How Warren Buffett thinks you can be a better investor
Some sage advice from the Oracle.
Although investors cover a spectrum of sophistication levels, we all tend to make the same mistakes over and over again.
Widely regarded as one of the best investors of all time, Warren Buffett, dubbed the Oracle of Omaha, saw his company Berkshire Hathaway through compounded returns of almost 20% per year from 1965 to 2024. In the same period, the S&P 500 returned a modest 10% per year.
Buffett spent his entire 60-year career at Berkshire generously sharing his perspective on how to achieve investing success. Whilst few of us will live to emulate even a tenth of what he achieved, he offers important lessons nonetheless.
Below are some of my favourite snips of wisdom from the Oracle.
“By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals.”
In a 1993 letter to Berkshire shareholders, Buffett discussed perceptions of ‘dumb’ and ‘smart’ money. As someone who has built their fortune and career through active investing, I find this one somewhat humorous.
In 2008 Buffett famously made a $1 million bet that an S&P 500 index fund would outperform most investment professional’s picks over a 10-year period. And indeed, he was right. Ted Seides, co-founder of Protégé Partners, accepted the challenge and handpicked five hedge funds he believed would outperform the S&P 500 over this period. The performance gap was striking.
I used to enjoy the process of doing the research and picking my own stocks – although often to the detriment of my returns. I’ve certainly learnt this lesson the hard way.
The reality is most investment professionals won’t beat the market, so what chance to retail investors have? But this isn’t a gloom and doom proclamation. I don’t think Buffett intended to discredit the entire industry. Rather, prove how difficult consistent outperformance is and how higher fees associated with managed investments erode returns.
The bottom line here is that investing doesn’t need to be complicated. Success doesn’t require executing sophisticated strategies or having vast resources at your disposal. Simplicity often trumps complexity.
This leads nicely into Buffett’s next proclamation:
“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.”
The ‘helpers’ he refers to here are “those who profit from giving advice or effecting transactions”. Even though he built his success through a highly concentrated portfolio through careful selection; his circumstances differ greatly from retail investors.
For starters, Buffett is an activist. That means Berkshire would often take significant stakes in companies and push for management changes on the inside. Secondly, he doesn’t follow the crowd. These days much of the market is driven by social media frenzy and speculation. Blocking out the noise can be quite difficult for retail investors. We see this contrarian approach in Buffett’s hesitancy towards direct investments in Bitcoin, betting on BYD when everyone was on the Tesla train and so on. I could go on and talk about Berkshire’s scale, depth of analysis, ability to deploy resources, the list goes on.
But of course, human nature ensures that there will always be people out there who believe they can beat the market. Whilst some might, the majority don’t and will likely pay heavily for it. Despite this being a widely held conviction, I suspect the people who actually acknowledge that they cannot beat the market comprise a very small portion of investors.
Thus, there will always be turmoil between passive index-tracking products and the innate human affliction to assume we’re a lot better at things than we actually are.
“The most important quality for an investor is temperament, not intellect.”
The above sentiment translates well to a point about the perception of the intellect required to participate in financial markets. It’s also reminiscent of the Peter Lynch quote about the most important organ in the stock market being your stomach rather than your brain.
Much of the financial industry tries to sell the image of delivering better returns through complex strategies that retail investors couldn’t possibly execute alone. And true this might be the case for a small portion of institutions on a short-term basis, but lacking superior intellect is not the barrier they want you to believe it is. It appears this fear mongering has worked particularly well for the industry but a lot of my work at Morningstar is to refute this notion.
Investor temperament is a large driver of portfolio returns. Morningstar’s Mind the Gap study aims to examine the gap between investor results and reported total returns of a fund. Our findings showed that the average dollar invested in US mutual funds and ETFs earned 6.3% per year over the 10 years to Dec 2023, which was 1.1% less than the average fund’s total return over the same period. This 1.1% gap was attributed to mistimed purchases and sales, likely driven by emotionally irrational decisions. Here it is clear to see the large effect that temperament has on returns.
Have you ever experienced the sunk cost fallacy? When you’ve invested too much time, effort or money into a pursuit which is failing but you can’t seem to let it go? This is an innate tendency to contribute more to an endeavour even if it no longer is working out.
Almost five years ago an ill-timed and poorly thought-out investment into Zip Co left me clinging onto the funds, despite watching my portfolio fall by 60%,70%,80% then finally selling at 90% down. This is a classic example of loss aversion under distress. I double downed and gambled the opportunity cost of withdrawing sooner and reinvesting in something else.
Buffett makes a good point here about a conundrum a lot of investors face – when to walk away from a poor investment decision. Or in this case, put the shovel down and stop digging yourself deeper.
Of course, there are many things we can do to avoid digging ourselves into a hole in the first place but those aren’t helpful when you’re already in the hole. You may feel tempted to double down just to reduce your cost basis, but taking a larger position doesn’t inherently change the company’s fundamentals or improve its outlook.
The best way forward in this circumstance is to revisit your initial thesis and whether the investment still presides within this. We all know we shouldn’t buy and sell things based on price movements, however if the company’s fundamentals change, or your own circumstances shift, there is good reason to re-evaluate your strategy. In a recent article, Mark discusses when you should sell shares.
