America’s greatest stock picker says “index”

Warren Buffett’s annual shareholder letter – always anxiously awaited by shareholders and others – was published last Saturday. As arguably the greatest stockpicker in history, (Berkshire Hathaway book value has compounded at about 20 percent annually since 1965) why does Mr. Buffett use the letter to recommend that investors take the exact opposite approach via indexing?

We can always count on the Buffett letter for its generous helpings of personal humility, long-term perspective and sage advice. On page 20 that advice turns directly to indexing, the benefits it provides for individual investors, and how it fits into his own financial plan.

It’s best to quote Mr. Buffett directly, since he says it best.

Warren on the past
In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20^th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot.

Warren on the future
The 21^st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. 

Warren’s investment formula for success
A low-cost S&P 500 index fund will achieve this goal.  The “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.

Warren’s own indexing plan
My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. … My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

There you have it.  Warren Buffett doesn’t suggest we try to find stocks that outperform the market. He doesn’t even suggest we buy Bershire Hathaway shares to benefit from his team’s phenomenal investment prowess. He simply suggests we get on the mighty train of capitalism with a diverse, low cost index. He seems to feel that if it’s good enough for his wife, it’s good enough for individual investors nationwide.

We agree completely.

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