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Warren Buffet: Stock Market Lesson In Passive Investment

InvestorEducation / Learning to Invest May 02, 2018 - 08:36 AM GMT

By: Christopher_Quigley

InvestorEducation

Every year I religiously read Warren Buffett’s letter to the shareholders of Berkshire Hathaway. I find them a treat,
a mine of information and knowledge. It always inspires me to review, in his famous introduction, how each year since 1965 he has been able to achieve such spectacular returns with a relatively simple long term investment strategy. Over the past 52 years Berkshire has returned a staggering 20.9% compound annual return. Thus 1,000 dollars invested with Mr. Buffett at the outset of his career is now worth 11,144,735 dollars. And what is the over-riding advice he gives to enable such fortunes to be made? The secret is stated boldly on page 13 of the 2017 newsletter:


“Stick with big, “easy” decisions and eschew activity”.

To emphasis this approach Mr. Buffett this year tells the story of a 10 year bet he made with financial advisers Protégé Partners. Warren won the bet and accordingly Girls Inc. of Omaha won over one million dollars.

The bet made by Warren with Protégé was as follows:

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S & P 500
will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses”.

To try to win the bet Protégé  Partners, a financial advisory firm, chose five, best-in-class-fund-of-funds, hedge fund managers. However, to the shock of the investment world, Protégé lost.  The fact that their chosen elite were unable to beat a “passive” investment in the S & P 500 index spoke volumes. It called into question the true value of Wall Street’s whole asset management industry. The true state of affairs, so eloquently articulated by Warren in this year’s broadside,  was that the high fees charged by advisers, hedge fund managers and brokers were not warranted and he accordingly “shouted from the rooftops” that the average investor was better off personally saving into a low cost S & P 500 index fund rather than trying to pick hedge funds, fund-of-funds, financial advisory firms or “active” managers.

Again to quote Mr. Buffett:
“During the ten-year bet, the 200-plus hedge-fund managers (in the fund-of-funds chosen by Protégé) that were involved, almost certainly made tens of thousands of buy and sell decisions. Most of those managers undoubtedly thought hard about their decisions, each of which they believed would prove advantageous. In the process of investing, they studied 10-Ks, interviewed managements, read trade journals and conferred with Wall Street analysts. All to no avail……….

I, meanwhile, leaning neither on research, insights nor brilliance, made only one real investment decision; to passively invest in the S & P”.

The one caveat pointed out by Buffett in his story, to be fair, is that one cannot adopt a short-term approach to his index investment strategy. Occasionally the market does panic and mis-prices equities. Under such circumstances the worst thing an investor can do is withdraw to cash. For example, to outline this point, in the 2017 newsletter he reminds his readers that over his 52 year career the American stock market went through four serious recessions and substantial drawdowns were experienced by Berkshire Hathaway shareholders, as follows:

Recession Period:                           Share Price Fall:
1997                                                   59.1%
1987                                                   37.1%
2000                                                   48.9%
2008                                                   50.7%

Despite the above gut wrenching share price implosions, following each recession, Berkshire Hathaway  went on from strength to strength. The moral of the story is that a well-diversified conglomerate such Berkshire or a broad  index such as the S & P 500 will always recover from recessions. Thus the “Sage of Omaha’s” advice is: in general invest for the long term and ideally choose a broad based, low cost index.

Market Note.
The market continues to be range bound, consolidating within a descending triangle. Range markets
are very difficult to trade and I have been advocating to students since mid-February to keep their "powder dry" until technical resolution is forthcoming and not waste the wonderful profits that were generated from the near 14 month Trump election momentum rally.

Where price action breaks from this current formation will be important for future trend. The bullish level is 24,900 (approx.). The bearish level is 23,500 (approx.). The longer the consolidation continues the better for traders as this means the eventual "break" will have more technical resonance, this ensuring the move has more momentum.

Chart: Dow Industrials: Daily.


Chart: Dow Industrials: Weekly.


Source: Warren Buffett/Berkshire Hathaway 2017 Shareholders Newsletter.

Charts: Courtesy StockCharts.Com.

Christopher Quiqley

B.Sc., M.M.I.I. Grad., M.A.
http://www.wealthbuilder.ie

Mr. Quigley was born in 1958 in Dublin, Ireland. He holds a Bachelor Degree in Accounting and Management from Trinity College Dublin and is a graduate of the Marketing Institute of Ireland. He commenced investing in the stock market in 1989 in Belmont, California where he lived for 6 years. He has developed the Wealthbuilder investment and trading course over the last two decades as a result of research, study and experience. This system marries fundamental analysis with technical analysis and focuses on momentum, value and pension strategies.

Since 2007 Mr. Quigley has written over 80 articles which have been published on popular web   sites based in California, New York, London and Dublin.

Mr. Quigley is now lives in Dublin, Ireland and Tampa Bay, Florida.

© 2018 Copyright Christopher M. Quigley - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

Christopher M. Quigley Archive

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