Investors should keep it simple, understand what they’re doing and ignore the day-to-day price of an investment they’ve made, Warren Buffett says in his coming letter to Berkshire Hathaway Inc. shareholders.
Buffett, the CEO and chairman of Berkshire, illustrates the lesson by recounting two real estate purchases he made years ago: a Nebraska farm and a retail building in New York City, according to an excerpt posted Monday by Fortune magazine.
“Ignore the chatter, keep your costs minimal and invest in stocks as you would in a farm,” he wrote. In other words, treat stock market investments like real estate and stay focused on the long-term potential for profits, not day-to-day fluctuations.
“Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations,” Buffett said. “Owners of stocks ... too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally as well.”
His buy-and-hold philosophy is not new, but his success at building the $280 billion Berkshire conglomerate makes his annual letter must reading for investors. The full letter to shareholders is to be posted on Berkshire’s website Saturday morning.
In the excerpt, Buffett recounted his purchase of a 400-acre farm 50 miles north of Omaha from a federal agency in 1986 for $280,000. The Federal Deposit Insurance Corp. had gotten the land from a failed bank that foreclosed on a loan during the 1980s’ farm finance crisis.
“I knew nothing about operating a farm,” Buffett wrote. “But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be.”
He expected at least a 10 percent return, plus more as crop prices moved higher. “Both expectations proved out,” he said. The investment “had no downside and potentially had substantial upside.”
Now the land is worth five times what he paid and has tripled its earnings, he said. “I still know nothing about farming and recently made just my second visit to the farm.”
Buffett bought the retail property, located next to New York University, in 1993 from the Resolution Trust Corp., which was disposing of property owned by savings institutions that had failed when a “bubble” in commercial lending burst.
With a superb location and rents that were going up, there was no risk in that purchase, either, Buffett wrote.
He was part of a small purchasing group that included friends experienced in property management. Now the group gets 35 percent of its initial investment back each year, and refinancing paid the group an additional 150 percent of what was invested.
“I’ve yet to view the property,” Buffett said.
He expects earnings from both properties to increase in the future and the property to be “solid and satisfactory holdings for my lifetime and, subsequently, for my children and grandchildren.”
Among the fundamentals of investing illustrated by the purchases, he wrote:
>> You don’t need to be an expert to get satisfactory returns, but “you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick ‘no.’ ”
>> Focus on future productivity. If you can’t estimate future earnings, “just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.”
>> If you focus on whether the price of the investment will increase, “you are speculating.” That’s not improper, but it’s more difficult to succeed.
Buffett also gave a preview of his will, saying that his wife, Astrid, and others will benefit from cash delivered to trustees. All of his Berkshire Hathaway stock — worth about $50 billion today — will go to charities over a 10-year period after he dies.
He said he will advise the trustees to put 10 percent of the cash in short-term government bonds and 90 percent in a low-cost mutual fund tied to the Standard & Poor’s index of 500 stocks. He recommended a Vanguard index fund with the ticker symbol VFINX.
The Omaha World-Herald Co. is owned by Berkshire Hathaway Inc.