Warren Buffett has gladly shared his perspective on how to
make money in the stock market, and he wants us to see there are
three simple things we all must do.
Source: The Motley Fool.
The incredible results
In his 2004 letter to
shareholders, Buffett noted, "Over the 35 years [since the 1960s
ended], American business has delivered terrific results. It
should therefore have been easy for investors to earn juicy
By all accounts, "terrific results" could be considered an
understatement, as Buffett noted the average annual growth rate
from owning the S&P 500 stood at a staggering 11.2% --
well above the stock market's historical average of 9.1% (from
1871 to 2013) -- meaning the returns over that 35-year
period nearly doubled what an investor should expect to see:
So did that mean Americans everywhere were leaping for joy
over the incredible run they'd been a part of? Some were, but
regrettably far too many weren't, as Buffett went on to note that
in order "for investors to earn juicy returns":
All they had to do was piggyback Corporate America in a
diversified, low-expense way. An index fund that they never
touched would have done the job. Instead many investors have
had experiences ranging from mediocre to disastrous.
There were three reasons some investors saw such poor
returns, and thankfully Buffett not only noted what they
were, but also how to avoid them.
1. High costs
Buffett began by noting the first reason was "High costs, usually
because investors traded excessively or spent far too much on
Of course, in excessive trading, or day trading, there is the
tangible up-front cost of each transaction. TheSecurities and
Exchange Commission warns that day traders should "be prepared to
suffer severe financial losses," as they "typically suffer severe
financial losses in their first months of trading, and many never
graduate to profit-making status."
One study conducted by the North American Securities
Administrators Association found that "70% of public traders will
not only lose, but will almost certainly lose everything they
Image Source: LaTunya Howard.
It's not just day trading that is expensive, but also
investment management. Whether using index funds or actual
financial advisers, there are always associated costs.
As my Foolish colleague David Hanson
, thanks to the typical 1% annual fees charged by financial
advisers, there is "future investment opportunity you lose every
time that financial advisor deducts from your account each
quarter. This means tens -- or even hundreds of thousands -- of
dollars can vanish over decades.
Meanwhile, index funds will automatically deduct fees known as
expense ratios from every dollar you put in them. If two funds
deliver the same returns -- let's say 8% -- while one charges
0.05% and the other charges 1.15%, an investor who had their
money in the second fund would have 35% less after 40 years,
despite supposedly "identical" returns.
So how do we avoid these high costs? Buffett
we must seek low-cost index funds -- he prefers those offered by
Vanguard -- and we
must beware of financial advisers who are trying to entice
us into day trading and rapid investing. Instead, we should
understand the true value of buy-and-hold investment
Image Source: The Motley Fool.
2. Don't blindly follow the crowd; instead, do your
Next, Buffett wants investors to also see there is great danger
in "portfolio decisions based on tips and fads rather than on
thoughtful, quantified evaluation of businesses."
Instead of buying a stock simply because a friend of a friend
suggested it, or a quick glance at its financials appeared
enticing, Buffett says investors should do careful research.
Going along with his first piece of advice, Buffett
investors in 2004: "If you like spending 6-8 hours per week
working on investments, do it. If you don't, then dollar-cost
average into index funds. This accomplishes diversification
across assets and time, two very important things."
3. Never try to time the market
The final thing Buffett warns against is an effort to jump in and
out of the stock market, saying that individual investors
have far too often been characterized by "a start-and-stop
approach to the market marked by untimely entries (after an
advance has been long under way) and exits (after periods of
stagnation or decline)."
As investment company
, $100,000 parked in the
at the end of 1927 would be worth a staggering $8.1 million in
2012, netting a return of nearly 8,000%. But if an investor
missed only the 10 best days over that 20,000-day period, that
investment would fall by an astonishing 67% to $2.6 million.
While that same investor would certainly end up with more if
he or she missed the 10 worst days, the best and the worst days
all too often closely follow each other.
Source: Invesco, The Tale of 10 Days.
Instead of aiming to time stocks, we should patiently invest a
set amount each and every month regardless of what the market is
doing -- this is exactly what the previously mentioned
dollar-cost averaging is -- and trust that great returns will be
In his 2012 shareholder letter, Buffett said, "Investors should
remember that excitement and expenses are their enemies ... The
risks of being out of the game are huge compared to the risks of
being in it."
The stock market offers great returns and great risks to
investors, and we must be keenly aware of both.
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3 Simple Suggestions Warren Buffett Gives to
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