Back in 2014, Warren Buffett (Trades, Portfolio) caused a stir when he proclaimed on CNBC’s "Squawk Box" that the best retirement portfolio was an S&P 500 index fund. For a billionaire that has made his name investing in stocks, this may seem like absurd advice at first. Yet for most investors, it could be the best way to grow your wealth in the long term.
Warren Buffett's Advice
In the 2013 Berkshire Hathaway annual shareholder letter, Warren Buffett (Trades, Portfolio) included some investing advice for his wife and her trustee:
“What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. . . . My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors . . .”
In the CNBC interview, Buffett went on to give more detail on this strategy, specifically why he thought the strategy was best for investors who have little to no experience in the market:
“I laid out what I thought the average person who is not an expert on stocks should do. And my widow will not be an expert on stocks. And I wanna be sure she gets a decent result. She isn’t gonna get a sensational result, you know? And since all my Berkshire shares are going to philanthropy, the question becomes what does she do with the cash that’s left to her? Part of it goes outright, part of it goes to a trustee. But I’ve told the trustee to put 90% of it in an S&P 500 index fund and 10% in short-term governments. And the reason for the 10% in short-term governments is that if there’s a terrible period in the market and she’s withdrawing 3% or 4% a year you take it out of that instead of selling stocks at the wrong time. She’ll do fine with that. And anybody will do fine with that. It’s low-cost, it’s in a bunch of wonderful businesses, and it takes care of itself.”
This short paragraph contains several nuggets of advice for investors. First of all, Buffett makes it clear that there should be some cash left on the sidelines for day-to-day uses. Having this cash will prevent his widow buying or selling equities at the wrong time and jeopardizing future returns -- a mistake all investors should seek to avoid. Secondly, it is evident from the statement above that Buffett is trying to achieve a steady result for his widow with a zero risk of capital loss -- the S&P 500 index fund should achieve just that. Granted, it won’t make you rich overnight, but it will produce steady returns growing the capital over time.
This is great advice for all investors, not just retirees.
Most Investors Fail
According to a study conducted by financial research firm DALBAR, the average investor realized an average annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually. High fees and lack of diversification and overtrading are all reasons cited as being behind this underperformance.
Buffett knows that he is an exceptional stock picker and most other investors would do better just buying an index fund. The figure above is an average annual return of only 3.7%. If you were to exclude the top performing decile of investors, the average annual return might be closer to 3% or even 2%, implying that most investors would do better owning bonds than stocks.
All in all, the majority of investors would do well to follow Warren Buffett (Trades, Portfolio)’s advice and buy a tracker fund rather than trying to pick stocks. That being said, there’s a huge volume of academic research which shows that a value investing strategy can outperform the wider market over time if a quantitative approach is used. So using a value strategy alongside a tracker fund could be a winning combination for those investors who are willing to take on the extra work.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Start a free 7-day trial of Premium Membership to GuruFocus.
