Words Of The Sage: Warren Buffett On Investing

For this series, "Words of the Sage," it is my goal to share selected investment thoughts and advice from some of the foremost investors of our times. I couldn't think of a better person to start with than Warren Buffett.

Warren Buffett - A Brief Biography

Warren Buffett was born on August 30, 1930, in Omaha, Nebraska. Readers may recognize that time frame as falling in the midst of the Great Depression. Nebraska did not escape the effects of this difficult period, and Buffett early on learned the value of the dollar. While still a boy, Buffett sold soft drinks and had a paper route. As one example of his early financial prowess, at the tender age of 15 he managed to amass $2,000 and use it to buy a 40-acre farm, the income from which helped him to pay his way through university.

Following his graduation from university, Buffett worked with his idol and mentor, Benjamin Graham, even moving to live in New York for a time. However, in 1956 he returned to Omaha, bought a home for $31,000 (which he still lives in to this day) and started Buffett Partnership, Ltd. Ultimately, this led to his joining forces with Charlie Munger and purchasing Berkshire Hathaway in 1964.

Today, his net worth is measured in the billions, second only to Bill Gates in the ranks of U.S. billionaires.

Following are some Warren Buffett investing tips that have influenced my investing viewpoint.

On The Benefits of Indexing

A choice that all of us must make as investors is how much we wish to get involved with active management, and all the fees that inevitably come with this, or taking a more index-based approach to tracking the markets. Of course, such indexing is possible with a portfolio of low-cost offerings from various ETF providers.

Here are some related thoughts from Buffett, as found in his 2007 Letter To Shareholders. 

Naturally, everyone expects to be above average. And those helpers – bless their hearts – will certainly encourage their clients in this belief. But, as a class, the helper-aided group must be below average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs they incur; 2) Passive and index investors, through their very inactivity, will earn that average minus costs that are very low; 3) With that group earning average returns, so must the remaining group – the active investors. But this group will incur high transaction, management, and advisory costs. Therefore, the active investors will have their returns diminished by a far greater percentage than will their inactive brethren. That means that the passive group – the “know-nothings” – must win.

I should mention that people who expect to earn 10% annually from equities during this century – envisioning that 2% of that will come from dividends and 8% from price appreciation – are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about double digit returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

Particularly is that first paragraph worthy of serious contemplation as you map out your own approach.

On Tuning Out The Noise

One of the challenges of our media-saturated environment is to "tune out the noise." At almost any hour of the day, you can turn on CNBC or similar outlet and hear any one of a number of talking heads telling you to "buy this, sell that, jump in with both feet, go to all cash" in a never-ceasing refrain. Further, it is not at all uncommon to hear or read two contradictory views within the same day, if not the same hour.

These related thoughts from Buffett are found in his 2013 Letter To Shareholders. He begins the section I am quoting from by telling the story of buying a farm and some retail property adjacent to NYU, in 1986 and 1993 respectively.

There is one major difference between my two small investments and an investment in stocks. Stocks provide you minute-to-minute valuations for your holdings whereas I have yet to see a quotation for either my farm or the New York real estate.

It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings – and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state – how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.

Owners of stocks, however, too often let the capricious and often irrational behavior of their fellow owners cause them to behave irrationally as well. 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.

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.

A “flash crash” or some other extreme market fluctuation can’t hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment. Indeed, tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.

My takeaways? Do your best to tune out the noise, and always keep a little spare cash on the sidelines so you can pick up bargains from those who are unable to do so.

On The "Riskiness" Of Stocks

These words are powerful. While I am a believer in maintaining a balanced portfolio, including things such as bonds and TIPS--and even a little cash with which to pick up bargains, as I featured in the last section--these words from Buffett in his 2014 Letter To Shareholders have greatly influenced my view of how "risky" stocks are.

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.

For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.

Summary and Conclusion

I hope this little tour through the words of Buffett will help you as much as it has helped me. As we form our own viewpoints and plans of action, at least being cognizant of the words of legendary investors with proven track records can only help us. Certainly, Warren Buffett is deserving of such recognition.

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