Warren Buffett's Advice for Investors: Don't Pick Stocks Like Me

Warren Buffett
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Warren Buffett is arguably the greatest living investor. Buffett turned an investment in a failed textiles firm into the number-four company on the Fortune 500 list, and his personal wealth has ballooned to over $60 billion, making him the third wealthiest person on earth.

Given his decades-long track record in the market, many investors want to learn how to pick stocks like Buffett. But for individual investors, including his own wife, Buffett continually comes back to a very basic investment strategy—and it's a strategy that has nothing to do with picking individual stocks.

Buffett’s Advice for His Wife

In his 2013 annual letter to shareholders, Buffett addressed his own mortality and offered clear instructions to the trustee charged with managing his vast estate for his wife.

“My advice to the trustee could not be more simple. Put 10% of the cash in short‐term government bonds and 90% in a very low‐cost S&P 500 index fund. I believe the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions, individuals—who employ high-fee managers.”

And it's advice he's repeated again and again. At the 2016 annual meeting of Berkshire Hathaway shareholders, often called the “Woodstock of Capitalism,” Buffett responded to a question on how an average investor should manage their funds: “Just buy an S&P index fund and sit for the next 50 years.”

Buffett’s disdain for expensive investment managers is clear.

And he doesn’t suggest his trust hold a single stock, not even his own Berkshire Hathaway. Instead, he funnels stock investments into an S&P 500 index fund, a type of mutual fund that follows the performance of 500 of the largest public companies in America.

Buffett’s strong belief in the S&P 500 is so strong that he bet $1 million that the S&P 500 would outperform a selection of top hedge funds over time.

As of now, it looks like Buffett is on track to win.

But Doesn’t Warren Buffet Invest in Individual Stocks?

You might be wondering why Buffett's own company doesn’t follow his advice. After all, Berkshire Hathaway was built on investing in individual companies, and its portfolio contains billions of dollars of stock investments in companies including Wells Fargo, American Express, and Coca-Cola.

It's a portfolio built on a philosophy called value investing, which was pioneered by Buffett’s mentor and professor Benjamin Graham. Value investing ignores swings in the markets and focuses on the intrinsic value of a company. Buffett and his team focus on finding companies that have a competitive advantage, great management, and have a higher value than the current stock price.

Buffett’s favorite metric for measuring a company’s value is book value per share. This measures the value of the company’s assets compared to the share price, giving you a conservative gauge of what the company is worth.

If you wanted to pick stocks, value investing would be a fine strategy to follow. Still, keep in mind that Buffett and his investment team manage billions of dollars in assets, and have the ability to make massive investments and influence the operations of the companies in the Berkshire Hathaway portfolio.

 Individual investors are typically working with thousands of dollars, not billions, and do not have the time, assets, or expertise to mimic Buffett’s success.

The Wisdom of Picking Stocks

Another important difference is that individual investors, unlike a huge institutional investor like Berkshire Hathaway, are less able to handle the big losses that come with investing in the market. 

And make no mistake: Those losses will come. Everyone's heard a story from someone who made a great stock pick and struck it rich—whether it's buying Google or Netflix stock at a low price shortly after their ​IPOs, or picking up an airline stock just after the September 11th attacks. But you are less likely to hear someone who lost everything when Enron fell to a scandal, or from the shareholders in GT Advanced Technologies who saw their stock become nearly worthless when Apple picked a new supplier for its glass iPhone screens.

Just as there are stories of glory in the stock market, there are stories of big losses.

How to Structure Your Portfolio

If you want to follow Buffett's advice for individual investors, here's one way you might go about it. As a reminder, here is his basic advice for structuring a portfolio built around index investing: "Put 10% of the cash in short‐term government bonds, and 90% in a very low‐cost S&P 500 index fund."

Let's start with those bonds. As with the S&P 500, you can buy a mutual fund or ETF to invest in a basket of short-term government bonds. Vanguard offers its own Short-Term Government Bond ETF with ticker VGSH. A lower cost Admiral Shares mutual fund is also available under ticker VSBSX.

As for that "very low‐cost S&P 500 index fund”? For this portion of the Buffett portfolio, there are plenty of fund options. Most investors would start with the Vanguard S&P 500 ETF, ticker symbol VOO. It is also available as a mutual fund, ticker symbol VFINX. Investors with at least $10,000 to dedicate to this investment can get lower fees though the Admiral Shares mutual fund, ticker symbol VFIAX.

We've used Vanguard funds in this example because of their low fees, but whatever brokerage you use will have similar options.

The Benefits of Index Funds

Investing in index funds has a lot of advantages over stock-picking.

Instant diversification: When buying individual stocks, it takes quite a bit of time and money to build up a diverse portfolio. It is important to implement diversification across both companies and industries. An investment in an S&P 500 index fund gives you 500 companies at once. Top holdings by weight include Apple, Microsoft, Exxon Mobil, Johnson & Johnson, Berkshire Hathaway, General Electric, and JP Morgan Chase. Learn more about the S&P 500 list on the official page at Standard & Poor’s.

A bet on the U.S. economy: Betting on the 500 biggest public companies in the United States is comparable to a bet on the overall United States economy. While one company may follow Enron’s fate on occasion, these are stable, Blue Chip companies that will see long-term stability.

Easier to control emotions: The best investment plan is to continue to contribute little by little over time. When you buy and sell individual stocks, you are always in the mindset of buying and selling. This inevitably leads many investors to buy and sell at the wrong time. It is virtually impossible to time the markets. Instead, follow a tried and true course where you enjoy the big upswing after a turbulent market period.

Lower trade fees: You can trade some stocks for free thanks to new brokerages like Loyal3 and Robinhood, but most brokers still charge around $10 per trade. Buying and selling stocks to build a portfolio can easily cost hundreds or thousands of dollars. However, most large brokerage firms offer access to their own S&P 500 index fund for no fee. If you don’t have a favorite, you can follow Buffett’s advice to buy the Vanguard version of the fund. Vanguard offers free trades of its own funds if you open a free Vanguard account.

Retire like Warren Buffett.