Berkshire Hathaway 2013 Annual Meeting Audience Question # 49

Which is better: invest in an index fund or choose the five best stocks and put a lot of money into them?

Warren Buffett:

OK. Station 5.

Audience Member:

Derek Foster, Ottawa, Canada.

First of all, thank you, Warren, for sharing all your information. You’ve changed my life. I took finance in university, couldn’t understand Greek formulas, but now I can invest reasonably well.

My question to you is, in the past you’ve said for an investor, you should simply… for 99 percent of investors… you should simply stick money in an index fund and let it go and don’t worry about it. Those 1 percent of investors, choose your best five stocks and put a substantial amount of money in it.

I’m just wondering, how about a strategy of, perhaps, buying 20 of the best stocks in America, you know, Procter & Gamble, Coca-Cola, Johnson & Johnson, whatever, the companies that have been around for centuries… or a century or decades or whatever… and just leaving it at that.

Do you think that that would outperform an index fund over the long term? And I want Charlie’s opinion as well.

Warren Buffett:

Well, I don’t know whether you’re saying the 20 largest companies or the 20 best. You might get different thoughts from different people on what they are.

But I think you would… probably the 20 you would pick would virtually match the results of an index fund. Who knows exactly which ones would be the best?

But the real distinction… and Graham made this in his book, basically… is between the person who is going to spend an appreciable amount of time becoming something of an expert on businesses, because that’s what stocks are, or the person who is going to be busy with another profession, wants to own equities, and actually will actually do very well in equities. But the real problem they have is that they may tend to get excited about stocks at the wrong time.

You know, they, really, the idea of buying an index fund over time is not to buy stocks at the right time or the right stocks. It’s to avoid buying them at the wrong time, the wrong stocks.

So equities will do well over time, and you just have to avoid getting… you know, getting excited when other people are excited, or getting excited about certain industries when other people are, trying to behave like a professional when you aren’t spending the time and bringing what’s needed to the game to be a professional.

And if you’re an amateur investor, there’s nothing wrong with being an amateur investor, and you just simply… you’ve got a very logical, profitable course of action available to you, and that is simply to buy into American business in a broadly diversified way and put your money in over time.

So I would say your group of 20 will probably match an index fund, and you’ll probably do well in that, and you will do well in an index fund.

Charlie?

Charlie Munger:

Well, I have nothing to add. I do think it’s… that knowing the edge of your own competency is very important. If you think you know a lot more than you do, well, you’re really asking for a lot of trouble.

Warren Buffett:

Yeah. And that’s true outside of investments, too.

Charlie Munger:

Yes. Works particularly well in matrimony.

Warren Buffett:

Do you want to give any other advice on that subject?

Charlie Munger:

No.

Warren Buffett:

He gave it in the movie. I saw people taking notes.

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