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Billionaire investor Warren Buffett is known for making huge sums of money by making canny investments in individual shares like Coca-Cola and Apple.
But when it comes to whether most small private investors with a bit of spare cash ought to follow his approach, he has a potentially surprising point of view. Simply put, he reckons many of them should forget doing that and instead simply put the money into a fund that tracks a stock market index, such as the FTSE 100 or S&P 500.
The logic of indexing
There are several reasons why this could make sense for investors. Investing in the stock market takes time and effort. Not everyone wants to learn things like how to read a balance sheet, or what different stock valuation techniques can tell us.
Simply putting money into an index tracker is a lower effort activity and, in theory at least, it ought to produce returns broadly in line with the economy (or at least that part of it that is represented by the index).
Another issue to consider is cost. Buying and selling shares can involve fees, commissions, charges and taxes and some of those have a minimum level no matter how little is being invested. Index trackers can be a more cost-effective way to put modest sums to work in the market, when it comes to such costs.
A key part of Buffett’s logic is also something that many of us might not want to believe. The reality is that, for many investors (and this is true for experienced institutional ones as well as small private ones), beating the market can be harder than it looks. It can actually be more financially rewarding simply to put money into an index tracker than to try and pick a range of individual shares that will do well.
Learning from demonstrated success
But hang on a minute, is individual stock-picking not exactly what Buffett does? Yes, it is.
While the ‘Oracle of Omaha’ reckons most small investors would be better off investing in an index tracker, that does not mean he thinks they all should. Buffett started buying individual shares as a young private investor (in fact, while still at school). As his example shows, it is possible for individual investors to do very well building a portfolio of specific shares.
I buy individual shares – and apply some Buffett wisdom while doing so. For example, consider my investment in Greggs (LSE: GRG).
It has a large, resilient target market – something Buffett always looks for. Thanks to its brand, unique products, wide distribution and existing customer base, it can compete effectively in that market. This reminds me of some classic Buffett investments, from Coca-Cola to Dairy Queen.
The Greggs share price has fallen 33% in the past year. Such falls do not typically happen without reason and here, one factor is the risk that higher employment-related costs will eat into profitability.
But, like Buffett, I am a long-term investor. Will Greggs continue to struggle with its cost base, or could this be a short-term bump in the road? I reckon it may well be the latter.
The baker has a proven business, is profitable, pays a dividend and has what I currently see as an attractive valuation. That is why I have been snapping up its shares.
