Editor’s note: This article was first published in February 2018; the market situation, Berkshire’s favourite companies and the Apple recommendation refer to that year’s letter, and the hedge-fund bet (made in 2007, settled at the end of 2017) is reported as it was then.
We’re continuing to go through the annual letter to Berkshire Hathaway shareholders, in which Warren Buffett usually offers some advice that anyone who cares about their financial future in the world of stock market investing takes into account. Earlier, we looked at some points Buffett made about the current market situation, as well as Berkshire’s favourite companies and his recommendation to buy Apple.
This time we focus on 3 tips he has given to shareholders who want to make money on the stock market or improve their chances of a better retirement with the money they have invested in shares.
Warren Buffett’s advice to investors
If you’re not familiar with Buffett’s investment philosophy, you can start with his ten commandments of investing.
Treat shares as businesses, not as “tickers”
Buffett puts it bluntly: you have to learn to see shares as businesses, not as ticker symbols to be bought or sold according to their chart patterns, analysts’ price targets or the opinions of pundits in the media.
This advice is no surprise, given that for Warren Buffett the ideal investment horizon isn’t the short or medium term, but “forever” if possible.
Good companies will be good investments in the long run
If we believe the businesses of the companies we invest in will succeed, our investment will succeed too. Sometimes the payoffs will be modest; occasionally the cash register will ring loudly. You need time and you need patience, because if the company’s business is sound and it has a good management team, decent results will come in the end.
See also: Warren Buffett’s investment portfolio: where he invests (2011)
According to Buffett, in the United States investors have the wind at their back. I suppose that’s his way of saying the wind is in your favour on the US stock market.
Don’t invest with “borrowed” money
Here Buffett doesn’t only mean that you shouldn’t take out a loan to invest in shares (which we always take for granted). He also warns against using leverage bought on credit. Why?
Because, he warns, you can magnify your losses when shares plunge and you panic. This is very common among individual investors, whereas a company the size of Buffett’s, with managers like Munger or Buffett, can keep a cool head in turbulent times.
But it’s very rare for an individual investor to keep a cool head, separate from their emotions. Remember that the stock market is more a matter of psychology than of mathematics. The best investor is more of a psychologist than anything else. That’s why they’re able to go against the crowd.
“There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.” That’s the argument Buffett gives for not buying shares with borrowed money.
Avoid high-fee investments
In 2007, Buffett made a sort of bet, claiming that a low-cost index fund tracking the S&P 500 would deliver higher returns over 10 years than 5 funds of hedge funds (hedge funds that invest in other hedge funds) run by high-prestige managers, and therefore with high-prestige fees, often considered the “smart money” on Wall Street.
See also: Warren Buffett gives his opinion on the current economic situation
And Warren Buffett has won the bet: the S&P 500 easily beat the hedge fund portfolios, with average annual gains of 8.5%, outperforming all 5 of them.
Conclusion: owning a broad basket of shares and holding it for at least 10 years is a better investment than any other kind of investment, including every type of trading.
In fact, it’s worth remembering that every study carried out so far has shown that, over a 10-year period, a diversified portfolio has not produced losses, regardless of the stage of the market cycle at the time.
As we can see, the smart money isn’t always so smart, and, just as in the business world, simplicity is sometimes more profitable than complexity.
And those would be the highlights of Warren Buffett’s letter to Berkshire Hathaway shareholders.
Featured image: Overjive, CC BY-SA 4.0, via Wikimedia Commons.
