Wise Words From Warren Buffett

by Michael on Mar 6, 2014

Warren Buffett’s annual letter to shareholders has always been a treasure trove of investing insight. This year’s letter, which was recently released, is no different.

Among other things, Buffett urges individuals to stay within their “circle of competence,” saying that:

“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.”

The good news is that:

“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). […] 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.”

He also addresses the issue of timing:

“The antidote to that kind of mistiming [i.e., entering the market at a time of exuberance and riding it down] is for an investor to accumulate shares over a long period and never to sell when the news is bad…”

Ultimately, by following his rules:

“…the ‘know-nothing’ investor who bother 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 long-term results than the knowledgable professional who is blind to even a single weakness.”

Good stuff. He’s essentially saying that you can win the investing game by not playing it. Instead, invest broad market indices to achieve diversification at minimal cost and tune out the noise.

But what I found most interesting in all of this is that it’s the exact advice he has laid out in his will should he pre-decease his wife.

“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. […] 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.”

Two asset classes. Even simpler than the good ole three fund portfolio.

Aggressive? Yes. But the Buffett’s have enormous risk capacity. Historically, such a portfolio would be expected to produce an average annual return of just under 10% with losses in roughly one-quarter of all years.


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