Summer 2017 2

Do What I Say, Not What I Do

by A. Scott White, CFP®, ChFC, CLU
President, Scott White Advisors

In Warren Buffet’s annual address to Berkshire Hathaway, the publicly traded holding company for Mr. Buffet’s investments, in February 2017, he advised the average investor to steer clear of “active managers” and instead invest in low cost “passive mangers” who try to replicate index returns. Buffett’s logic seems simple: Someone who invests in a passive manager will get index-like returns at a low cost, while someone who invests in an active manager will get average investment returns over time; some managers’ investments will do well, and others won’t. But when you consider the higher cost of actively-managed investment options, the actual returns the investor experiences from active management will be well below average.1

This advice clearly flies in the face of the investment advice Buffet eschewed in his 1984 article “The Superinvestors of Graham and Doddsville”. Buffett’s main point in that article is that Graham and Dodd’s (an active investment management strategy) pupils consistently beat the S&P 500 in the period from 1955 to 1983 by using the “value” style of investing. He describes in detail, using audited track records, by using different techniques, how all of these value investors had beaten the S&P 5002.

What happened since 1984 to change Buffet’s simple advice to use value investing and a margin of safety for superb results? As we look at the performance of Berkshire Hathaway since 1993, this simple advice has obviously proven very successful for Mr. Buffet over the years.

Berkshire Hathaway, Inc. performance vs. the S&P 500 since 1992. Source: Nasdaq.

Why is it that in 2017 Buffett believes value investing is irrelevant, and he now advises investors to give up on active investing and switch to passive managers favoring index-like portfolios? Does quality and price no longer matter when investing? While we might not ever know why Buffet has changed his tune, it seems logical to me that he believes now that neither the investors nor their advisors have the fortitude or intellect to practice the discipline that value investing demands. From that point of view, I believe Buffet may be on to something: In my experience, not only do the average investors not possess these qualities, but neither do their advisors.

While I’m sure everyone can agree that Buffet acts as a fiduciary for Berkshire Hathaway as acting CEO working for the best interests of his company, what many people may not know is that not every financial advisor acts as a fiduciary for their clients. Most average investors tend not to work with financial advisors who are fiduciaries that place the client’s need ahead of his or her own. Some advisors are simply held to a “suitability standard” whereby the investment recommendation should appear suitable for someone in a similar investor profile. Please note: There can be a big difference between an investment that appears suitable versus an investment that is in the investor’s best interest.

Perhaps Buffet’s statement might stem from understanding of the importance of a written strategic plan for his company, and he might also be aware that according to a 2015 Gallup study, the average investor does not have a written financial plan that identifies measurable investment goals.3 Perhaps Buffet understands that many investors and their financial advisors utilize some type of risk tolerance questionnaire to determine asset allocation instead of developing a written Investment Policy Statement. An Investment Policy Statement is a vital part of a well-written financial plan that considers the investor’s unique situation and circumstances to develop an asset allocation.4 In addition, Buffet may recognize the average investor may compare past investment performance against an index to evaluate an investment’s suitability, instead of analyzing the investment selection process and the role of an investment in an overall investment portfolio in the first place.5 And finally, knowing how emotionally demanding it might be for an investor to stick to a well thought out strategy, Buffet is wary that the average investor, lacking a sound written Investment Policy Statement, may sell out of a sound portfolio the moment it underperforms against an index, regardless of the reason.6

Let’s take closer look at some of the reasons why Buffet may have changed his tune over the past 33 years. In my opinion, it’s impossible for a financial advisor to understand what is in a client’s best interest without developing a written financial plan that identifies measurable investment goals—and then monitoring the client’s progress toward those goals year in and year out. After all, it is only by comparing where you want to be to where you currently are that you can begin an intelligent conversation about how any year’s performance can be measured. Was our year-end outcome affected by factors we can control or those we cannot, such as changes in tax rates, inflation, Social Security, or medical costs? Without a way to measure progress, once investors realize they are off course, it is too easy to simply blame the investment portfolio. You will always be able to identify in hindsight investments that did better than yours and it is easier to change the investment portfolio than to identify the real culprit. The real question is: Is your investment portfolio designed to give you a relatively high probability in reaching your goals in the face of many different types of investment risk? In my opinion, building an investment portfolio based on risk tolerance questionnaires instead of your family’s unique needs fails to consider a variety of risks such as market risk, exchange rate risk, purchasing power risk, business risk, default risk, interest rate risk, and sector risk, to name a few. And these risks are not easily addressed without considering the price and quality of investments, which passive managers simply can’t do.

Another concern Buffett may suspect that places the average investor at a disadvantage is that many financial advisors recommend building investment portfolios based on economic or political forecasts that may or may not happen. In my opinion, that is speculation, not investing. If financial advisors place importance on events they cannot control like interest rate forecasts, GDP growth estimates, unemployment forecasts, and presidential election outcomes, then the chances of having better investment results than index returns might be greatly reduced. Poorer long term performance is associated with the behavior of acting emotionally based on economic and geopolitical events, as shown in the 2016 Blackrock study that found the average investor’s returns were 2.11% from 1995 to 2015 versus the average rate of inflation of 2.18%7, which says that the average investor lost money in real terms. I believe the CEOs of the world’s most profitable companies are in a much better position to judge the probability of global geopolitical and economic events and how they might impact their own company’s profitability—and hence my investment—than an economist from a financial institution. After all, weren’t these large financial institutions the very source of the Great Financial Recession of 2008? And if their economists were so good, then how could they have possibly missed seeing the Great Recession coming? Why would anyone build a portfolio strategy based on their forecasting?

While we may never know why Buffet made his statement to shareholders this past February, I do know that at Scott White Advisors we work as fiduciaries, as defined by the Investment Advisors Act of 1940, looking out for each of our clients’ best interests, and we always develop written financial plans utilizing a written Investment Policy Statement as a process to monitor our clients’ progress in meeting their goals. You can be assured that when it comes to building your investment portfolio we will not use a risk tolerance questionnaire or speculate on events that may or may not happen.

(1) Warren Buffett Just Revealed the Best Investment Most People Can Make – Mark Frankel, The Motley Fool, February 26, 2017.
(2) The Superinvestors of Graham And Doddsville – Is Buffett A Hypocrite? ­– Sven Carlin, InvestIvDaily, March 7, 2017.
(3) More Nonretired U.S. Investors Have a Written Financial Plan – Jeffrey M. Jones,, July 31, 2015.
(4) The Importance of the Investment Policy Statement – Survey of Advisers, Russell Investments, Investment News, Blaine F. Aikin, October 27, 2013.
(5) 4 Reasons to Stop the S&P 500 Comparisons – 4Bloomberg View, Noah Smith, September 15, 2015.
(6) 4 Reasons to Stop the S&P 500 Comparisons – 4Bloomberg View, Noah Smith, September 15, 2015.
(7) Inflation is represented by the Consumer Price Index. Average Investor is represented by Dalbar’s average asset allocation investor return, which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/15 to match Dalbar’s most recent analysis.

There is no assurance that past trends will continue into the future. The effects of any updates released after the period shown above are not reflected in this data. Past performance is no guarantee of future results. Indices are unmanaged and cannot accommodate direct investments. An individual who purchases an investment product which attempts to mimic the performance of an index will incur expenses such as management fees and transaction costs which reduce returns. Please see disclosure information at the end of this presentation.

Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss. Investments mentioned may not be suitable for all investors. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and investors may incur a profit or a loss.

Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market vary. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.