Warren Buffet Index Funds Advice: Why it’s Wrong!

Everyone is fuckin’ obsessed with Vanguard.

The major driver of this obsession is the cult of Warren Buffet, who in his 2016 letter to shareholders stated “My regular (investment) recommendation has been a low cost S&P 500 index fund”. YouTubers, journalists, authors, and content creators on all platforms spread the message that investing in Index Funds is the only way to invest and that you’d be an idiot to consider anything else.

Now this is better advice than a lot of the absolute shit advice you see on social media, but it’s ironic because Buffet himself doesn’t invest in Index funds!

In reality, Warren Buffet is a famously successful value investor who looks to invest into blue chip but undervalued companies. And this has proven to be pretty profitable for Buffet and his company, Berkshire Hathaway. But if Buffet doesn’t invest in Index funds, what does he actually invest in?

What Does Warren Buffet Invest In?

Buffet runs his company Berkshire Hathaway with his partner Charlie Munger and they’ve done so since 1965. Now Berkshire Hathaway is a company, but it operates more like a mutual fund or an investment fund as it makes its money from its investments in other companies.

Some of the big names that Berkshire Hathaway owns or has a major stake in include, American Express, Coca Cola, Bank of America, BNY Mellon, Apple, Kraft-Heinz, Brooks, Dairy Queen, Duracell, GEICO, Fruit of the Loom, and many, many others.

Warren Buffet and Charlie Munger manage their investments in Berkshire Hathaway by specifically choosing the companies they want to invest in, rather than buying the whole S&P 500.

So how has that worked out for them? Well from 1965 to 2016, the S&P 500, including dividends, has provided a total return of 12,717%.

That looks pretty good, until you see that over that same time period, Berkshire Hathaway’s share price has increased by 1,972,595%.

That’s not a typo.

Let’s put some figures around this. If you could have invested in an Index Fund back in 1965 and you’d put in $1,000, it would be worth $125,274 in 2016. Not too shabby for a $1,000 outlay.

But what about if you’d invested that $1,000 into Berkshire Hathaway stock instead? Well that would be worth $30,058,322. Ouch.

By investing with an investment company that actively chooses and changes its underlying investments based on research and analysis, you would be better off by $29,933,048.

Let’s think about this for a second, Buffet and Munger have outperformed the S&P 500 consistently now for over 50 years and yet he recommends everyone else should invest in index funds. Why?

Why Does Warren Buffet Recommend Index Funds?

Buffet says it’s because of fees, but I think it’s also because Buffet wants an easy life. Let me explain.

In the 2016 shareholder letter Buffet goes into greater detail on his recommendation of index funds. His main concern is that of fees, that active managers will generally provide same or worse performance to that of the market as a whole via an Index Fund like Vanguard.

In many ways, he has a point. If the rate of return on an investment is the same, the lower the fees on that investment, the less drag on the compounding effect and the bigger the balance at the end.

But I have 2 main problems with this.

The first is that the comparisons laid out in 2016 shareholder letter include eye wateringly high fees on the side of the actively managed funds. The funds in question charged an average of 2% in annual charges AND they take 20% of any outperformance they generate.

Those fees are insanely high and they are not typical of what a normal actively managed fund would charge. Buffet also ignores the fact that actively managed funds CAN outperform the index. He himself is proof of this fact! Is it guaranteed, no. Can it be relied upon, no. Does it happen? Yes. Personally, I wouldn’t care how high the fees are if I’m still getting great value out of those fees.

The second problem with this is that he is considering only one stock market and one asset class. The US stock market is the largest and most diverse in the world and it is generally going to make up a large proportion of any investors portfolio. Because it is so large, so liquid and so widely traded, it is known to be a market where consistent outperformance is incredibly difficult to achieve.

But what about the stock markets in Europe or the UK? What about the Asian markets or emerging countries like Brazil or China? What about investments in bonds and fixed interest? What about infrastructure and property funds?

Looking only at the S&P 500 is leaving a huge portion of the investment universe out of this equation, and these other markets and asset classes are areas where active investment managers have an arguably greater chance of outperforming the market.

Looking at investments outside of the US doesn’t mean investing in small, undeveloped companies. Outside of the US there are giants such as BP, Volkswagen, Toyota, Shell, Samsung, Sony, Honda, Mitsubishi, BMW, HSBC, Nestle and Saudi Aramco. These are all massive companies and they are all not included in the S&P 500.

Most investors would likely want to have exposure to these companies or at least the sectors they operate in, and any investment portfolio that is limited only to investing in the S&P 500 is going to be severely lacking in diversification.

So am I saying that index investing is a waste of time and you should only invest with active investment fund managers? Of course not. Index funds are actually awesome and in many cases they are the best option to use. My point is that they aren’t the only option to use.

Don’t get swept away by the cult of Buffetology. Look at your own portfolio and consider how it meets your own specific circumstances, not how closely it matches how some guy in Nebraska says you should invest.

Who is Warren Buffet?

That’s where Buffet lives by the way. He lives in the same, modest house that he purchased back in 1968. It’s a fairly nice house, but it is in Nebraska, so it only set him back $31,800 at the time which is the equivalent of roughly $285,000 today. Not quite what you’d expect from a billionaire.

This brings me nicely onto the second reason I believe Buffett is always banging on about index funds, that he wants an easy life.

This is very clearly a man who doesn’t do drama. He was born in Omaha Nebraska, married a woman from Omaha Nebraska, and setup what would go on to be one of the world’s biggest companies in Omaha Nebraska.

When I say an easy life, I don’t mean he doesn’t want to work hard or make difficult decisions, obviously he does both of those things. What I mean is that I’m sure he can’t be assed with having news anchors, millionaires and billionaires hassling him about his investment tips.

So when he’s asked, what investment recommendations do you have for new investors, he could rattle off his favourite companies or give some macroeconomic spiel about the Euro against the Dollar or something, but all this would do is open him up to getting things wrong and having people give him shit about it in the future.

I reckon Buffet just doesn’t want that hassle.

“Just invest in an index fund”. This is the most benign investment recommendation there is. Firstly, it’s not bad advice. Second, it matches his persona and investment philosophy of buying and holding for the long term and third, he can’t be wrong. If the market goes down, it’s just “the market” that’s failed not Buffets advice. So he keeps to the same simple line to avoid the drama.

To be honest, with a net worth of over $100 billion, I can’t say I blame him.