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Buffett’s rules for your DIY fund | Eureka Report

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Buffett’s rules for your DIY fund
SCOTT FRANCIS

16 SEPTEMBER 2013

Sum m ary: Investment guru Warren Buffett has made tens of billions of dollars by follow ing a disciplined approach to investing.
Nearly 40 years ago he w rote a letter to the Washington Post detailing his key strategies for managing pension assets, and they’re
still just as relevant today as they w ere back then.
Key take-out: More than anything else, Buffett w arns people to be prepared over the long term to deal w ith inflation.
Key beneficiaries: General investors. Category: Portfolio management.

The superannuation system in Australia forces people to take on a tough role – being the manager of their
pension assets. Roughly one-third of the assets of the superannuation system are now controlled by DIY funds.
Indeed almost 1 million people are dependent on the successful management of self-managed funds, and that
number is rising every year.
But with power comes responsibility: Running a DIY fund can be demanding, and in times of financial stress
(such as the years surrounding the GFC) the pressure can be quite intense.
There are multiple decisions that come with managing a pension account into and during retirement, but perhaps
the three most important issues are:
How quickly can assets be withdrawn?
How do you cope with inflation?
What mix of assets is appropriate?
As I said, it’s not easy, but there is help at hand – and it comes from none other than Warren Buffett, the world’s
greatest living investor. To be precise, it comes from a memo sent nearly four decades ago from Buffett to the
former head of the Washington Post Company, in October 1975.
The Washington Post Company was the first major stock investment for Buffett and his Berkshire Hathaway
investment company – in 1973 he put $10 million into the company, and by 1977 his investment had tripled.
As the investment matured Buffett became more engaged with the diversified newspaper company and he
became a key ally of the legendary publisher, Katharine Graham.
Buffett may have been making money hand over fist in what was then the glory days of The Washington Post –
the newspaper had virtually brought the Nixon administration to its knees through the efforts of reporters Bob
Woodward and Carl Bernstein. Nonetheless, Buffett did not think the pension scheme at the company was being
run properly.
The letter is addressed Katharine Graham, whose son Don Graham was recently key to the deal where the
newspaper assets of the still-listed company were sold to Amazon’s Jeff Bezos.
Remarkably, after the recent Bezos deal, it has become clear that although The Washington Post has many
problems – the pension fund is not one of them. In fact The Washington Post pension fund has about $1 billion
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eurekareport. inflation is widely expected to rise in the years ahead. The second option he suggests – which was new at the time – was the use of an index style investment to capture slightly lower (because of fees) than average market return. In other words. it is crucial to think about how goods and services will increase over the timeframe of our retirement. The third option is to try and identify an investment manager managing small amounts of money with a good record – and then “hope that no one else finds him”. are unlikely to perform the average return. as goods and services increase over time. The particular problem at hand was the promises being made to journalists and printers at the Washington Post Company. The first option is the use of “large conventional money managers” – today’s equivalent of fund managers in the Australian environment.000 hamburger a month obligation”. although “not at anything like a 45 degree angle”. Inflation may be low at the current time. The Hamburger Factor Buffett talks about inflation’s impact on pension obligations by talking about a “1. Buffett’s letter to Graham and the board of The Washington Post stands as an essential document for anyone seeking principles for running a pension fund. rather think of them as http://www. but when you are dealing with pension funds you are dealing with very long periods of time – bear this in mind. according to the US Fortune magazine. 1. Look Before You Leap At the very beginning of the letter. In terms of DIY funds this could be translated as the risks of promising yourself.au/article/2013/9/16/portfolio-construction/buffetts-rules-your-diy-fund 2/4 . and these costs move to further reduce returns. and being conservative in the rate we withdraw on out assets to fund retirement. that you can actually run a successful fund.” 2. As we plan our pension. of course. In essence then the letter puts forward five outstanding principles for commencing and managing any pension fund operations … DIY funds could benefit greatly from these instructions. Buffett warns Graham on the risks of making set promises to anybody. This includes the observation that collectively. He also makes the points that as these funds trade they incur costs. He then makes a number of very sophisticated arguments as to why this approach must lead to returns “slightly poorer than average”. As Buffett suggests: “know what you are getting into before signing up. This is. He says that he leans toward this approach. after costs. or your retirement. Because the hamburger will increase in price over time. it is difficult to know how much capital is needed to fund this obligation. The last strategy he talks about is to “treat portfolio management decisions much like business acquisition decisions”. don’t think of stocks as stocks. the large fund managers make up a large portion of the market and so. He also comments that “I am virtually certain that above average performance cannot be maintained with large sums of managed money”. or those close to you. To view Warren Buffett’s full 1975 memo to Katharine Graham. This will lead us to think about putting aside additional assets prior to retirement.com. 3. Buy Businesses. the preferred Buffett option. I am often surprised by how many people plan to withdraw 7% a year from their retirement assets – where 4% to 5% is far more realistic. Not Stocks Buffett then moves to consider the different approaches to managing the sharemarket investments of a pension account. click here.28/4/2557 Buffett’s rules for your DIY fund | Eureka Report more than it needs to pay its obligations.

it will serve any investor well. However. This is important for us as we manage our pension assets – it is easy to get distracted by short-term returns. 5. Therefore.” And just to douse enthusiasm for fund managers even further. as the “time span against which pension fund results should be measured” is a longer one. However.” 6. returns should be measured over longer periods of time.” Having made the point theoretically.au/article/2013/9/16/portfolio-construction/buffetts-rules-your-diy-fund 3/4 . however it will be 10. he counters this by reminding us that the time frame for a pension investment is long – a retirement could be 30 years or more. even then promising to “beat the market”. Get Tough … Handle Volatility Buffett also comments on the volatility of sharemarkets. As Buffett warns early in his missive to Graham in the context of superannuation. As the pension manager of our own funds. we all should be able to win a little’. In other words. a fixed interest strategy has an appeal for many investors. All rights reserved. and previously work ed as an independent financial advisor. 4. inflation is the problem. if you’re asset allocation is wrong in the early years of a fund you might not get that essential early growth in capital you are looking to achieve in order to finance a more conservative later-in life investment asset allocation. investment approaches. as Buffett points out in his letter. while the comfort level with this strategy might be “high”. the importance of thinking about inflation or the balance between sharemarket or fixed interest investments. if we all play carefully tonight .eurekareport. ABN 84 111 063 686 Australian Financial Services Licence Number: 433424 Privacy Policy Relevant Ads Opt-out http://www. Scott Francis is a personal finance commentator. Buffett takes another dig at them later in the memo with the remark: “I am virtually certain that above-average performance cannot be maintained with large sums of managed money. Fixed Income Investments Are Not Enough After the sharemarket fall and volatility during the global financial crisis. Conclusion The most remarkable thing about reading a Warren Buffett letter from almost 40 years ago is how relevant his advice remains.28/4/2557 Buffett’s rules for your DIY fund | Eureka Report buying a slice of a business. Buffett later puts it in more colloquial terms: He suggests: “It’s analogous to the fellow sitting down with his friends at the poker table and announcing ‘well fellows. 15 and even 20-year returns that will be crucial to the success of our retirement strategies. “errors compound”.com. simply could not deliver … mathematically! As Buffett says: “A little thought or course would convince anyone that the composite area of professionally managed money can’t perform above average. Buffett warns Graham that the plethora of professional fund managers. Nobody Beats The Market All The Time In what would later become a regular refrain from the ‘Sage Of Omaha’. Eureka Report Pty Ltd Copyright © 2013. acknowledging that they “may bounce widely and irrationally”. his advice on pensions is worth keeping in mind – whether it be about market timing.

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