Hay Stack _ whole and find

The Continuing Wisdom of the Oracle of Omaha

Hay Stack _ whole and find

“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.”

                                --Warren Buffett, 2013 Berkshire Hathaway Letter to Shareholders

 

At Index Fund Advisors, One of the events that we look forward to every year is the publication of Warren Buffett’s annual letter to the shareholders of Berkshire Hathaway. The 2013 letter definitely did not disappoint us. There are so many great quotes that it becomes quite difficult to choose among them. Drawing upon his experiences with real estate investments in Nebraska farmland and New York office buildings in his unequaled story-telling fashion, Buffett reminded us how vitally important it is to ignore the talk and noise of the financial media and stick to our well thought-out investment plans:

“Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits – and, worse yet, important to consider acting upon their comments.”

Buffett invoked a humorous analogy to help us understand this point. Suppose that his Nebraska farm bordered a crazy guy with a farm of his own who every day would call out a price at which he would be willing to buy Buffett’s farm or sell Buffett his farm. Assuming that Buffett is free to act in either direction if the called out price is absurdly high or low (or do nothing if it is neither), this should be nothing but a benefit, yet investors who are faced with an analogous situation with continuously updated market prices only seem to hurt themselves by buying high and selling low.

“Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of ‘Don’t just sit there, do something.’ For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.”

In his past letters, Buffett has strongly endorsed indexing, and this letter may be his strongest endorsement yet, as he reveals how index funds will be used to the benefit of his heirs:

“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.”

Interestingly, the index fund chosen by Buffett is the same one he picked for his $1 million ten-year bet against Protégé Partners. As of the end of the sixth year, the Vanguard fund is up 43.8% while the collection of hedge funds chosen by Protégé is up only 12.5%. Our money is on the Oracle of Omaha.

While we certainly agree with Mr. Buffett’s assertion that the S&P 500 index will outperform the majority of active managers, we do not think it should be the entirety of investor's equity allocations. We often describe our own approach to portfolio construction as lying at the place where Warren Buffett meets Jack Bogle. The risk factors that have served Buffett so well over the decades are cost-effectively captured in the DFA funds that IFA advises for our clients. As IFA’s “Big Chart” shows below, combining global small cap and value indexes with the S&P 500 has resulted in far more efficient portfolios, and we expect that to continue going forward. To learn more about our investment approach that synthesizes Bogle with Buffett, give us a call at 888-643-3133.