crisis, because it is unprofitable to sell cheap.
- Choose funds with minimal transactional and maintenance costs (usually it is recommended not more than 1% of the final commissions per year).
- It is almost always best to add bonds and foreign stocks to your portfolio. This gives the investor a better diversification.
To prove his point, Buffett publicly wagered $ 1 million with hedge fund managers (the results were surprising to many investors).
And the founder of the world's largest hedge fund, Ray Dalio, on the contrary, supported Buffett and also advises passive investments