Warren Buffett is well-known for massive investments totalling billions of dollars. But it wasn’t always that way. Buffett started his investment journey younger than most, as a schoolboy. What does resonate with a lot of other investors’ experience is that when he started, Buffett wasn’t working with a huge pool of capital like he is now. He saved up earnings from part-time jobs like a paper round and began investing on a small scale.
So, even if I was investing just a few hundred pounds, I think I could learn lessons from Buffett. But they are surprising ones.
Buffett on active trading
Buffett is best known for what is called active trading. In other words, he purposely chooses specific companies in which to invest.
That is different to what is known as passive investing. Passive investing is where a fund such as a unit trust basically tracks a basket of shares, for example the FTSE 100 index. Instead of actively moving in and out of shares like Buffett, passive managers usually just invest their funds using an automatic programme so that the portfolio mimics a share index.
It’s not what he’s famous for, but Buffett is an advocate of passive investing in many cases. In fact, Buffett reckons many investors would be better off putting all their investment capital into index funds. In his 2005 shareholders’ letter, Buffett argued that “active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still.”
The reason for that is not that Buffett doesn’t think at least some active managers can be good stock pickers. It is primarily because of the cumulative effect of the fees they charge. Even if those fees sound small, over many years they could add up to a huge amount. That could more than consume any additional benefit active management may offer over passive management.
Does this Warren Buffett advice apply to me?
But wait a minute. What if I don’t want to buy an actively managed fund, but instead choose my own shares? I won’t be charged a management fee for share picking in that case. So would Buffett’s advice still be the same?
In short, yes. Even without concerns about expensive fees, Buffett reckons that for most investors, the most suitable investment would be an index fund. Buffett made the point again bluntly at this year’s annual meeting of his company, Berkshire Hathaway. He said, “I do not think the average person can pick stocks”. With only £350 to invest, the room for error is small. It can also be hard to diversify by buying lots of different shares, as trading fees would eat into the capital fast.
So, with £350 to invest, Warren Buffett is clear that for most people, the best course of action would be to buy a low-cost index fund. Note, however, that he doesn’t say no one can pick stocks. After all, Warren Buffett can: he’s got rich doing exactly that. Instead, Buffett is talking about the average person. If I have some edge in terms of temperament or analytical mind set compared to the average person, maybe I could put £350 into shares I picked. Otherwise, listening to Buffett, a low-cost index fund might be the most suitable investment for me.
Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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