Why Warren Buffett Is a Terrible Guide for Small Investors

Sure, Warren Buffett is America's second-richest man, and the stock of his company, Berkshire Hathaway (BRK.A), has had compounded returns of 20.2% for the past 46 years. But does that mean when the "Oracle of Omaha" speaks about investing, the small investor should try to do what Warren does?

Over the weekend, Buffett released an upbeat assessment of his company and the American economy in his annual letter to investors. Several days later, while appearing on CNBC, he gave his view on investing in stocks vs. bonds.

"I think it would be very, very foolish to have your money in long-term fixed-dollar investments or short-term fixed-dollar investments if you had the ability to own equities and hold them for a considerable period of time," Buffett said.

What Would Warren Do?

So should investors run out and sell their Treasury bills and buy stocks? Amazon is full of books about how to invest "the Warren Buffett way" -- and some clever entrepreneurs even sell online courses in Buffett-style investing. But can the little guy actually make money that way?

"You can't do what he does," says William J. Bernstein, an investment adviser and author of The Investor's Manifesto: Preparing for Prosperity, Armageddon and Everything in Between, an investment guide that advocates putting money in a mixture of bond and stock index funds.

"Why do you have to listen to Warren Buffett tell you to buy equities?" Bernstein asks. "He was also telling you to buy stocks 18 months ago -- why weren't you listening to him then?"

"You'll Always Be Three Steps Behind"

Meir Statman, a professor of finance at Santa Clara University in California and author of the recent book, What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions, says small investors can't make money trying to copy Buffett's admittedly brilliant investment style.

"Don't try to emulate Buffett, though it's tempting to try," Statman says, "because you'll always be three steps behind him. When he buys a stock of an individual company, Buffett doesn't say 'in a week I'm going to buy this stock.' He buys it, and you'll find out a week or a month or a year later. And when he sells, you'll find out too late."

Although Buffett likes to call himself a value investor, he hasn't followed in the footsteps of classical value gurus like Benjamin Graham and David Dodd. For one thing, Berkshire makes much of its money -- $2 billion in profit last year -- simply earning a return on the "float" of its insurance companies, which has nothing to do with buying the shares of a company that seem underpriced by some form of financial analysis.

Why Buy High?

He also likes companies with so-called intangible value -- the cachet of Coca-Cola's (KO) brand, which arguably isn't a value company, either.

"Buffett was never a cigar-butt investor in the style of Ben Graham's investing," says Bernstein. "You can't do what Buffett does. He doesn't buy stocks, he basically buys companies and takes a corner office. He buys huge blocks of stock when he can pick it up for next to nothing."

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In fact, Bernstein disagrees with Buffett's investment advice; saying this isn't the time to buy equities. "The time to be piling into stocks was in 2008 and 2009 when stocks were low," Bernstein says. "What makes you think buying when stocks are high is a good idea? Whatever your stock allocation was 18 months ago, it should be lower now because stocks are more expensive."

Both Bernstein and Statman are equally dubious about even buying Berkshire Hathaway stock -- despite Buffett's legendary reputation as a picker of great businesses, such as his 2010 purchase of Burlington Northern Santa Fe Railroad.

Bernstein says Berkshire carries an enormous premium compared to what it actually owns. "There's a Buffett premium that's built into Berkshire, and he's no spring chicken. The minute he catches a cold, the Berkshire premium is going to disappear." Buffett turned 80 last year.

Holding on to Those Treasury Bills

Statman is also cautious on the stock. "Whenever you buy shares of Berkshire Hathaway, you're buying from another shareholder," he says. "Unless that other shareholder is totally or generally underestimating Warren Buffett's abilities and therefore getting rid of the stock at some bargain price, you're not going to benefit from it."

And what about those long- and short-term fixed-dollar investments that Buffett advised against?

According to the Berkshire Hathaway annual report, the company held $33 billion in fixed-income investments, including U.S. Treasurys and corporate bonds, and $34.7 billion in cash and cash equivalents, which include Treasury bills, money market funds and other investments of three-months duration or less.

Buffett told the story of how his grandfather gave his children $1,000 each and advised them not to invest the money, because they always might need cash. He explained that's why his company is holding over $30 billion in cash now.

So, Bernstein says Buffett shouldn't be advocating that investors sell their short-term Treasurys to buy stocks. "If we get horrible inflation, or stocks plunge," he says, "I'm going to feel pretty good about my Treasury bills."

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