By Levi Sanchez, CFP®
Every year since 1977, Warren Buffett has written a letter to Berkshire Hathaway shareholders that captures more than the shareholder's attention. Anyone who is interested in understanding the thought process of a genius businessman and investor has tuned in over the years, and the investment philosophy of many can be traced back to Buffett's advice: Keep investment expenses low, take a long-term approach, be patient, find intrinsic value and manage emotions. These are all cornerstones of this industry giant's operating principles, and for good reason.
Warren Buffett's Track Record
Warren Buffett's track record is impressive to say the least. Since 1965, Berkshire Hathaway has averaged an annual compounded gain of 20.9%, (compared with the S&P 500 at 9.9%). That's a cumulative gain of 2,404,748%. Buffett's philosophy is about more than investing in businesses—he always invests in people just as much. He has aided in the success of many businesses by investing in great management, then allowing them to operate independently while having access to Berkshire Hathaway's extensive resources and capital.
Here is some advice from Buffett's latest letter:
Don't Borrow Money to Invest
"Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don't need."
Warren has always been against borrowing money to invest. Using borrowed money, or margin in investing terms, to chase returns in the short-term is unpredictable and can lead to disastrous results. On a relative basis, we can predict markets will grow over extended periods of time, so having a long-term approach to investing, while being able to enjoy life in the present, is a much better formula for success. Borrowing money in the hopes of hitting it big with a short-term investment only amplifies your risk. (For related reading, see: 3 Long-Term Investing Strategies With Strong Track Records.)
Invest in the Actual Business, Not Just the Stock
"Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their 'chart' patterns, the 'target' prices of analysts or the opinions of media pundits."
When you turn on the TV or read investing articles, it's common to get lost in the fact that when you purchase a stock, exchange-traded fund (ETF), or index fund tracking the S&P 500, you're buying a stake in an actual business. You're an owner of a public business. Looking at it from that perspective, why do people try to buy and sell businesses based on the movement of the business price on any given day?
Technical analysis, what Buffett is alluding to in this statement, has zero impact on the intrinsic value of a business. This strategy is simply trying to guess what the movement of a stock price will be next based on the movement it's had in the past. This makes no sense. What matters is fundamental analysis. What are the numbers telling us? Does management take a long-term view as well?
Occasionally, technical analysis and its followers will allow fundamental investors to buy stocks cheaper than what their intrinsic value might be. That's when investors should pounce. During market corrections or recessions, long-term investors have great opportunities to invest at a discount.
Performance Cannot Overcome High Fees
"Performance comes, performance goes. Fees never falter."
Ten years ago, Buffett made a $1 million dollar bet for a charity that an S&P 500 index fund would outperform a hedge fund of funds (a hedge fund investing in other hedge funds). The chart below shows the average annual gain and the cumulative gain, with the index fund vastly outperforming any other fund. (For related reading, see: Buffett's Bet With the Hedge Funds: And the Winner Is....)
This highlights the simple fact that no matter how great an investment manager may be, overcoming high fees is an insurmountable task in most cases.
The true value of a financial advisor to their clients is derived through creating a financial plan and helping manage behavior when it comes to investing. Vanguard estimates that behavioral coaching adds roughly 1.5% in net returns for the average investor. An unbiased third party, who's with you to plan for your life goals and the financial necessities to achieve them, can be priceless.
Long-Term Investors Better Served by Investing in Equities
"It is a terrible mistake for investors with long-term horizons—among them, pension funds, college endowments and savings-minded individuals—to measure their investment 'risk' by their portfolio’s ratio of bonds to stocks."
Given you have a long-term time horizon, typically referred to as 10+ years, common belief that a diversified portfolio needs to contain bonds holds less truth, especially in times of rising interest rates. When the Fed continues to increase interest rates, longer-term bonds react most negatively. If an investor knows they can get a higher interest rate on a bond today, why would they buy a longer-term bond that pays less? This results in the long-term bond losing value.
As history suggests, long-term investors are best served by investing in equities. Portfolios have time to weather the unpredictable, yet certain, corrections and recessions of the market in the short-term. However, they will greatly benefit from compounding over the long term. This becomes even more pronounced if investors continually invest and put extra cash to work during market corrections or recessions.
Using these investing strategies has earned Warren Buffett billions, which is why his annual letter garners so much attention—and why, as an investor, it should also garner yours.
(For related reading, see: Always Bet on Berkshire Hathaway (And Here's Why).)
This article was originally published on Investopedia.