What is Warren Buffett (Trades, Portfolio)’s secret to investing? This is a question almost every investor asks, but few have been able to answer. Personally, I’m not going to claim to be an expert on Buffett. I have done plenty of research and writing on the Oracle of Omaha in the past, but there are other writers who have conducted much more research than I.
However, even though there are other writers who have compiled a more comprehensive rundown of Buffett’s strategy, I can offer the average reader some insight into how the billionaire has managed to build his wealth over the years, in just a few paragraphs.
An iron will
Buffett is a magnificent stock picker; that’s the ultimate route of his success over the years. Without just a few key investments, Buffett wouldn’t have the wealth he has today.
Investments in American Express (AXP, Financial), Coca-Cola (KO, Financial) and GEICO turned Buffett into a genius in the eyes of many and to this day they remain his most important trades. Another thing to consider about Buffett is most of his wealth was created after his 60th birthday and arguably most of the wealth created since this date has been from American Express, Coca-Cola and GEICO (if not directly, wealth has been created indirectly through reinvesting cash payouts).
You could take the easy route and argue that Buffett is a fantastic stock picker and therefore no one else will ever be to replicate his success, which is true to a certain extent. Or you could also argue that the best way to replicate Buffett’s performance is to buy and hold similar shares which will also yield results (although you should never blindly follow a guru investor into a position without first conducting your own due diligence). But there is one main difference between Warren Buffett (Trades, Portfolio) and the average investor that most people fail to spot, and this is why most investors will never be to replicate his success.
Patience and time
Patience and time are Buffett’s two key advantages. Most investors don’t have either of these qualities which is why most investors will never be up to replicate Buffett’s performance. Buffett has had the time and patience to wait out and invest through the market’s most severe declines – when most other investors fled.
In these periods of market turbulence you need an iron constitution to be able to hold through the downturn. Take American Express, for example. During the financial crisis the stock dropped from a high of $63 in 2007 to a low of $10. How many investors would have been able to hold through this decline? Those who did were well rewarded when the stock topped out at $95 in 2014 but I doubt few investors held on for the ride.
Short termism
In 2007, the Dow Publishing Co. released a research document written by Chief Investment Officer Clifford G. Dow, which looked at the portfolio turnover rate of mutual funds. Unlike other turnover data, these figures considered mutual funds specifically so there’s no impact from short-term market traders. The paper highlighted research from 1998 when data showed the 435 mutual funds categorized by Morningstar as "Large-cap Growth" funds had an average turnover of 93% (a 12.9-month average holding period). Over the 10-year period 1989-1998, the "large-cap growth" funds had average turnover rates of 93% (12.9 months), and both the midcap and small-cap growth funds had average turnover rates of 114% (10.5 months). The more active mutual funds apparently reported turnover rates that ranged from 215% to 972% and averaged 320%, which translate into average holding periods of 24 weeks, 5 weeks and 16 weeks. Other nonmutual fund data shows that the average holding period of the stock fell from eight years in 1962 around five days by 2012. Additional figures, this time from the Vanguard Group and once again taken from the year 2000 before high-frequency traders started to take over Wall Street, show that the holding period of the index fund powerhouse collapsed over the decade between 1990 and 2000:
“A few years ago, the annual redemption rate was 10%, equaling a 10-year holding period, according to Jack Brennan, CEO of the Vanguard Group and chairman of the Investment Company Institute (ICI). The redemption rate now is close to 40%, bringing the average holding period down to about 2.5 years, he says.”
The bottom line
The fact is, if the average investors can’t hold an index fund or single stock for longer than a few years, they will never be able to re-create Buffett’s performance. Even if you’re the world’s best stock picker, jumping in and out of stocks every three years will significantly reduce your chances of creating enormous wealth over the long term. Extending your holding periods doesn’t require anything other than patience.
Buying and holding an index fund is easy; you can pocket gains of 9% per annum with little or no effort. There’s no need to spend time researching or picking stocks. The hard part is holding on to the fund and not trying to beat the market.
You may never have Buffett’s stock picking acumen, but it’s easy to replicate his buy-and-forget attitude.
Disclosure: The author owns no share mentioned.
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