Even Warren Buffett Thinks Stock Picking is Hard

Warren Buffett is arguably the greatest investor of all-time.

In his recent shareholder letter, even he — The Oracle of Omaha — admitted how hard it is to consistently pick winning stocks.

Buffett summed up 58 years managing capital in the following:

At this point, a report card from me is appropriate: In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so. In some cases, also, bad moves by me have been rescued by very large doses of luck. (Remember our escapes from near-disasters at USAir and Salomon? I certainly do.) Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years – and a sometimes-forgotten advantage that favors long-term investors such as Berkshire.

The lesson for investors boils down to the following:

The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.

A few big winners carry most of the freight in an investing lifetime. In a hyper-competitive world, the idea there are important investing decisions to be made on a daily basis couldn’t be further from the truth.

As Buffett’s partner Charlie Munger is fond of saying, “The big money is not in the buying and selling, but in the waiting.”

Using data from Morningstar, look at the returns of active managers in aggregate. Only one asset class (US Real Estate) has more than 50% of managers outperforming their benchmark over a 10-year time horizon.

Most active managers don't add any value.

The reason it’s so hard to outperform an index is because the biggest returns come from so few stocks. And if you don’t own those few outperformers, there’s little chance to beat the index.

One interesting paper on this topic comes from Henrik Bessembinder, who found 26,168 firms listed public equity between 1926 and 2019. 15,132 of those companies (58%) underperformed risk-free treasury bills during their time as public equity.

The image below from Dimensional Fund Advisors roughly finds the same result, though depicted differently.

From 1994-2016, missing just the top 10% of performers each year in the S&P 500 takes the annualized performance of the index from 7.3% to 2.9%. And if you remove the top 25% of performers, the returns fall to (-5.9%).

If you don’t own the best performing stocks, it’s virtually impossible to beat an index.

The result of this? More money is flowing into low-cost index funds.

Last March, for the first time in history, retail investors’ index fund holdings exceed their holdings in actively-managed funds, according to data from Morningstar.

During his long investing career, Buffett has internalized most of this data. Which is why his most common advice to investors is one simple tip:

"Consistently buy an S&P 500 low-cost index fund. I think it's the thing that makes the most sense practically all of the time."

None of this is to say indexing is perfect or easy. Rather, it’s a good place to start and likely the most practical advice for the majority of investors.

It certainly doesn’t have to be all or nothing; there is room for active and passive in a diversified portfolio. Owning stocks can be fun and rewarding in a way that ETFs can’t replicate.

But the point remains, there’s not a new stock to be purchased every day. The truly great opportunities only come around so often. The most important thing is deciding what mix is right for you and sticking with it!

After all, the big moneys not made in the buying and selling…