In this article, I will show how some direct Warren Buffett quotes from a recent question could apply to investors for not buying the S&P 500 index fund in 2023 using his parameters.
In recent years at a Berkshire Hathaway shareholder meeting, a lady asked a well-thought-out question to, Warren Buffett. Suppose he believes so much in buy-and-hold investing, specifically in the S&P 500 index. Why doesn’t he hold Berkshire’s excess cash above the cash needed for insurance underwriting in equities? This would have led to a huge outperformance above his already great returns for the Berkshire portfolio.
Here is her question:
“Warren, you are a big advocate of index investing and of not trying to time the market, but by your having Berkshire hold such a large amount of cash and T-bills, it seems to me you don’t practice what you preach. I’m thinking that a good alternative would be for you to invest most of Berkshire’s excess cash in a well-diversified index fund until you find an attractive acquisition or buyback stock.” she continues, “Had you done that over the past 15 years, all the time keeping the $20 billion cash cushion you want, I estimate that at the end of 2018, the company’s $112 billion balance in cash, cash equivalents, and short term investments in T-bills would have
instead been worth about $155 billion. The difference between the two figures is an opportunity cost equal to more than 12 percent of Berkshire’s current book value.”
This is how Warren Buffett responded to her question about keeping all his excess cash in index funds instead of treasury bills:
“That’s a perfectly decent question, and I wouldn’t quarrel with the numbers, and I would say that is an alternative, for example, that my successor may wish to employ. Because on balance, I would rather own an index fund than carry treasury bills. I would say that if we’d instituted that policy in 2007 or eight, we might have been in a different position in terms of our ability to move in late 2008 or 2009. It has certain execution problems with hundreds of billions of dollars than it does if you were having a similar policy with a billion or two billion or something sort, but it’s perfectly rational observation, and certainly, looking back on ten years of a bull market it really jumps out at you, but I would argue that if you were working with smaller numbers, it would make a lot of sense, and if
they’re working with large numbers it might well make sense in the future. Berkshire would operate that way, you know, we committed $10 billion a week ago, and there are conditions under which and they’re not they’re not remote, they’re not likely in any given week or month or year, but there are conditions under which we could spend $100 billion dollars very very quickly, and if we did if those conditions existed it would be the capital very well deployed and much better than in an index fund so we’ve been uh we’re operating on the basis that we will get chances to deploy capital they will come in clumps in all likelihood and they will come when other people
don’t want to allocate capital, Charlie; what do you think about it?”
Charlie Munger continued the response to her question following Buffett’s points:
“Well, I plead guilty to being a little more conservative with the cash than other people and but I think that’s all right. We could have put all the money into a lot of securities that would have done better than the S&P with 2020 hindsight. Remember we had all that extra cash all that period if something had come along in the way of opportunities and so on. I don’t think it’s a sin to be a little strong on cash when you’re as big a company as we are. We don’t have to. I watched Harvard use the last ounce of their cash including all their prepaid tuition from the parents and plunge it into the market at exactly the wrong moment and make a lot of forward commitments to private equity, and they suffered like two or three years of absolute agony we don’t want to be like Harvard. Because of timber and a whole bunch of things. We’re not going to change.”
Warren Buffet interjected:
“We do like having a lot of money to be able to operate very fast and very big. You know, and maybe we won’t, we know we won’t get those opportunities frequently I don’t think, certainly you know, in the next you know, in the next 20 or 30 years, they’ll be good two or three times when it’ll be raining gold and all you have to do is go outside but uh we don’t know when they will happen and we have a lot of money to commit and I would say that if you told me I had to either carry short-term treasury bills or have index funds and just let that money be invested in America generally, I would take the index funds, but we still have hopes, and one thing you should very definitely understand about Berkshire is that we run the business in a way that we think is consistent with serving shareholders who have virtually all of their net worth in Berkshire. I happen to be in that position myself, but I would do it that way under any circumstances we have a lot of people who trust us who really have disproportionate amounts of Berkshire compared to their net worth. If you were to follow standard investment procedures and we want to make money for everybody, but we want to make very, very sure that we don’t lose permanently money from anybody for anybody that buys our stock somewhere around intrinsic business value, to begin with. We just have enough, we have an aversion to having million-plus shareholders, maybe as many as two million, and having a lot of them ever really lose money if they’re willing to stay with us for a while, and we know how people behave if when the world generally is upset, and they want to be with something I think they want to be with something that they feel was like the rocketed roller, and we have a real disposition toward that group.”
Here are some interesting points to take away from his response:
- It’s good to have a large cash reserve to buy great individual stocks at a value when the opportunity arises.
- It’s good to raise cash during high-valuation bull markets like 2007 to buy during bear market crashes.
- Buffett advises only buying even Berkshire stock at fair value to optimize future returns.
- Buying and holding only looks like a great strategy in hindsight and after long bull markets.
- Due to the risk, Buffett did not want to hold all his cash in stock index funds in late 2007.
- Buffett does not say anything about dollar cost averaging but looks to buy during great opportunities with low stock valuations.
For investors who think stock valuations are still too high in 2023 and the stock market has lower to go based on the economy, Buffett’s advice could mean to raise cash and wait for the stocks you want and the S&P 500 index to return to a more fair value.
“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” – Warren Buffett