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Warren Buffett’s Surprising Advice

With his latest annual report to shareholders in his Berkshire Hathaway investment fund, multi-billionaire Warren Buffett — the world’s most successful investor, and its fourth-richest individual — has again created headlines.

83-year-old Buffett probably didn’t expect to outlive his first wife, Susie, who died in 2004. But he certainly seems to think it unlikely that he’ll outlive his second wife, long-time partner Astrid Menks.

Which is why, he explains to Berkshire Hathaway shareholders, he has left explicit instructions as to how investments held in trust for her after his death are to be managed.

Low-cost growth

Having gathered some of the world’s best fund managers and investment experts around him, you might expect that Buffett would simply rely on their expertise. Not so.

“My advice to the trustee could not be more simple,” he wrote earlier this year. “Put 10% of the cash in short‑term government bonds, and 90% in a very low‑cost S&P 500 index fund.”

In other words, forget trying to pick stock market winners, and instead buy a low-cost basket of shares that aims to simply mirror the relevant stock market index.

Beat the professionals

Why does this endorsement of cheap-and-cheerful index trackers matter?

Because — literally — it’s a case of Buffett putting his money where his mouth is. He and long-time sidekick Charlie Munger have long urged ordinary retail investors to put their money in index trackers. But now, he’s taking his own advice.

Here’s Buffett in 1993, for instance:

“By periodically investing in an index fund, for example, the know‑nothing investor can actually out‑perform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”

And again in 1996:

“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”

And yet again, in 2007:

“A very low‑cost index is going to beat a majority of the amateur‑managed money or professionally managed money… The gross performance [of a hedge fund] may be reasonably decent, but the fees will eat up a significant percentage of the returns. You’ll pay lots of fees to people who do well, and lots of fees to people who do not do so well.”

In short, instead of aiming to beat the market, investors should simply aim to buy the market. As Buffett points out, after fees and expenses are taken into account, a low-cost tracker is the surest way to bank on the stock market.

The income option

Yet there’s one group of investors for whom Buffett’s savvy advice perhaps doesn’t apply: income investors.

Because the stark fact is that while index trackers provide a decent home for long-term savings, their yield is — naturally — no better than that of the stock market as a whole. And for the FTSE All-Share, for instance, that’s around 3.5%.

Which is one reason why savvy income investors are increasingly looking at putting their money into decent, higher-yielding dividend-paying shares.

It’s what I’m doing myself, for instance, building up a steady stream of income from companies such as Royal Dutch Shell, GlaxoSmithKline and Unilever.

And depending on the individual shares that you pick, it’s possible to obtain a yield from blue-chips that’s 50% higher than that obtainable from the market as whole.

Better still, with shares held directly, there’s no fund manager to pay — even the minimal 0.15%-0.25% fees charged by market-leading low-cost index trackers.

But which shares to buy? And which companies have the makings of a decent, dividend-paying share that will reliably churn out dividends--and dividend growth--for 10, 20 or 30 years?

So if you're thinking about questions such as these, then I recommend downloading The Motley Fool's latest free wealth report, entitled How To Create Dividends For Life. As I say, the report is completely free, and without obligation, so to get your copy today, click here now.

Malcolm owns shares in Royal Dutch Shell, GlaxoSmithKline, and Unilever. The Motley Fool owns shares in Unilever and has recommended shares in GlaxoSmithKline.

See all articles by Malcolm Wheatley