Why Warren Buffett Is a Terrible Guide for Small Investors

Sure, Warren Buffett is America's second-richest man, and the stock of his company, Berkshire Hathaway (BRK.A), has had compounded returns of 20.2% for the past 46 years. But does that mean when the "Oracle of Omaha" speaks about investing, the small investor should try to do what Warren does?

Over the weekend, Buffett released an upbeat assessment of his company and the American economy in his annual letter to investors. Several days later, while appearing on CNBC, he gave his view on investing in stocks vs. bonds.

"I think it would be very, very foolish to have your money in long-term fixed-dollar investments or short-term fixed-dollar investments if you had the ability to own equities and hold them for a considerable period of time," Buffett said.

What Would Warren Do?

So should investors run out and sell their Treasury bills and buy stocks? Amazon is full of books about how to invest "the Warren Buffett way" -- and some clever entrepreneurs even sell online courses in Buffett-style investing. But can the little guy actually make money that way?

"You can't do what he does," says William J. Bernstein, an investment adviser and author of The Investor's Manifesto: Preparing for Prosperity, Armageddon and Everything in Between, an investment guide that advocates putting money in a mixture of bond and stock index funds.

"Why do you have to listen to Warren Buffett tell you to buy equities?" Bernstein asks. "He was also telling you to buy stocks 18 months ago -- why weren't you listening to him then?"

"You'll Always Be Three Steps Behind"

Meir Statman, a professor of finance at Santa Clara University in California and author of the recent book, What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions, says small investors can't make money trying to copy Buffett's admittedly brilliant investment style.

"Don't try to emulate Buffett, though it's tempting to try," Statman says, "because you'll always be three steps behind him. When he buys a stock of an individual company, Buffett doesn't say 'in a week I'm going to buy this stock.' He buys it, and you'll find out a week or a month or a year later. And when he sells, you'll find out too late."

Although Buffett likes to call himself a value investor, he hasn't followed in the footsteps of classical value gurus like Benjamin Graham and David Dodd. For one thing, Berkshire makes much of its money -- $2 billion in profit last year -- simply earning a return on the "float" of its insurance companies, which has nothing to do with buying the shares of a company that seem underpriced by some form of financial analysis.

Why Buy High?

He also likes companies with so-called intangible value -- the cachet of Coca-Cola's (KO) brand, which arguably isn't a value company, either.

"Buffett was never a cigar-butt investor in the style of Ben Graham's investing," says Bernstein. "You can't do what Buffett does. He doesn't buy stocks, he basically buys companies and takes a corner office. He buys huge blocks of stock when he can pick it up for next to nothing."

In fact, Bernstein disagrees with Buffett's investment advice; saying this isn't the time to buy equities. "The time to be piling into stocks was in 2008 and 2009 when stocks were low," Bernstein says. "What makes you think buying when stocks are high is a good idea? Whatever your stock allocation was 18 months ago, it should be lower now because stocks are more expensive."

Both Bernstein and Statman are equally dubious about even buying Berkshire Hathaway stock -- despite Buffett's legendary reputation as a picker of great businesses, such as his 2010 purchase of Burlington Northern Santa Fe Railroad.

Bernstein says Berkshire carries an enormous premium compared to what it actually owns. "There's a Buffett premium that's built into Berkshire, and he's no spring chicken. The minute he catches a cold, the Berkshire premium is going to disappear." Buffett turned 80 last year.

Holding on to Those Treasury Bills

Statman is also cautious on the stock. "Whenever you buy shares of Berkshire Hathaway, you're buying from another shareholder," he says. "Unless that other shareholder is totally or generally underestimating Warren Buffett's abilities and therefore getting rid of the stock at some bargain price, you're not going to benefit from it."

And what about those long- and short-term fixed-dollar investments that Buffett advised against?

According to the Berkshire Hathaway annual report, the company held $33 billion in fixed-income investments, including U.S. Treasurys and corporate bonds, and $34.7 billion in cash and cash equivalents, which include Treasury bills, money market funds and other investments of three-months duration or less.

Buffett told the story of how his grandfather gave his children $1,000 each and advised them not to invest the money, because they always might need cash. He explained that's why his company is holding over $30 billion in cash now.

So, Bernstein says Buffett shouldn't be advocating that investors sell their short-term Treasurys to buy stocks. "If we get horrible inflation, or stocks plunge," he says, "I'm going to feel pretty good about my Treasury bills."

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Major Fraud Alert

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May 29 2011 at 12:44 AM Report abuse rate up rate down Reply

Warren needs to start thinking about all the people that works for him that makes him all that money and give them some instead of giving it all away to gates i am sure all of his employes would love to see a big bonus check but no all of us middle class people dont count to them

March 26 2011 at 10:24 AM Report abuse rate up rate down Reply

Small investors are always wrong! Treir timing is atrocious. If the little guy is bearish it's time to buy, if he's bullish it's time to sell!

March 05 2011 at 8:53 PM Report abuse rate up rate down Reply

I was looking over my mom's retirement funds the other day. Her stocks invested in a blue chip fund made about 100-120% over the past 20 years which is OK, not great. But her bonds made only about 9% average for the PAST 20 YEARS! TOTAL! That doesn't even keep up with inflation which averages about 3-4% a year. That return is horrible! Read Benjamin Graham's Intelligent Investor and invest in good, financially sound companies if you're going to go at it by yourself or find a good, honest value investor. I don't know much about bonds, I'm sure for some they are a good investment, maybe, and you should NO WAY put all of your money into stocks, but a 9% return over 20 years is abysmal. If I had extra money to spare maybe I would buy US Government bonds, maybe. But that would have to be a lot of extra money.

March 05 2011 at 6:08 PM Report abuse rate up rate down Reply

Hmm should I take advice from the little "business" journalist about investing or one of the richest men in the world.... More so a rich man who thinks he should pay more in taxes... I dont see pat roberson doing that...

March 05 2011 at 5:14 PM Report abuse +1 rate up rate down Reply

Anyone who is smart can duplicate Warren Buffets method of stock trading.
Losers cannot. Warren only buys shares in Profitable Companies that are well managed and that have a long history of profitability and a decent return to investors. He buys shares in companies that are already leaders in their business their sector.
The average investors are fools and they buy shares in the Hyped up stocks of the day looking to make a fast buck and instead hey lose their bucks fast.
The average investor is far too lazy to read earnings reports and to look into the history of the companies they buy shares in.

March 05 2011 at 2:40 AM Report abuse +1 rate up rate down Reply
Mark Anthony Migut

Either embrace "Cyclical index trading" <-- riding indexes in and out over monthly plus range time frames,,,or live the life of a neurotic day trader or the couch potatoe life of a "Bank CD" ownner for life !

But never ever buy things after you have read to buy them , they are being sold by the Buffet man and Wallstreet as you read and click your pathetic day trading mouses......EOM...!!!! ......HAHAHHAHAHHAHHHAAAAAAAAAAAAAAAAAAAAAAA

March 04 2011 at 9:30 PM Report abuse +2 rate up rate down Reply

Buffet is a terrible investment guide. He lives in a $31,500.00 51 year old house and drives a used led sled car. Sorry, but that IS NOT successful financial performance, just a lot of talk...Alfie

March 04 2011 at 3:04 PM Report abuse -2 rate up rate down Reply
1 reply to alfredschrader's comment

"2nd-richest man in USA & 3rd richest man in world" ≠ "successful financial performance"

Sorry, I'm trying real hard, but I can't quite follow that train of thought.
Could you please take pity on a poor, ignorant soul, and explain this in more detail?
Cause if what you're saying is that "successful financial performance" requires extravagant spending, I don't think most people -- especially those who have earned great fortunes -- would agree.
It's more likely that Mr Buffett's choices not to spend his hard-earned money on frivolities and vanity is a part of why he has amassed so much personal wealth (and made so much for his firm's shareholders).
Might want to check out a great book called "The Millionaire Next Door," by Thomas Stanley and William Danko, which goes into this principle in great detail, and with very convincing facts and logic.

March 05 2011 at 1:56 PM Report abuse +3 rate up rate down Reply

An old man on the street corner with a tin can in his hand asking for money gave the best advice ; Take every dime you are offered , steal the rest and horde it all , let family and friends mean nothing only money and worship it as a God .

March 04 2011 at 2:26 PM Report abuse -2 rate up rate down Reply

Warren just sneezed , SELL , SELL !!!!!!!!!!
Depends Diaper Stock just skyrocketed when Buffett got constipation .

March 04 2011 at 2:22 PM Report abuse -1 rate up rate down Reply