It’s that time of year folks. No, not just tax season, it’s the time of year that Warren Buffet, the so-called Oracle of Omaha, writes his annual letter to his investors.
This letter has been seen as a yearly revelation for both shareholders and the investing community as a whole. In this last letter, Buffett chose to call out fund managers for their expensive fees, speak about the effects of tax reform, and remind us to be patient when making bets. There are a few kernels we can glean, so let’s dive in.
For those who aren’t completely familiar with Warren Buffett or Berkshire Hathaway, let’s get a bit of context before we continue.
Buffett and Active Management
At its core, Berkshire Hathaway is an insurance company. Insurance companies like Berkshire Hathaway make money through reinsurance, underwriting and through investing with the float; Buffett’s firm isn’t entirely different than other insurance companies except for what it decides to do with the float. Buffett uses the float from insurance companies he’s bought and reinvests that money into buying part or all of other companies. As an investor Buffett believes in investing in what he knows; he’s looking for high-performing companies as opposed to the latest fads (ie, Bitcoin). This is Buffett’s north star when it comes to investing, while we believe you can’t pick the winners from the losers even with the best due diligence, there are points of truth we can take.
Back to the letter!
As I’m sure you already know, Buffett hates active management and the fees that come with it. In this most recent letter, Buffett revisited the topic and specifically talked about, “The Bet” between him and Protégé Partners. This bet occurred from 2007 to 2017 and was a challenge to test active vs passive management.
Protégé Partners was no easy competition, Buffet even said in the letter that they were, “An elite crew, loaded with brains, adrenaline, and confidence”. But if you are a member of the Church of Bogle and Buffett you might have guessed what the outcome would be: Buffett’s passively managed S&P 500 index fund beat the heavily managed and traded funds in Protégé’s portfolio.
Why investors still go back to active management, we may never know, but Buffett definitely loved adding this to his letter to reiterate that any investor at any level should be looking at index funds before they even think about investing in a hedge fund.
There are quite a few takeaways from Buffett’s letter that you as an investor can leave with, let’s focus on the ones specific to our outlook.
As Buffett recommends, we at M3 believe that it’s best to invest in low fee, value plays (index funds) which generate returns over a long period. These plays may not be the flashiest but on average you will be more secure than trading individual stocks.
Beyond Buffett’s love for index funds, he reminded us of the perils that go along with leverage and margin trading. Buffett is a strong believer in buying with cash on hand and keeping a savings of about 20% in cash (Berkshire Hathaway has a war chest of about $116 Billion). This strategy allows Buffett to buy when people are selling, we need just look to last month’s flash crash and the buying opportunity created by this haircut.
As Buffett himself wrote:
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.
This investment strategy, beyond keeping you with more hair on your head, is part of how Buffett has built his empire. He has always had a bit of cash lying around just in case a deal would come across his desk.
The magic with Warren Buffett is that there is no magic. He does things that anyone could do, what sets him apart is an almost monk-like control over natural emotions which many investors inevitably fall victim to. Whether the market runs high or low, it’s key to stick to your strategy and ride out the storms. You can’t control the ups and downs but you can control the ride that you get on. That’s why we at M3 believe in understanding your tolerance for risk, picking a strategy that helps you reach your goals, and staying the course.
Let other people worry about MSNBC. Warren Buffett doesn’t seem concerned, and neither should you. Not sure where you stand? Set your free risk profile to see which investment strategy is right for you: