Berkshire Hathaway Chairman Warren Buffett walks through the exhibit hall at Berkshire Hathaway Inc's annual shareholder meeting on May 4, 2019.SCOTT MORGAN/Reuters
On Feb. 7, I went out for a drink with one of my best friends. To protect the innocent, let’s call him Bob. He wanted to ask me a few questions about index investing.
For the past couple of decades he’s been a stock picker, though a very conservative one. No day trading, no crypto. Just a handful of big, dividend-paying companies.
“I don’t know if you’ve gone back and checked,” I said, “but over time, you’ve almost certainly underperformed the market.”
“That’s probably true,” said Bob. “Though I made a killing in one stock: Coca-Cola KO-N. I bought it about 10 years ago, and it’s up something like 900 per cent.”
I bought Coca-Cola Co. – stock symbol KO – more than a decade ago for my late mom’s portfolio, so I knew what he was saying made no sense. At the time we were speaking, I knew that Coca-Cola’s shares were up around 70 per cent over the previous decade.
“That can’t be right,” I said. He insisted it was. I pulled out my phone to call up Google Finance. He pulled out his phone to log in to his online brokerage.
And then, as we clicked our keys, I had a eureka moment: “Bob, I bet you accidentally bought the wrong stock.”
“What?” he said, not looking up from his phone.
“I’ll bet you dollars to doughnuts you bought stock symbol COKE rather than KO.” The latter is global colossus, and one of 30 blue-chip companies in the Dow Jones Industrial Average. The former is a small bottling operation, partly owned by Coca-Cola Co., called Coca-Cola Consolidated Inc.
Bob nodded, smiled and held up his screen. He had meant to buy KO, but had instead bought around $20,000 of COKE – which was now worth $207,000. His biggest investing success is owed to a happy accident. A typo, basically.
It’s a reminder of why index investing – buying and holding the whole market rather than trying to pick winners and losers – is the right strategy for most of us. Just ask Warren Buffett.
Mr. Buffett, who answered six hours of questions last Saturday at the Berkshire Hathaway annual meeting, has long been an advocate of index investing. Not for himself – like Liam Neeson in Taken, he has “a very particular set of skills” – but for everyone else. Why? Because it’s exceedingly difficult for stock pickers to outperform a broad equity market over a long period of time. And because the whole equity market, held for decades, has historically done quite well.
Investing, as Mr. Buffett quipped at the 1997 annual meeting, “is the only field I can think of where the amateur, as long as he recognizes he’s an amateur, will do better than the professional.”
Back in 2007, Mr. Buffett offered a wager on a website called Long Bets. He put half a million dollars on the proposition that “over a 10-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.”
As Mr. Buffett wrote in Berkshire’s 2016 annual report, “I then sat back and waited expectantly for a parade of fund managers. … Why should they fear putting a little of their own money on the line? What followed was the sound of silence.”
A fund of hedge funds called Protégé Partners did eventually step forward to take the bet. And despite the stock market being crushed during the financial crisis of 2008-09, the index fund tracking the S&P 500 outperformed the chosen hedge funds, 125.8 per cent vs. 36.3 per cent.
The score won’t always be so sharply in the index’s favour, but an index should beat the average active investment manager. Why? Because the average investment manager, competing against a universe of other managers, will do no better than the market average. What’s more, the average active manager will charge a pretty penny. As Mr. Buffett put it in 2017, “fees never sleep.”
“If Group A (active investors) and Group B (do-nothing investors) comprise the total investing universe, and B is destined to achieve average results before costs, so, too, must A. Whichever group has the lower costs will win.” And “if Group A has exorbitant costs” – hello, hedge funds – “its shortfall will be substantial.”
Lotteries always have some winners, but over repeat plays and a long time it’s exceedingly difficult for individual stock pickers or active managers to outperform. Even Berkshire (full disclosure: I’m a shareholder since 2005) has trouble doing it nowadays, thanks to its ever-growing pool of money to invest. Its per-share increase in market value has beaten the S&P 500, including dividends, in just three of the past five years.
And what about Bob? On Feb. 7, COKE closed at US$512.28. On Monday, it closed at US$651.97. Bob is up another $55,000 or so.
Sometimes one random stock on Wall Street or Bay Street turns into a winning lottery ticket. But for most of us, investing in the whole street, and holding for decades, is the only sure winning strategy.