Usually the super-wealthy get the best things in life,
Warren Buffett says, but when it comes to investments, you actually have a huge
advantage. Specifically, if you are not doing a better job with your money than
millionaires or college endowment funds, you could be, despite their resources
and investment opportunities.
As you might imagine, Buffett, the chairman of Berkshire
Hathaway, gets asked for investment advice (and general life advice) from time
to time. He’s long recommended that people keep their investing cheap and
simple, by putting their money in low cost funds that track the stock market.
Of his friends, Buffett says, only ordinary investors
tend to heed this recommendation. “I believe … that none of the mega-rich
individuals, institutions or pension funds has followed that same advice when
I’ve given it to them,” Buffett wrote in his annual letter to Berkshire
shareholders, which was released Saturday. “Instead, these investors politely
thank me for my thoughts and depart to listen to the siren song of a high-fee
manager.”
By having the humility to simply accept the returns of
the stock market, and paying next to nothing in expenses, ordinary investors
will outpace most pros.
Hedge funds, a popular choice for wealthy individuals,
are costly, as fund managers tend to charge a 2% fee on the money you invest and
a 20% fee on money that the fund earns you. That’s great for them, but it tends
to be a lousy deal for their investors. Not only are these investments
expensive, but overall, they have miserable track records relative to the
S&P 500. So, while you’d pay a hedge fund $20 for every thousand you
invest, while also sacrificing a chunk of any gains, you can pay mutual funds
or ETF providers such as Fidelity, Vanguard, and Schwab just $1 or less, and
keep all gains. Over time, with compounding, those lower fees will make a big
difference.
Investors, however, continue to put their money into
hedge funds, which employ complex investment strategies, such as shorting
stocks to bet on price drops. Buffett thinks he knows why wealthy investors
keep playing an expensive, losing strategy. “The financial “elites” … have
great trouble meekly signing up for a financial product or service that is
available as well to people investing only a few thousand dollars,” he wrote.
“This reluctance of the rich normally prevails even though the product at issue
is – on an expectancy basis – clearly the best choice.”
While actively managed funds have made a bit of a
comeback in recent months, listen to Buffett: Investing in index funds is still
the “best choice” – not just for young adults who are just starting out with
their retirement funds, but also more generally. You can build a portfolio that
gives you exposure to all the key areas of the investing world with only a
couple cheap index funds or ETFs. Over time, you’ll enjoy solid returns. And
then, when you become a millionaire, you don’t have to change your strategy.
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