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Articles on this Page
- 08/04/14--06:00: _Here's How Simply I...
- 08/11/14--06:07: _Here's How Investin...
- 09/25/14--06:00: _12 Wacky (and Not-S...
- 04/13/15--10:00: _7 Stocks Warren Buf...
- 06/15/15--06:00: _The 5 Best Pieces o...
- 09/02/15--06:00: _14 of the Coolest S...
- 09/22/16--02:00: _7 Reasons You Shoul...
- 03/24/17--03:00: _5 Surprising Budget...
- 04/10/17--02:00: _Why Warren Buffett ...
- 07/12/17--01:30: _How to Buy Berkshir...
- 09/21/17--01:31: _Bookmark This: A St...
- 09/29/17--01:30: _Why the Dow Will Hi...
- 08/04/14--06:00: Here's How Simply Investing in Companies You Love Can Make You Rich
- 08/11/14--06:07: Here's How Investing in Companies You Hate Can Make You Rich
- 09/25/14--06:00: 12 Wacky (and Not-So-Wacky) Investment Strategies That Actually Work
- 04/13/15--10:00: 7 Stocks Warren Buffett Loves — And You Should, Too
- 06/15/15--06:00: The 5 Best Pieces of Financial Wisdom From Warren Buffett
- Retirement account: Participate in your employer's retirement plan or set up your own, such as a Solo 401(k), to build up your nest egg and postpone your tax bill until retirement.
- Savings account: Set up an automatic monthly deposit into your savings account. Take advantage of high-yield online savings accounts, such as Ally Bank and Capital One 360.
- Emergency fund: 26% of Americans have no emergency savings.
- 09/02/15--06:00: 14 of the Coolest Sayings About Investing
- 09/22/16--02:00: 7 Reasons You Shouldn't Invest Like Warren Buffett
- 03/24/17--03:00: 5 Surprising Budget Habits of Wealthy Financial Gurus
- 04/10/17--02:00: Why Warren Buffett Says You Should Invest in Index Funds
- Index funds buy a mix of stocks in a proportion that represents the overall stock market or a particular market segment. Index funds are typically managed automatically by a computer algorithm, and management fees for this type of fund are usually very small — around 0.1 percent or sometimes even lower.
- Hedge funds put money into alternative investments that can go up if the stock market goes down. Of course, hedge funds also try to provide maximum returns and beat the stock market if possible. Hedge funds may invest in real estate, commodities, business ventures, and other opportunities that fund managers think will hedge against potential stock market losses and produce good returns. These funds are actively managed and have high management fees of around 2 percent or more.
- 07/12/17--01:30: How to Buy Berkshire Hathaway and Other Blue Chip Stock for 17% Off
- 09/21/17--01:31: Bookmark This: A Step-by-Step Guide to Choosing 401(k) Investments
- 09/29/17--01:30: Why the Dow Will Hit a Million, Eventually
Putting money in the stock market can seem scary and overwhelming, but there's an approach to making money that even the newest investor can understand. It's also a philosophy followed by some of the most wealthy market gurus.
When it comes to choosing individual stocks, top investors including Warren Buffett and Peter Lynch advise people to invest in what they know and like.
The logic behind "invest in what you like" is quite simple. If people like a product or service, they will buy it. Lots of happy customers means more revenue, and thus a growing stock price. (See also: What Makes a Company an Attractive Investment?)
A look at Fortune's'list of most admired companies could also be a list of some of the best stocks to invest in over time. Nearly all of the firms have seen returns outpacing the broader stock market in recent years.
Here's a look at some well-liked companies and their returns for investors.
Coke and Pepsi
Coca-Cola [NYSE: KO] is one of the most iconic American companies, and one of the world's most valuable brands. PepsiCo [NYSE: PEP] isn't too far behind. The companies placed first and second, respectively, in a CoreBrands survey that sought to determine the most respected brands. These are enormous companies with product lines full of things people love, from soft drinks to Doritos to Quaker Oats.
Investors in Pepsi have seen the company's shares rise about 75% in the last decade, while Coke's prices have gone up about 70%. (It should be noted that Buffett's Berkshire Hathaway owns about 9% of Coca-Cola.) Returns from these companies mirror the S&P 500. Long-term investors have done well and should continue to do well over time with these firms.
Yum! Brands [NYSE: YUM]
Pizza Hut? Taco Bell? KFC? You're talking about three of the most popular restaurant chains in the world. If you eat at these places all the time, why not invest in the parent company?
After being spun off from Pepsi back in 1997, Yum! Brands has become a truly international phenomenon, getting nearly 70% of its revenues from overseas. It already operates more than 3,800 restaurants in China, and its latest move has been to bid for Little Sheep Group, a popular hot-pot chain in the world's most populated country. In the last 10 years, Yum! share prices have risen more than 300%, or more than triple the S&P 500.
Apple [NYSE: APPL]
When people camp out for days to get their hands on your new products, you know you're on to something. It's been a little while since Apple blew anyone away with a new device, but anyone who invested in this company early made a killing. Shares since 2004 have risen nearly 2,000%, making it one of the best performing stocks in recent years.
Google [NASDAQ: GOOG]
One of the few companies to rival Apple in the tech space, Google went public in 2004 and has been a gangbuster ever since. The company dominates the search engine space, and its Android mobile platform has spawned numerous viable competitors to Apple's iPhone.
Early investors in Google would have seen shares rise nearly 1,000% over the decade, and there's almost no window of time when Google's share prices haven't greatly outperformed the S&P 500.
Disney [NYSE: DIS]
Who doesn't love Mickey Mouse and Co.? This company is an entertainment behemoth, with properties that include ABC and ESPN, Pixar and Marvel Entertainment, and 11 parks and resorts. In the last decade, Disney investors have seen a 250% return, with much of that gain in the last five years.
Starbucks [NASDAQ: SBUX]
If you can't get through the day without a tall caramel macchiato, you're not alone. Starbucks has leveraged America's coffee addiction and seemingly placed a coffeeshop at every corner. The Seattle-based chain now boasts quarterly sales of nearly $4 billion, and investors have been jumping for joy even without the aide of caffeine. An investor who bought Starbucks stock in 2004 has seen prices rise more than 230%, or nearly double that of the NASDAQ.
Nike [NYSE: NKE]
This company helped bring along the fitness craze more than 40 years ago and hasn't slowed down since. Athletic shoes and apparel is a competitive market, but Nike has consistently managed to shine, as partnerships with top athletes Michael Jordan, LeBron James, and Tiger Woods have proven to be lucrative. In the last decade, shares of Nike have risen more than 300%, or nearly four times that of the S&P 500.
Can you think of any other well-regarded companies that are also great long-term investments? Please share in comments!
It's often been said that one simple and effective investment strategy is to invest in companies you know and like.
This is a good approach to getting a solid return on your portfolio, but it's worth noting that investors can also make money taking an opposite approach. (See also: Here's How Investing in Companies You Love Can Make You Rich)
Strange as it may sound, "buy what you hate" may also be an effective investment philosophy when you examine the long-term investment gains on companies with negative reputations.
Simply put: A company's popularity (or lack thereof) is not always reflected in its balance sheet. In fact, some companies may make great investments due to their ruthless focus on profits above most other considerations. Moreover, some companies may be disliked because of their dominant position in the market.
Here's a look at some companies that many Americans seem to hate, but that still offer better-than-average investment returns.
Your Cable Company
On the popularity scale, cable companies rate somewhere in between dentists and waiting in line at the DMV. A typical person's Facebook feed is likely rife with complaints about high prices and shoddy customer service their local cable TV co provides. In fact, Comcast [NASDAQ: CMCSA] and Time Warner Cable [NYSE: TWC] were recently named two of the most-hated companies in America by the University of Michigan's Ross School of Business.
But if you've invested in either of these companies, you probably have made out very well, as they offer television and high-speed Internet services that many Americans can't seem to live without.
Comcast started out as a small cable provider in Philadelphia and is now one of the nation's largest companies, with revenues of more than $64 billion in 2013. Its share price has risen 200% since 2004, compared to 130% for the NASDAQ as a whole.
Since being spun off from Time Warner in 2009, Time Warner Cable has seen share prices rise nearly 400%.
Comcast in February announced it would seek to buy Time Warner Cable in a $45 billion deal that is pending regulatory approval. If it goes through, expect shareholders to make out well.
Other cable companies including Verizon [NYSE: VZ] and AT&T [NYSE: T] have lagged behind the S&P 500, but offer some of the highest dividends around.
Exxon Mobil [NYSE: XOM]
This company gets blamed for everything from global warming to the high cost of gasoline. But even as Americans are starting to drive less and use more fuel-efficient cars, ExxonMobil has continued to rake in the dough, reporting revenues of $420 billion in 2013. Share prices have risen more than 125% in the last decade, well outpacing the S&P 500.
Halliburton [NYSE: HAL]
Often ranked among America's most hated companies, Halliburton was criticized after being awarded a multi-billion dollar contract for work related to the Iraq war. It also pleaded guilty to destroying evidence related to the Deepwater Horizon explosion in 2010.
But controversy has not been bad for investors. Halliburton, which offers products and services for the oil and gas industries, has seen its stock price rise nearly 340% in the last decade.
Monsanto [NYSE: MON]
This St. Louis-based company is the world's largest producer of seeds, and has engineered patented products resistant to herbicides. But it is enemy number one among those opposed to genetically modified foods. Decades before entering the seed business, it produced controversial chemical products including DDT.
But hated or not, Monsanto has grown acres and acres of money for its investors.
Despite a growing movement toward organic foods, Monsanto has seen profits soar and in the last ten years, the company's stock has risen nearly 600%.
Tyco International [NYSE: TYC]
In the early part of the last decade, Tyco was the poster child for ugly corporate excess.
In 2002, then-CEO L. Dennis Kozlowski was forced to resign after throwing a massive birthday party for his wife, complete with an ice sculpture of Michaelangelo's David and a private concert from Jimmy Buffett. He was later convicted in 2005 of crimes related to an unauthorized bonus of more than $80 million. (He was released from jail this past January.)
It was an ugly period for the company, but investors who hung on to shares of Tyco since then have been rewarded. Tyco International has been split numerous times in the last decade, with investors winding up with shares of several well-performing companies including Pentair, TE Connectivity, Covidien, and ADT. Investors can now boast of a diverse set of holdings that includes exposure the industrial supplies, electronics and medical device industries.
Tyco is an example of how corporate scandals are not always an indicator of the strength of a company's underlying business.
McDonald's [NYSE: MCD]
Opinions about McDonald's are certainly mixed, at best. The fast food chain has been blamed for everything from the nation's obesity problem to keeping wages low for workers. But it's still the beefiest restaurant chain in the world, serving 68 million customers a day. McDonald's remains one of the most valuable brands in the world, and pulled in $28 billion in revenue in 2013. In the last decade, McDonald's shares have gone up 250%.
Would you ever consider investing in a company you hate?
There's no single right or wrong way to invest. If there was, we'd all be insanely rich and would not need to read great websites like this one.
The most tried-and-tested approach to investing is to buy and hold. In other words, get into the market as early as you can and don't exit until you absolutely need the money. (See also: 5 Investing Basics That Can Make You Rich)
But not everyone follows that approach. In fact, some people have some truly off-the-wall strategies for growing their portfolio. Here's a look at some of the most common investment approaches, plus a few other more unusual strategies.
In simple terms, this is all about finding stocks that you believe are underpriced. If you have faith in a company's underlying financial strength, you should not be overly worried about its stock price. In fact, you may view this as an opportunity to purchase shares of a great company at a bargain. The key to value investing is to have some understanding of a company's financials and the true reasons why Wall Street may be undervaluing it. Warren Buffett is a big proponent of value investing, and he's done pretty well for himself.
This is a long-term approach to investing that is founded on the premise that it's foolish to try and time the market. If you invest a specific amount of money on a consistent basis — $200 per month, for example — you'll be able to buy more shares when the market goes down and fewer when it goes up. This makes your portfolio less vulnerable to major market drops, but perhaps it's biggest attribute is that it allows disciplined, steady savings.
Lump Sum Investing
This is the counterargument to dollar-cost averaging. A 2012 report from Vanguard suggested that placing a lump sum of money into the markets will result in a higher return than dollar-cost averaging (DCA) about two-thirds of the time. There are supporters in the lump sum and DCA camps, but both are based on three key principles: invest as much as you can, invest early, and invest for the long haul.
This is very similar to value investing, but takes things a step further. Contrarian investors will not only look for value, but embrace stocks that are truly being beaten up by investors, analysts, and the financial media. In other words, if everyone else hates a stock, a contrarian investor will see it as an opportunity.
Top Down Investing
The premise behind this strategy is to look at the big picture of how the economy or overall markets will perform, then determine the sectors that should be expected to do well as a result. Then, you purchase shares in the best-performing companies in that sector. For example, let's assume that everyone is predicting mortgage rates to drop in the near future. A top down investor might then surmise that homebuilder stocks will benefit as a result. Thus, the investor will buy shares in the most well-regarded homebuilder.
Bottom Up Investing
This works in reverse to top down investing. Bottom up investors aren't too concerned with macroeconomic factors. Instead, they will perform rigorous research about individual companies, and will usually look for companies with specific criteria, such as a low price-to-earnings ratio or a certain rate of earnings growth. Bottom up investors generally believe that good companies are good investments, regardless of how the broader economy is faring.
Dogs of the Dow
In simple terms, this strategy calls for investors to find the 10 blue-chip stocks with the highest dividends relative to their stock prices. The theory is that dividends are a more reliable indicator of a company's true worth, and that companies with high dividends but low prices should be poised to rebound. There is some evidence to suggest this strategy can generate some nice returns, but it is not without its critics, who argue that it's no better than investing in the broader stock market. Moreover, this strategy can result in a lot of buying and selling of stocks, which may result in fees and taxes. (Forbes published this takedown of the strategy earlier this year.)
The conventional wisdom surrounding retirement planning is to gradually adjust your portfolio to be more conservative as you approach retirement age. This means moving away from stocks and into safer investments like bonds and cash. There is an inherent logic to this strategy, as no one wants to see their nest egg drop in value significantly just as they retire. But there are some advisors who say it's okay to stay aggressive with your investments even as you age. Rob Arnott of Research Associates claims that his analysis shows that someone starting in bonds and gradually moving into stocks will end up with a greater sum of money in the end.
So who's right? Well, this is a source of considerable debate, but most advisors say it's best to take your own risk tolerance into account when choosing a strategy. And, ultimately the goal should be to put aside enough assets so that either strategy leaves you enough to retire comfortably.
Sell in May, Go Away
This investment approach is based on the idea that the bulk of the stock market's gains take place between the fall and spring. The strategy suggests exiting the markets (or at least taking a more conservative posture) in May, and then returning in October or November. The reviews on this approach are mixed, with advisors generally saying that the stock market is too unpredictable for this to work on a consistent basis. Some observers say it works, but not in election years. Advisors do agree that this strategy of exiting and reentering the market can result in capital gains taxes and fees. So it's worth analyzing your own portfolio to determine whether it makes sense.
Invest Like a Billionaire
If folks like Warren Buffett and Carl Icahn have made billions in the stock market, why don't people just do what they do? There's an argument to be made that an easy way to wealth is to simply have your portfolio mirror that of the world's wealthiest investors.
Last year, Direxion created an exchange traded fund based on its "iBillionaire Index," containing 30 of the S&P 500 stocks most favored by billionaire investors. So, you can literally invest like a billionaire without a whole lot of effort.
You may do well with this investment strategy. After all, billionaire investors are often quite skilled at finding solid, long-term investments. But it's important to remember that they may have access to investments not available to us mere mortals, and their goals, risk tolerances and time horizons may differ.
Do you make decisions based on complex planetary charts and the signs of the Zodiac? Then this investing strategy is for you! There is, believe it or not, a devoted following to this investment approach, which assumes that the movement of the solar system affects the movement of the markets. Is it possible to time the markets based on heavenly knowledge? There's not a lot of of evidence that this is an effective approach, though the author of one astrological investing newsletter claims to have rightly predicted when the market would bottom out in 2009, according to Forbes.
There's always a segment of the population that seeks to find wealth not from traditional markets, but the buying and selling of collectibles and other physical items. From autographed baseballs to Star Wars figurines, there are huge markets out there for all kinds of things. One person is now trying to sell a single card from Magic: The Gathering on eBay for $100,000.
There's not a ton of evidence to show that investing in collectibles is any more lucrative than putting cash in the stock market, but we all seem to know of a guy who sold his comic book collection for a million bucks.
Do you follow any of these investment strategies? Another? Please share in comments!
Warren Buffett is one of the most successful investors of all time. He's also famous for living modestly (he still occupies a very middle class home in Omaha and drives an older vehicle) and investing in products that can be easily understood by anyone. (That's enough to make any Wise Bread reader swoon.) Here are seven of the stocks he loves that we should all seriously consider for our portfolios:
1. Wells Fargo
Mr. Buffett devotes almost a quarter of his stock portfolio to Wells Fargo. Many financial services stocks boomeranged during the recession. In this instance, Wells Fargo's diversification helped cushion them from the losses and rock bottom stock prices that many of their competitors experienced during the depths of the financial crisis. Its motto could be simply stated as "steady as it goes." And if there's anything that Mr. Buffett likes, it's stability.
Coca-Cola is synonymous with Americana. I still remember the iconic commercials from my childhood, and its polar bears remain a staple of Christmas advertising. All of the nostalgia aside, the world's most famous beverage (and brand) has held its value. For almost 40 years, it's steadily climbed its way up in price from $0.81 per share in 1978 to almost $41 per share in 2015.
3. American Express
American Express zeroes in on wealthier customers who tend to experience less strife during a difficult economy. Though Amex experienced a significant decline in its stock price during the most recent recession, it has since bounced back nicely. Since its low of $10 in 2009, the stock has clawed its way back to almost $80 per share, significantly higher than its share price prior to the recession.
IBM is a bit of a roller coaster stock if we focus on any short-term timeframe. However, if we zoom out and take a look at its performance over the long-haul, we see that the highs outweigh the lows. Mr. Buffett is famous for taking the long view, and IBM is a great example of the value of this perspective. Since the doldrums of 2009, IBM has doubled its per share price.
There's plenty of criticism in the press when it comes to Wal-Mart's business practices. Many take umbrage with its employee practices and environmental policies. But when it comes to making an investment in a company that provides returns, Wal-Mart is another stock that consistently delivers for its shareholders. Even during the latest recession when many other companies were bottoming out, Wal-Mart held its value. In the past 20 years, its stock price has grown more than seven times over.
6. Procter & Gamble
Open up your medicine cabinet or look under your sink, and chances are you've got at least one Procter & Gamble product that's a staple in your daily life. Mr. Buffett loves companies like this because they are such a part of the fabric of American consumer's habits. P&G is an innovation leader with a careful and thoughtful eye toward improving the lives of its customers through its products. This commitment shows in its stock price, which has grown by over 28% in the past five years.
7. U.S. Bancorp
Like many of Mr. Buffett's other stock picks, U.S. Bancorp has been on an upward climb since the depths of the latest recession. Though it hasn't seen a dramatic rise in price like American Express and Wal-Mart, it's nonetheless a solid bet thanks to its business spanning the full range of financial services from retail banking, to capital markets, to investment management.
In Mr. Buffett's portfolio we immediately notice one obvious pattern — he invests in brands that are well-known and ubiquitous to American life. In the days of flashy startups, over-the-top IPOs, and Silicon Valley's flashes in the pan, Mr. Buffett provides us with a salient counter example for the prudent investor: invest in what you know and in what everyone else knows, too.
Do you own any of Warren Buffett's favorite stocks? If so, which ones and why?
The "Oracle of Omaha" truly lives up to his name.
Between 1964 and 2014, the S&P 500 increased by a whopping 2,300%. On the other hand, the stock price of Berkshire Hathaway, the company of which Warren Buffett is chairman, president, and CEO, grew an even more mind-blowing 1,800,000% over the same period.
This performance cements Buffett's reputation as the most successful investor of the 20th century. Here are his five best pieces of financial wisdom that you should take note of.
1. Invest in Stocks
In his 2012 letter to shareholders of Berkshire Hathaway Inc., Buffett wrote "American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance."
Buffett's optimism in the American economy is backed up by strong facts. Remember that stocks still managed to return 2,300% from 1964 and 2014 — despite wars and recessions. The takeaway is that the average investor shouldn't be discouraged by the normal ups and downs of the U.S. stock market. Invest in stocks and do so for the long run. In Buffett's own words, "if you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."
2. Don't Chase "Winners"
Everybody is looking to buy low and sell high.
For example, if you had purchased AOL stock at a rock bottom price of $12 per share on September 1, 2011, you would be jumping with joy at AOL's May 2015 price (now over $50 per share due to Verizon's acquisition of AOL). (See also: The 4 Greatest Stock Reversals in the Last Decade)
However, Buffett recommends that the average investor not play stock picker. Instead, he recommends that the average investor invest in a low-cost S&P 500 index fund.
Keeping true to his own advice, Buffet laid out in his will that his trustee puts 10% of the cash left to his wife in short-term government bonds and the remaining 90% in Vanguard's S&P 500 index fund. That's as simple as it gets.
In simple terms, you already have a day job, so stick to it. You'll save a lot of money in trading fees, too.
3. Avoid Get-Rich-Quick Schemes
In the book The Tao of Warren Buffett, you can find many inspiring sayings from The Oracle of Omaha. Here is a great baseball analogy from Buffett about the stock market:
"The stock market is a no-called-strike game. You don't have to swing at everything — you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'"
Past stock picking performance is not a guarantee of future success. Take any five-year period and only 20% to 35% of actively managed funds beat the benchmark for their category. Resist the temptation of jumping on any "hot investment," particularly when you don't understand what the investment is about. (See also: 5 Investors With Better Returns Than Warren Buffett)
"When promised quick profits, respond with a quick 'no'", Buffett suggests.
4. Pay Yourself First
Roughly half of Americans are saving 5% or less of their incomes. Even worse, 18% of us are not saving at all.
The main problem is that most people are going the wrong way about saving. Most of us first pay rent or mortgage, then take care of bills and debt payments, and after that spend on dining out and shopping. With such a strategy, it's no wonder that 18% of us aren't saving.
"Don't save what is left after spending; spend what is left after saving," recommends Buffett. Just like you budget based on your net paycheck after federal and state taxes have been applied, you need to start planning on your net paycheck after savings.
There are three key ways to pay yourself:
Pay yourself first by automatically funding your retirement, savings, and emergency fund accounts. Only start paying bills and spending on necessities after you have taken care of these three key items.
5. Pay Down Debt
Of course, to be able to save, you must first take care of debt.
In another letter to shareholders of Berkshire Hathaway Inc., Buffett warned, "Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks."
The "chronically leaking boat" that Buffett is referring to is living paycheck-to-paycheck, which 76% of Americans are doing. On the other hand, the "patches" are expensive forms of financing, such as car and payday loans, and withdrawals from retirement accounts. (See also: 25 Dumb Habits That Are Keeping You in Debt)
Robbing Peter to pay Paul will catch up with you. For example, the more you treat your 401(k) as an ATM, the bigger the financial hole that you'll build. A study of borrowers from 401(k) plans shows that 25% of them took out a third or fourth loan, and 20% of them took out five or more loans. Borrowing from your nest egg too often turns into a vicious and expensive cycle.
If you think that paying down that huge credit card balance is near to impossible, think again. One couple was able to pay off $48,000 in debt over 2.5 years and a young entrepreneur paid off $40,000 in student loans by age 24. Any debt monster can be slayed no matter how scary it may appear. All it takes is consistency and time.
What are other Buffett-isms that have improved your financial situation?
To many of us, the world of investing might seem big and scary.
The good news is that many of the pros are willing to share their financial wisdom with the rest of us. From Benjamin Franklin to Warren Buffett, several successful investors have uttered down-to-earth phrases that can teach us worlds about investing. Here are 14 of these coolest sayings.
It isn't a coincidence that we start off this list with pearls of financial wisdom from Warren Buffett. The Oracle of Omaha is well known for his charming way of explaining the world of finance and his no-nonsense investment style.
1. "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."
When making investments, Buffett stresses the importance of doing your homework. You should never approach an investment as if it were a slot machine. Buffett only invests in companies that he has thoroughly researched — and so should you.
2. "Someone's sitting in the shade today because someone planted a tree a long time ago."
The most powerful weapon in any investor's arsenal is time. The earlier that you start saving for retirement, paying down debt, and building an emergency fund, the more likely you are to achieve your financial goals.
3. "Our favorite holding period is forever."
Buffett is absolutely right in suggesting to hold stocks for a long time. Several studies conclude that the historical average U.S. stock market return is about 8.5%. However, you can only achieve that kind of investment return by resisting the urge to sell your stocks during slumps. Stay the course and hold your stocks for the long term.
4. "When promised quick profits, respond with a quick 'No.'"
Despite his outstanding performance, Buffett insists that investing is difficult. Buffett points out that even the pros have a hard time beating the market. His advice is to ignore empty promises of a quick buck and to stick with safer investments, such as low-cost index funds, certain to perform reasonably well over time.
There are very few investors with better returns than Warren Buffett. One of them is the legendary investor and financial author, Peter Lynch. If you had invested $1,000 on the first day that Lynch took over Fidelity's Magellan Fund, your money would have earned $28,000 by the end of Lynch's 13-year tenure.
5. "Go for a business that any idiot can run — because sooner or later, any idiot probably is going to run it."
CEOs come and go, but truly great companies stick around for a long time.
6. "Although it's easy to forget sometimes, a share is not a lottery ticket... it's part ownership of a business."
Unlike buying a lottery ticket, making an investment is an ongoing process. For example, when you buy shares of a company or mutual fund, you will start receiving prospectuses, annual reports, and proxy forms. Read those documents to inform yourself about your investments and, when applicable, cast your vote to support initiatives that you agree with.
7. "Know what you own, and know why you own it."
Whether it's a real estate property, a retirement account, or a stock share, you have to keep an inventory of that investment and be able to explain you own it. Remember that there are plenty of sneaky investment fees to watch for.
8. "Never invest in any idea you can't illustrate with a crayon."
And the "why you own it" should be a quick one or two-sentence statement, not a 500-word essay.
American Founding Father Benjamin Franklin epitomised the concepts of frugality and prudence when it came to saving and investing.
9. "An investment in knowledge pays the best interest."
As many as 74% of Americans see having a postsecondary degree or credential as a pathway to a better quality of life. And for good reason. Recipients of a bachelor's degree earn about $1 million more in their lifetimes than individuals with only a high school diploma. Additionally, studies have shown that people with higher education have lower rates of many chronic diseases compared to those with less education. (See also: 5 Expensive Life Essentials Worth Investing In)
10. "Rather go to bed without dinner than to rise in debt."
Buy more of what you want, and you will have less to buy what you actually need.
11. "In this world nothing can be said to be certain, except death and taxes."
So, plan accordingly. Two key foundations for any investment strategy are to have a clear will and to secure the wellbeing of all of your financial dependents. If you're the main or sole breadwinner of your household, buying life insurance is a must for protecting your dependents. (See also: Make These 7 Money Moves Now or You'll Regret It in 20 Years)
And taxes? Well, they happen every year, so you need to plan ahead. By increasing your contributions to retirement accounts and taking advantage of applicable deductions, you can effectively reduce your tax bill.
Sir John Templeton
An investor and mutual fund pioneer, Sir John Templeton created one of the world's largest and most successful international investment funds.
12. "The four most dangerous words in investing are 'This time it's different.'"
Learn from investment mistakes of the past and apply those lessons to your future investments. There is nothing worse than a blind person that doesn't want to see.
13. "Invest at the point of maximum pessimism."
You may know this better by the investing maxim of "buy low, sell high."
But when are those times when you can buy low? Sir Templeton answers, "at the point of maximum pessimism." During the Great Depression of the 1930s, Sir Templeton purchased 100 shares of each company listed in the New York Stock Exchange spending less than a $1 per share and, many years later, he sold those shares for a huge profit.
The first American to win the Nobel Memorial Prize in Economic Sciences, Paul Samuelson provides one of top of the coolest sayings about investing.
14. "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."
Buffett, Lynch, Franklin, and Sir Templeton would all have agreed with this statement by Samuelson. All successful investors agree that consistency is the key to make it in the world of investing.
"Watching paint dry" may not sound that sexy, but... heck, watching your money grow surely is!
What are some other cool sayings about investing?
Warren Buffett is, by most accounts, one of the most successful investors in history. The CEO of Berkshire Hathaway has amassed billions of dollars (more than $65 billion, at last count) through his savvy understanding of corporations' performance and the stock market.
But investing like Warren Buffett isn't easy, and an examination of Berkshire's holdings indicates that average investors might not necessarily benefit by following his every move.
Here's a look at some reasons to avoid investing like Warren Buffett.
1. Because You Can't
We can all try to invest like Warren Buffett, but at a certain point it will be clear that he can do things that us mere mortals can't. Buffett has access to information that most people wish they had. He's super wealthy, so he can buy shares in much larger quantities and take risks that we simply can't. He has mountains of cash, and the reputation to cut deals that we can't make. He has access to different types of investments (preferred stock, venture capital) that are often unavailable to non-wealthy people. It's possible to follow his general approach to investing, but at a certain point it's nearly impossible to do what he does.
2. His Goals Aren't the Same as Yours
The average person should be investing with long-term growth in mind, focused primarily on building a large retirement fund. An older investor might invest for income through dividend stocks and bonds. Berkshire Hathaway's investment motives, however, are far more complex. While it is focused on building wealth over the long-term, it also makes decisions to please its shareholders in the short-term. It makes acquisitions that don't make sense immediately, but have a broader strategic value.
3. He's Not Very Diversified
Berkshire Hathaway is a large and sprawling company with investments in a wide range of industries. But most of the company's holdings are still comprised of a handful of companies. More than half of the company's value is tied up in its stakes of Kraft, Coca-Cola, Wells Fargo, and IBM. Nearly 40% of Berkshire's portfolio stems from the consumer staples sector, while another 30% is tied up in financials. Meanwhile, the company has relatively small investments in major sectors including health care, energy, or telecommunications.
4. He Sometimes Invests With His Heart, Not His Head
Yes, even Warren Buffett is known to invest with his heart rather than his head. Not all of his investments are unemotional and purely driven by cold facts. Consider his affection for Coca-Cola. (He's known to drink several Cokes a day.) While it's true that Coca-Cola is one of the stock market's great success stories, it's actually underperformed the broader stock market over the last five years. Despite this, Buffett's Berkshire Hathaway has about 400 million shares of Coca-Cola, or 9% of the company.
5. He's Missed Out on Technology
When tech took off in the 1990s, Warren Buffett was not on board. No big investments in Microsoft, Apple, or Cisco. And he's also declined to invest in recent tech success stories including Alphabet (neé Google), Amazon, Netflix, or Facebook. He is a big investor in IBM, but bought shares late in the game and the company has had several years in a row of declining revenues.
Buffett has said he hasn't invested in tech because he doesn't understand it. While it's wise to avoid investing in something you don't understand, it also means he's missed out on some big gains over the years.
6. You're Better Off With Mutual Funds and ETFs
Warren Buffett is a great stock picker. His Berkshire Hathaway is a sprawling firm with investments in a wide range of companies in various industries. But for most people, it's foolish to try to invest in individual companies and expect to beat the broader stock market. It takes a lot of work to assemble a well-balanced portfolio if you're buying individual stocks. Mutual funds and exchange-traded funds offer the ability to invest in the broader stock market without worrying about share prices of individual companies.
7. He's Too U.S.-Centric
There's nothing wrong with betting on America and its companies. But a well-diversified portfolio should also have a good amount of international exposure, and Warren Buffett has tended to invest heavily in U.S.-based companies while ignoring the potential growth from overseas firms.
The suggested amount of exposure to international and emerging market stocks varies depending on the investor's age and goals. But Morningstar's Lifetime Allocation Indexes are one possible guide. These indexes, which offer a mix of investments appropriately balanced for a person's retirement age, have between 10% and 40% invested in non-U. S. stocks. Morningstar suggests holding more international stocks the further you are from retirement.
Warren Buffett hasn't eschewed international investing entirely, as Berkshire Hathaway does have holdings in European insurance companies and recently bought a German motorcycle accessory manufacturer. And some Berkshire holdings, including Coca-Cola and IBM, do have a significant overseas presence. But many of Berkshire's top holdings, including U.S. Bancorp, Wells Fargo, and Charter Communications, offer very little international exposure.
"He who will not economize will have to agonize," warned Chinese philosopher Confucius as early as the 5th Century B.C. His advice has survived the test of time and has become the mantra of many individuals in their quest for financial success.
However, you would think that once somebody "makes it," it's time to sit back and "treat yourself." Not so fast! Let's review five wealthy financial gurus who continue to save money in the most surprising ways.
1. Warren Buffett eats McDonald's every day for breakfast
With an estimated net worth of over $78 billion, Warren Buffett can definitely afford to sip mimosas for breakfast without sweating the bill. Still, the Oracle of Omaha revealed in a recent 2017 documentary that he sticks to a daily breakfast budget of no more than $3.17 at Mickey D's.
Buffett usually picks up his breakfast from the drive-thru of a nearby McDonald's on his way to the office. "When I'm not feeling quite so prosperous, I might go with the $2.61, which is two sausage patties, and then I put them together and pour myself a Coke," Buffett deadpans. Coke for breakfast, you ask? Buffett's investment company holds over 9 percent of shares from the drink company.
2. T. Boone Pickens owns a pair of shoes from 1957
Through his success in the oil and gas sector, T. Boone Pickens amassed a fortune over the years and ventured into the financing and investment sectors. In 2012, Pickens ranked #913 on Forbes' list of billionaires. Nowadays, he doesn't rank in that list at all because he has given more than $1 billion away through his philanthropic efforts.
Despite his financial success, the author of The First Billion Is the Hardest uses what he buys until it falls apart, which can be several decades later. "If I want something, I look at it, decide what it is, but it will usually be the best product. I've got a pair of loafers that I still wear that I got in 1957," he disclosed during an interview in 2011.
And it's not just shoes, Pickens limits the size of the pieces on his closet in general. "People are always surprised that I don't have a closet full of suits," Pickens told Kiplinger. "I buy three suits every five or so years and only own 10 total. That's all I need."
3. Mitt Romney hunts for cheap flights
While you may know Mitt Romney mostly for being a former presidential candidate, he is also the co-founder of the private equity firm Bain Capital. Through his work as a management consultant and private equity investor, he has a high net worth — estimated at $230 million by Forbes when he ran for office back in 2012.
Not a stranger to the finer things in life, you would expect Romney to stick only with premium buys. While he has purchased six-figure Warmblood horses, he also loves finding bargains. According to The New York Times, he is obsessed with scoring cheap flights on JetBlue. A longtime adviser to Romney supported that claim by stating that, when asked to change a flight, Romney hesitated and responded, "Well, it's a cheap flight. It's a middle seat, but I got a great JetBlue rate."
4. Jack Bogle eats PB&J sandwiches for lunch
One of the few investors with better returns than Warren Buffett is John "Jack" Bogle, founder and retired CEO of the Vanguard Group. If the Vanguard name sounds familiar, it's most likely because you own one of its low-cost index funds in your retirement or investment account. And you wouldn't be alone: Just the Vanguard 500 Index Investor Shares fund [Nasdaq: VFINX] has $292.36 billion in assets as of February 2017!
As the pioneer of low-cost passively managed index funds, Bogle believes that the key to making it big in investments is to aggressively minimize fees. And he sticks by this belief in life as well. Many publications have recounted that his go-to lunch food is peanut butter and jelly sandwiches. He began bringing a PB&J sandwich and an apple when he first started Vanguard because he refused to pay the prices charged in his own cafeteria. And when he does have to order there, he sticks with a simple grilled cheese sandwich.
5. David Cheriton cuts his own hair
A common daydream of individual investors is to uncover the next Microsoft, Facebook, or Apple, become the first one to invest in that moneymaker, and be set for life. Stanford professor David Cheriton happens to be one of those investors that hit the jackpot when in 1998, he wrote a check for $100,000 to Google founders Larry Page and Sergey Brin. Today, that investment makes up the bulk of his estimated $4.2 billion net worth.
As of 2012, the "Billionaire Professor" had invested over $50 million across 17 startups and companies, and continues to invest. To this day, he continues to plunk down checks in several other companies, such as AISense and ThreatSTOP.
With such an investing pedigree, you would think that he wouldn't mind splurging a bit on a nice haircut once a month. For over three decades, Cheriton prefers to cut his hair himself. "It's not that I can't fathom a haircut," said Cheriton. "It's just easy to do myself, and it takes less time," he confessed to Forbes. Since the professor is adept at making good calls, probably nobody would argue with him on this one.
About nine years ago, Warren Buffett made a $500,000 bet. He wagered that a simple index fund would outperform an actively managed hedge fund run by expert investors. Which would you pick?
Before you decide, here is some additional information about the fund contenders:
Buffett picked a simple S&P 500 index fund for the wager. He bet against an investment manager who picked a set of five hedge fund portfolios. After letting these investments play out for nine years, Buffett announced the results of this wager in the chairman's letter in this year's annual report for the holding company he controls and runs, Berkshire Hathaway: The index fund outperformed the actively managed funds. (See also: The 5 Best Pieces of Financial Wisdom From Warren Buffett)
Buffet's experience mimics numerous studies that have shown that index funds consistently beat the results of actively managed funds. Why does a simple and essentially automatic investment strategy (the index fund) outperform sophisticated investment funds managed by active expert investors?
Fund fees, also known as expense ratios, are much lower for index funds than for actively managed hedge funds or mutual funds. You can find index funds with fees under 0.1 percent, while actively managed hedge funds can have fees of 2 percent or more.
Although the wager Buffett made concerned hedge funds with high expense ratios, the same principle applies when comparing index funds to actively managed mutual funds, which can have fees as high as 1 percent. Higher fees mean that actively managed funds have to outperform the market significantly to offset them. Over the long run, actively managed funds may not consistently outperform the market by enough to make up for the higher fees.
Another reason actively managed funds can fall behind index funds is investment errors. In active funds, someone is making investment decisions and moving money around trying to get higher returns. Sometimes an investment manager can outperform the market and get higher returns, but this doesn't always work out. It only takes one mistake to wipe out a lot of investment gains. In an index fund, the only investment decision is to adjust the ratio of holdings to match the market segment of interest.
Index funds accurately reflect the performance of the market they are mirroring. The investment strategy is simple, and there is no opportunity for investment error. If you invest in an index fund, you will reliably receive similar returns to the market that your index fund represents.
How to buy an index fund for your portfolio
During my research for this article, I moved around $10,000 of my own investment funds from actively managed funds into index funds with much lower fees. I figured if index funds are good enough for Warren Buffett, they are good enough for me!
You can log in to your investment account website and view the expense ratios for your current investments and for other available funds. I found that my investment choices had expense ratios ranging from 0.02 percent to 0.83 percent — a difference of more than 40-fold. This is definitely a big enough difference to worry about.
A good first step is to check your own investment funds and find out how high the fees are. You may be happy with what you find, or you may decide you want to move to index funds with much lower fees.
Of course, when choosing your investment funds, you shouldn't look only at the expense ratio. You should balance your portfolio to include a strategic mix of large cap, medium cap, and small cap investments and an intentional balance of foreign and domestic stocks to meet your investment goals.
When I moved my investment money into index funds with very low fees, I picked funds that made sense to balance my portfolio. For example, I moved some funds from a mid-cap growth fund with a 0.3 percent expense ratio into a mid-cap index fund with a 0.07 percent expense ratio — over four times lower fees. In the long run, I think this is a bet that will pay off.
Even if you don't have $500,000 to wager, you might as well minimize what you are paying in fees by moving from actively managed funds to index funds. You'll keep more of your money working for you instead of having it go to work for someone else.
Over the years, Warren Buffett has built incredible wealth through the growth of his company Berkshire Hathaway. Berkshire Hathaway is a holding company that includes stock of companies wholly-owned by Berkshire Hathaway, as well as positions in a number of large financial and consumer-oriented companies.
You might be interested in buying stock in the company that Warren Buffett manages himself, but shares of Berkshire Hathaway are currently selling for around $250,000 per share [BRK-A] which is out of reach of most small investors.
Berkshire Hathaway for small investors
Fortunately, there is a way to own Berkshire Hathaway with a smaller minimum investment. In 1996, Berkshire Hathaway started issuing Class B shares [BRK-B] with limited voting rights that are currently selling for about $170. Class B shares were offered to protect small investors from pursuing Berkshire Hathaway imitation funds with high fees or other unfavorable terms.
But Warren Buffett himself has advised against small investors buying Berkshire Hathaway stock. Berkshire Hathaway stock typically sells at a premium of 20 percent to 50 percent above the net asset value (NAV) of its holdings. Warren Buffett didn't get rich buying things for more that they are worth!
Berkshire Hathaway for 17 percent off
I decided to check out stocks with low price-to-earnings (P/E) ratios trying to find a good value. While investigating, I stumbled upon an interesting fund called Boulder Growth & Income Fund [BIF]. This 1.2 billion dollar fund is composed of about 30 percent Berkshire Hathaway stock (23 percent Class A shares plus 7 percent Class B shares). BIF also includes large, deep value financial and consumer companies that Warren Buffett likes to hold.
A relevant fact about this fund is that it is selling for about 17 percent below net asset value. By contrast, Berkshire Hathaway is currently trading for about 40 percent over net asset value.
Getting Berkshire Hathaway and other blue chip stock at a deep discount sounds like a great deal, but why is BIF trading for 17 percent less than asset value? BIF is a closed-end fund, which means that no additional shares of the fund will be issued. Only the existing shares of the fund are available to be traded. This is different from open-end funds that are more common, where new shares continue to be issued when investments are received.
The trading price for BIF on the New York Stock Exchange (NYSE) is subject to supply from investors wanting to sell and demand from investors wanting to buy. One downside of owning a closed-end fund is that there may not be a large pool of investors interested in buying when you want to sell. Plus, there is no guarantee that closed-end funds bought at a discount to NAV will ever converge to full market price. A drawback of BIF in particular is that the management fee is high: 1.43 percent total expense ratio in 2016.
Find discounted stock funds
If you are looking for value stocks, buying a closed-end fund at a significant discount is an alternative to other bargain-hunting strategies such as looking for stocks with low P/E ratios or following stock tips. As with any other investment, investigate to understand the goals of the fund, expenses and fees, and the financial health of the fund before buying.
It's no secret that 401(k) fund options are notoriously opaque. While target-date funds provide convenience to investors, they often come with higher fees than alternative investment vehicles, have highly variable returns, and aren't a good fit for many retirement savers. Let's simplify things, and review a low-stress strategy for building a solid two-to-three-fund portfolio for your 401(k).
The downsides to target-date funds
Designed to gradually adjust your investment mix as you approach retirement age, target-date funds have exploded in popularity since their designation as qualified default investment alternatives by the 2006 Pension Protection Plan. The upsides of target-date funds are that they're easy to select (96 percent of Vanguard plans make it the default investment option), they automatically rebalance, and they offer appropriate investment diversification. (See also: What You Need to Know About the Easiest Way to Save for Retirement)
However, all that convenience comes at a high price. A 2015 review of over 1,700 target-date funds by FutureAdvisor determined that their average expense ratio (the annual fee charged to shareholders to cover operating expenses) was a relatively high 1.02 percent, meaning that you'd pay $51 every year for every $5,000 in your balance. Assuming an average investment return of 7 percent per year, you would miss out on an extra $4,998 in retirement savings over a 30-year period.
On top of high fees, some target-date funds' returns barely cover their high annual expense ratios. The same review of 1,700 target-date funds pointed out that the lowest five-year average annual returns were 2.9 percent. (Returns are expressed net of expense ratios.) As of September 2017, 2.9 percent is not that much higher than the rate of a five-year CD at a credit union.
Here's a better alternative to target-date funds.
Your guide to choosing your 401(k) investment options
In his 2013 letter to Berkshire Hathaway shareholders, Warren Buffett (aka The Oracle of Omaha) provided an investment strategy that would "be superior to those attained by most investors who employ high-fee managers." Buffett recommended putting 90 percent of one's investments in a very low-cost S&P 500 index fund, and the remaining 10 percent in short-term government bonds. This is the same advice that he has set in his will. (See also: The 5 Best Pieces of Financial Wisdom From Warren Buffett)
More and more 401(k) plans are offering passively managed index funds that track a benchmark, such as the S&P 500. And for good reason: The Vanguard 500 Index Investor Shares Fund [Nasdaq: VFINX] has an annual expense ratio of 0.14 percent, just a $7 annual fee for a balance of $5,000. That's $44 in annual savings when you compare it to a target-date fund with a 1.02 percent annual expense ratio.
Worried that this approach doesn't provide you enough diversification? Think again: An index fund tracking the S&P 500 is investing in 500 large-cap companies. That's as diversified as you can get. (See also: How Too Much Investment Diversity Can Cost You)
Let's use Buffett's advice to build your 401(k) plan's portfolio.
Step 1: Check your plan for a U.S. equities index fund
There is a good chance that your 401(k) plan offers a low-cost S&P 500 index fund. Buffett personally recommends an S&P 500 Vanguard index fund. Vanguard is an investment management company known for having very low fees compared to competitors, especially on its index funds. In 2016, close to 60 percent of Vanguard plans offered an index core giving you access to broadly diversified index funds for U.S. stocks. In truth, you can do just as well with other index funds tracking the S&P 500, such as the Fidelity 500 Index Investor [Nasdaq: FUSEX] and the Northern Stock Index [Nasdaq: NOSIX].
In the event, that you don't have access to a low-cost index fund tracking the S&P 500 through your workplace 401(k), you have two action items. First, see if your plan offers another large cap index fund (one investing in large U.S. companies based on a market index). This type of fund normally invests at least 80 percent of its assets in securities within its benchmark index, such as the Fidelity Large Cap Stock Fund [Nasdaq: FLCSX] and the Vanguard U.S. Growth Fund [Nasdaq: VWUSX]. Second, contact your plan administrator and request adding a low-cost S&P 500 index fund.
Step 2: Check your plan for a fund of short-term investment-grade bonds
Just like there are index funds for investing in equities, there are also index funds for investing in bonds. For example, there is the Vanguard Short-Term Investment-Grade Fund [Nasdaq: VSFTX], which has an annual expense ratio of 0.20 percent, or $10 in fees for a balance of $5,000.
Don't have access to such a fund? Look for a low-cost fund giving you the most exposure to high- and medium-quality, investment-grade bonds with short-term maturities, including corporate bonds, pooled consumer loans, and U.S. government bonds. Why short-term maturities? Short-term bonds tend to have low risk and low yields, ensuring that one portion of your nest egg remains stable at all times — something you'll really benefit from during any recessions.
Then, request that your plan administrator add a low-cost index fund for domestic bonds.
Step 3: Allocate 90 percent to the equities index fund and 10 percent to the bonds index fund
Now you're ready to rebalance your portfolio. Using your online portal, look for an option that says "exchange funds" or "transfer money between funds" to move your nest egg dollars from your existing investments into the equities index fund and bonds index fund. (Note: Depending on your plan rules, including vesting rules, you may not be able to move 100 percent of your balance until a certain date. In that case, move everything that you can and the remaining once it becomes eligible.)
Exchange your entire 401(k) balance and allocate 90 percent of that amount to the equities index fund and 10 percent to the bonds index fund. Confirm your transaction.
Step 4: Adjust your future contributions
To keep future contributions going into the right place, adjust your paycheck investment mix so that 90 percent of withholdings go to the equities index fund and 10 percent go into the bonds index fund.
If your 401(k) offers an automatic rebalance feature, opt-in for it so that your portfolio is automatically readjusted to the 90/10 without you moving a finger. If your 401(k) doesn't offer that feature, plan to manually rebalance your account once a year.
Step 5: Revisit the 90/10 allocation at important life changes
Marriage. Birth of your first child. Purchase of your first home. Being able to start making catch-up contributions. Reaching age 59 1/2. These and more critical milestones in your life may require you to adjust your 90/10 allocation. As you get closer to retirement age, you should gradually shift from a growth strategy (selecting funds that exhibit signs of above-average growth) to an income strategy (picking funds that provide a steady stream of income) so that you hold fewer stocks and more bonds. The beauty of a target-date fund is that is does all of this for you automatically as you age. Without one, you'll need to stay on top of this occasional rebalancing yourself.
The bottom line
One of the main reasons that your 401(k) will perform better is that you're minimizing fees. If you were to allocate 90 percent of a $5,000 401(k) balance into the Vanguard 500 Index Investor Shares Fund [Nasdaq: VFINX] and 10 percent into the Vanguard Short-Term Investment-Grade Fund [Nasdaq: VSFTX], you would just pay $7.30 in annual fees. That's $43.70 in annual savings over putting the entire $5,000 in a target-date fund with a 1.02 percent annual expense ratio. It doesn't sound like a large amount of savings, but compounded over the years it can add up to thousands of dollars more in your retirement fund.
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At an event earlier this month, Warren Buffett, one of the most successful investors of all time, revealed his prediction that the Dow Jones industrial average (DJIA) will be "over 1 million" in 100 years.
With the DJIA currently sitting at about 22,400, is it even reasonable to think that the stock market could grow that much? Growth from the current value of the Dow to 1 million would represent an increase of about 45 times over. My first impression was that a value of 1 million for the Dow is very high, and Mr. Buffett must be either confused or overly optimistic to put forth such a prediction.
But since this prediction came from someone who clearly has a good understanding of investments and the stock market, I decided to check out the math behind this prediction to see if it makes sense.
An important part of Warren Buffett's prediction is the "in 100 years" part. One hundred years is a long time, and although it may be surprising, Warren Buffett's prediction of the Dow topping 1 million is actually quite reasonable given the historical performance of the market. In fact, the prediction of the Dow reaching 1 million in 100 years may even be conservative.
Here's the math
Let's look at what kind of growth rate would be required for the Dow to reach 1 million in 100 years. As I mentioned, the Dow would need to grow by 45 times its current value. When thinking about investment growth, it is informative to look at the growth in terms of the number of doublings that would be required.
2n = 45
n ln(2) = ln (45)
n = ln(45) / ln(2)
n = 3.81 / 0.693
n = 5.5
So the market value would need to double 5.5 times from its current value to reach 1 million. Let's look at this in the form of a table to make sure it makes sense:
# of Doublings
Resulting Dow Value
22,400 (current Dow)
1,433,600 (Dow over 1 million)
From the table above, you can see that doubling the current Dow five times yields 716,800, and doubling six times yields over 1 million, so the number of doublings for the Dow to reach 1 million must be somewhere in between. Our estimate of 5.5 doublings makes sense.
So the Dow would need to double 5.5 times in 100 years — or in other words, it would need to double every 18.2 years: 100 years / 5.5 doublings = 18.2 years to double.
The next step to checking out Mr. Buffett's prediction is to figure out what rate of growth would be required for the value of the Dow to double every 18.2 years.
For a quick estimate, I turned to the "Rule of 72." The Rule of 72 is a handy approximation to find how many years it will take an investment to double — simply divide 72 by the annual rate of growth. I flipped the Rule of 72 formula around to check the rate of growth required:
72 / growth rate = years to double
72 / growth rate = 18.2 years
Solve for growth rate:
72 = 18.2 x growth rate
growth rate = 72 / 18.2 = 3.96 percent annual growth
So the "Rule of 72" approximation tells us that an annual growth rate of 3.96 percent would be required to double the Dow every 18.2 years, which is the rate of growth needed for the Dow to hit 1 million in 100 years.
If you don't want to settle for an approximation, or if you are just geeky in a cool sort of way, you can do a more exact calculation:
2P = PeYr
2P = Pe(18.2)r
ln(2) = 18.2r
r = ln(2) / 18.2
r = 0.038 or 3.8 percent
The approximation from the Rule of 72 matches pretty closely with the exact calculation, so it seems we have nailed down the rate of growth that is required for the Dow to reach 1 million.
It turns out that that an annualized growth rate of 3.8 percent is well within the historical growth rate of the stock market over the past 100 years. The average rate of return from the stock market is typically considered to be as high as 7 percent.
Of course the stock market does not march steadily along at an average rate of growth year after year. The market swings up and down from day to day and follows longer upward and downward trends during bull and bear markets. But over the long haul, the average trend for the stock market has been upward at a rate of well over 3.8 percent average growth over the past 100 years.
In addition to the mathematical consideration of the rate of growth required for the Dow to reach 1 million in 100 years, another consideration is whether the world's people and natural resources will continue to sustain economic growth over the next 100 years. With development of exciting new technologies and emerging global markets to drive growth, it seems reasonable that the stock market could keep going up.
So it looks like Mr. Buffett's thinking makes good sense as usual, and the prediction of the Dow 1 million makes perfect sense.
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