Opinion: 7 Warren Buffett investing tips that could hurt regular investors
Reprinted courtesy of MarketWatch.com.
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It’s always controversial when I publicly challenge the advice of Warren Buffett, widely regarded as one of the world’s best investors.
Although I don’t have anything like his wealth or his following, I have something Warren Buffett never will have: more than half a century “in the trenches” helping thousands of real people get the most from their investments.
This vast experience, at least in my view, gives me the right (and I daresay the duty) to challenge Buffett’s pronouncements when I think they will hurt more people than they will help.
If you can’t stand anybody who dares to disagree with Buffett, stop reading right now. What follows won’t make you happy. But if you are willing to consider an alternative view based on the real world that most of us nonbillionaires live in, read on.
The following seven items of Buffett’s investment advice, along with my comments, are taken from a recent article in AARP.
ONE: Hold plenty of cash for emergencies and opportunities.
- Buffett: Establish a large cash reserve when you retire so you can withstand the inevitable financial challenges you will face. Don’t be afraid to tap into this fund to take advantage of lucrative investment opportunities. Retain your ability to take action and invest at the best possible time.
- Merriman: This advice invites retirees to become would-be market timers looking for what they see as bargains. How will they know a bargain when they see it? Apparently they are on their own for that. What are they to do if these “opportunities” turn into dogs and they suddenly have little cash left? Not Buffett’s problem. My advice: Don’t try to time the market; use index funds to buy value stocks by the hundreds; keep three months of living expenses in an emergency fund, and don’t use it to chase investment “opportunities.”
TWO: Embrace the boring.
- Buffett: You won’t have interesting cocktail party stories to tell about your “boring” companies like Procter & Gamble, maker of diapers, soap, toilet paper and toothpaste. However, companies like that often are the best in their business and thus can provide excellent long-term returns. Investors who put $1,000 into P&G stock in 1986 and reinvested the dividends would have more than $32,000 today.
- Merriman: If Buffett wants boring investments, he should listen to his own advice and invest in index funds instead of individual stocks. Sure, P&G is a good company, but every serious investor already knows that, and its attributes have been built into the stock’s price for decades. Take Buffett’s advice to invest in value stocks, and do it through “boring” index funds. In case you are interested, in 1986 you could have invested $500 each in U.S. large-cap value stocks and U.S. small-cap value stocks. Those investments would be worth $36,912 now, with vastly less risk than P&G stock. But if you did that, you wouldn’t be able to brag about “your” detergent-and-toothpaste company.
THREE: Look for top-brand companies that control prices.
- Buffett: Coca-Cola has extended one of the most valuable brands in the world to bottled water and juices. It charges more money than its competitors for essentially the same products, making lots of money for investors.
- Merriman: If flavored, caffeinated sugar water makes you feel good, then buy the products. But please don’t delude yourself into thinking that owning Coca-Cola stock makes you a savvy investor. You can own hundreds of well-known growth stocks through index funds that give you the rewards while reducing your risk. That’s boring, but better.
FOUR: Minimize your mistakes and learn from those you make.
- Buffett: Everybody makes mistakes. Keep a record of where you foul up, and figure out exactly what went wrong. This will help make you a better investor. Teach these lessons to your children and grandchildren.
- Merriman: If you want to help your children and grandchildren, teach them not to buy individual stocks and to follow Buffett’s advice to invest in index funds. The real mistake to guard against is the belief that you will do better than the market by picking and choosing stocks. (See items TWO and THREE above.)
FIVE: Never overpay.
- Buffett: No matter how successful a company is, don’t overpay for its stock. Wait until Wall Street sours on a company you like and drives the price down into bargain territory. By making a watch list of interesting stocks and waiting for their prices to drop, you increase the potential for future capital gains.
- Merriman: I agree completely with the lesson: Don’t overpay. Don’t pay AT ALL for “advice” from commission-based salespeople. Don’t pay loads on mutual funds. Don’t pay high recurring fund expenses. However, I don’t think individual investors have any business trying to recognize undervalued companies and determine when they should buy and sell. To buy value companies, use index funds. To “time” your purchases to avoid overpaying, use dollar-cost averaging.
SIX: Buy and hold.
- Buffett: It’s easier to make an excellent buy or sell decision once than to do it over and over again. If you buy at the wrong time, you could pay too much. If you sell at the wrong time, you could lose money or give up future profits. The buy-and-hold investor makes only one decision: which stocks to buy. After that, all you have to do is have the discipline to keep the stock. Don’t hold every stock forever, but minimize the number of decisions you have to make.
- Merriman: I agree wholeheartedly with buying and holding. But Buffett’s “advice” might as well be to buy only stocks that are going to go up, and sell them only when they are about to stop going up. Every buy and sell decision you make is likely to seem “smart” at the time you make it. Only later will you discover whether it was actually smart or dumb. This is not buying and holding.
SEVEN: Stick with what you know.
- Buffett: Investors can be successful without becoming expert in every part of the market. In the late 1990s he refused to embrace technology stocks, and hence didn’t get killed in the tech bust in 2000 to 2002. Focus on what you are familiar with and take advantage of any special insight you have.
- Merriman: I agree completely that you should stick with what you know. However, individual investors almost never have “special insight” that would give them an edge on the full-time institutional investors that dominate the markets. I have a friend who spent his career in banking and knew that business as well as anybody. Against my advice, he put most of his retirement money into banking stocks, especially Washington Mutual — the company he believed he knew best. When WAMU imploded a few years ago, my friend lost most of his life savings — despite the fact that he took this bit of Buffett advice. One thing you should “know” about investing is that you cannot know enough to outsmart the markets.
Warren Buffett is a value investor, and I believe in that approach. To learn more, check out my podcast entitled How value stocks can keep you from outliving your money.
Richard Buck contributed to this article.