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You don't have to be Warren Buffett

Richard Morin

Update :
Update :
October 11, 2019

If the gyrations of the financial markets and the increasingly frequent mention in the media of the risk of a recession are causing you some anxiety, reading this blog should help you relax.

First of all, you are not alone in your concerns: for most of us, the financial future, and in particular retirement planning, is a much greater source of anxiety than it was for our parents. Indeed, unless you work in the public service, the lifetime job and 70% pension as our parents knew it are well and truly over. Today, we have an average of 7 employers in our working life and through all these changes, it is our responsibility to save for retirement and to make those savings grow.

Your financial advisor's speech

The financial services industry has developed a wide range of "investment solutions" to attract these retirement savings. Traditionally, the industry (banks, brokers, mutual fund companies and their distribution networks, as well as private management firms) has focused on two main areas:

1. You need a portfolio manager who knows how to select "winners" - which will outperform - and avoid "losers";

2. Your advisor/manager must also be adept at predicting major market cycles and selling a portion of your stock portfolio before a market decline and buying back before the market rises

To use an industry phrase: you need to invest like Warren Buffett. The problem is that neither you nor your advisor has the talent (or the billions!) of Warren Buffett!

Mission impossible

The first objective - to beat the market by selecting winning stocks - is mathematically impossible for the mass of investors. William Sharpe, a Nobel Prize winner in finance, demonstrated this in 1991[1 ] with a simple rule of 3. His argument is irrefutable: not everyone can have a return above the average (which is the index), any more than all students in a class can have a grade above the class average. At best, the average investor will realize the return of the index minus the fees incurred, hence the importance of paying as few fees as possible.

If you are not convinced by Sharpe's article, you should know that less than 10% of Canadian mutual funds have outperformed the stock market index over the past 10 years. [2] In fact, almost two-thirds of the funds have performed so poorly over the past 10 years that they have simply had to be closed! And if you think that it is enough to invest in the 10% of funds that have performed well in the past, think again: a majority of them will probably be among the losers of the next 10 years!

The second goal - trying to avoid market downturns - is even more unattainable: on average, investors who try to do this get about 5% less annual return than if they did nothing! Why do they do this? Simply because they give in to their impulses and tend to sell following a downturn and thus miss the powerful stock market rebounds that usually follow such declines.

Are you anxious about all this? Don't despair, the solution is simple.

Mrs. Buffett's portfolio

Warren Buffett himself said it: there is no need to beat the stock market or predict stock market cycles. Just invest in low-cost index funds (the S&P500 and a bond fund in his case) and hold them for the long term. This is the portfolio he recommends to his wife!

In other words, he recommends buying a stake in "USA Inc" (because that's what the S&P500 index of the 500 largest publicly traded companies is) without worrying about which sector or company will do best, and growing that stake over your lifetime. You'll reap the annual dividends paid by the S&P500 companies and benefit from their long-term growth.

The Canadian equivalent of Buffett's portfolio consists largely of a holding in "Canada Inc", the S&P/TSX Composite Index of the largest publicly traded Canadian companies. But because the Canadian economy is small on a global scale and our stock market is concentrated in certain sectors (notably natural resources), we diversify by adding a healthy dose of USA Inc, World Inc (Europe, Australasia and the Middle East) and Emerging Markets Inc to the recipe.

Like Mrs. Buffett, we balance the portfolio with bonds (you guessed it, by buying a bond index fund), which are an insurance policy against economic downturns. You can also add diversification with a real estate trust index fund.

If you can't invest like Warren Buffett, you should invest like his wife. There is no other investment strategy available to you that offers better return prospects. This approach is available to all investors, regardless of their portfolio size or level of knowledge. If you have the knowledge and discipline, you can do it yourself at a discount broker. If not, your financial advisor can do it for you. Either way, your fees will be significantly lower than the average investor and your returns will be higher.

Combined with a good financial plan that your advisor will develop with you, this investment strategy should help you reach your financial goals and lower your anxiety level!

[1]Sharpe William, The Arithmetic of Active Management, The Financial Analysts' Journal Vol. 47, No. 1, January/February 1991. pp. 7-9[2]SPIVA Canada Scorecard, 2018