Warren Buffett’s Legacy of Investing Lessons

Last weekend, at the Berkshire Hathaway (BRKB) shareholders meeting, Warren Buffett surprised everyone except his two children, who were the only people he had told beforehand, by announcing that he would be retiring as the company’s CEO. I guess we shouldn’t have been surprised that a 94-year-old wanted to retire, but Buffett’s boundless energy and enthusiasm for investing created an illusion that he would go on forever. He didn’t, of course, but much of his investing advice will. Warren Buffett was enormously successful as an investor, but the things that really set him apart were his willingness to share the principles behind his success and, most of all, to express those ideas in a way that made sense to the average investor.

While Berkshire Hathaway is best known for investing in insurance and financial companies…they own GEICO, for example, but he has also shown himself to be a fan of fast food and snack companies, with Dairy Queen, Coca-Cola (KO), and KFC and Taco Bell parent Yum! Brands (YUM) represent a large part of his portfolio. More recently, he has made significant bets on the expansion of fracking in the US, buying a railroad and, over the last year or so, a significant stake in Occidental Petroleum (OXY), having taken some big profits on tech investments, most notably Apple (AAPL).

If that seems like a mixed bunch, it is. However, Buffett has never limited himself to any one sector, industry, or style of stock. He has invested in what are classed…

If that seems like a mixed bunch, it is. However, Buffett has never limited himself to any one sector, industry, or style of stock. He has invested in what are classed as both growth and value stocks in almost every industry imaginable. There is a common theme, though. He likes products and services that people use regularly and with which he can identify, and he likes companies that are already well run. A Berkshire Hathaway investment is not a warning sign for a company’s executives, it is a vote of confidence in them.

Probably the best-known Buffett quote on how to invest for success was when he said that we should “…be fearful when others are greedy and be greedy when others are fearful.” It is by far the most often quoted Buffettism. In fact, it has been used so often by writers like me that it has become a tired cliché, lessening its impact considerably. However, ubiquity does not equal irrelevance. It is still not just relevant, but essential to remember as a great encapsulation of the principles behind contrarian investing and trading. Regular readers will know that that is my preferred style, for somewhat obvious reasons.

Most of us know that we should buy low and sell high if we can, but human nature tells us to do the exact opposite. We want to join in with the crowd, which leads to us buying after a move up and selling near the end of a drop, even though logic tells us that there must be a correction to those moves at some point. By putting the focus on the mental state of others, though, Warren Buffett reminds us that we don’t have to pick exact tops and bottoms of stocks, nor do we necessarily have to pick exact stocks. We can be successful just by knowing what greed and fear look like, something that most of us do.

That has led to much of BRKB’s success over the years. Buffett didn’t predict the 08/09 crash, but he did sell a substantial amount of stock in front of it, based simply on the fact that by early 08, investors were getting greedy, then, when things got so ridiculous that Bank of America stock (BAC) hit around a dollar despite it being basically solvent and essentially protected by potential government intervention, he started to buy back. Nor did he know that stocks would drop dramatically in January of this year, but he was still selling at the close of last year. The market was hitting new highs seemingly every day, despite the fact that economic policy was about to change. Whether you think that change was for good or bad, it was bound to be disruptive, so that level of exuberance at that time suggested greed rather than rational analysis.

For most individual investors, though, who tend not to try to predict even long-term market moves, the fear and greed thing was not the most important of Buffett’s lessons. That honor goes to his insistence that, for most of us, the number one factor that determines success or failure in investing is the fees we pay to financial institutions. As was usually the case with Buffett, he was not afraid to put his money where his mouth was when it came to his convictions.

In 2005, he said that he would bet $500,000 of his own money, later doubled to $1 million, that a low-cost index fund, specifically the Vanguard S&P 500 tracker VOO, would outperform the average return from a selection of leading hedge funds. Fund manager Tom Seides accepted the challenge, beginning on January 1^st, 2008, but accepted defeat even before the decade was fully up. The point Buffett made here was not that investors shouldn’t make changes to their portfolio. (For his attitude to that, see the above about fearful and greedy), but rather that if high fees will inevitably cripple the best investment managers in the world, what chance does a small, individual investor have.

Needless to say, that bet made Buffett unpopular in some areas of the finance and investment industry, but unpopularity was something with which he was quite familiar. Over the last decade or so, as American politics has both shifted rightwards and become more divisive, Buffett is often held up as a bogeyman by those on the right. Prior to that shift, though, he was hated and despised by the left, who saw him as just another capitalist, getting rich by investing other people’s money to take advantage of when a company was struggling.

It seems that neither criticism surprised nor bothered Mr. Buffett. He remained focused on making money by sticking to his investing principles: being fearful when others were greedy and vice versa, investing in companies that were well run but being dragged down by circumstances, and keeping costs low. That is a formula we can, and probably should, all follow.

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