Lessons From Warren Buffett

At the ripe old age of 96, Warren Buffett announced that he was stepping down as chairman of Berkshire Hathaway, the company that he and his business partner Charlie Munger built into a $1 trillion investment powerhouse. Although few would ever think that they could replicate Buffett's results, you don't need a lot of money to learn lessons from the so-called "Oracle of Omaha."

Start with one of his core premises: doing nothing is often the best course of action. He advised that once you have a financial and investment plan, you need to stick to it and avoid activity, noting "though markets are generally rational, they occasionally do crazy things." Our challenge is to sit still when those crazy times occur despite feeling the emotional tug that can lead us to unnecessary action.

Buffett has long been known to be a calming voice when times were tough. In October 2008, amid the Great Financial Crisis, he urged investors to maintain their faith in the U.S. economy and markets. He said, "Over the long term, the stock market news will be good," and underscored that neither he, nor anyone else, can predict the short-term movements of the stock market. But stocks tend to move higher over time, and well before either investor sentiment or the economy turns up.

Buffett once said that "It is not necessary to do extraordinary things to get extraordinary results." More than a dozen years ago, he told the trustees of his estate to "put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund." He thought that this simple strategy would be superior to the results attained by most investors who employ high-fee managers.

Buffett put his money behind the belief that investors are better off with low-cost index funds, rather than paying higher fees to managers, especially hedge fund managers. In 2007, before the bottom fell out of the market, Buffett challenged any active investment manager to beat the S&P 500 index with a portfolio of hedge funds. The wager became known as “The Million-Dollar Bet.”

The only taker was Ted Seides, the founder of asset manager Protégé Partners LLC, where he served as President and Co-Chief Investment Officer. The clock on the ten-year bet started on January 1, 2008, just as the financial crisis was forming. In the early going, the Seides funds lost less than the overall market, but when the recovery gained steam, the index fund pulled ahead. 

In the end, Buffett didn’t just win, he killed it. The average annual gain for the index fund over ten years was 8.5 percent. The five funds of hedge funds selected by Seides reported average annual gains between 0.3 percent and 6.5 percent. As Buffett aptly noted, “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients.”

Because we are just coming out of Life Insurance Awareness month, I thought it would be apt to conclude with Buffett’s advice about preparing for risk. In his 2001 shareholder letter, he referenced something called The Noah Rule, which Buffett described as “predicting rain doesn’t count, building an ark does.” This quote came to mind when I learned the results of a new survey which found that 47 percent of Americans say they would have trouble covering living expenses within six months of losing a primary wage earner. In Buffett’s terms, these folks are violating the Noah Rule, by living their lives with a dangerous level of a known risk and not doing anything about it.