In June this year Forbes released its most recent Global 2000 list that ranks the world’s largest public companies. The top four were all Chinese banks. Number 5 was a company from Omaha, a Midwestern US town with a population of less than half a million people. Its name is Berkshire Hathaway.
The story of this business is the amazing tale of how Warren Buffett took over a struggling textile firm in the early 1960s and turned it into the biggest investment company on the planet. Such has been Buffett’s success that he is widely regarded as the greatest investor in the world.
Many books have been written about how Buffett operates and how invests, but the truth is that he follows very simple principles. That doesn’t mean he’s easy to copy, but there are vital lessons to be learnt from what he does.
The most important lesson is that Buffett only ever invests in what he understands. He is not interested in chasing the next big thing or betting on hot ideas. He stays within what he calls his “circle of competence”. Put another way, he gets the odds in his favour by doing things he has done before.
Many investors make the mistake of always hunting for the best possible investment. But Buffett has proved that you don’t need to always pick the investments that shoot the lights out. You only have to make one good, solid investment after another and the rewards will stack up.
Perhaps this is best illustrated by advice that he gave to investors in Berkshire Hathaway’s 2014 annual shareholder letter in which he revealed that he had written in his will that the money he is leaving to his wife is to be put into an index tracker for her.
It seems incongruous that the greatest investor in the world would pick a passive investment for his wife, but as Kokkie Kooyman of Sanlam Investment Management says, it really makes perfect sense. “Buffett himself understands the risks and has a huge opportunity set from which he can choose. But if you think of the average investors, they don’t have that same knowledge,” Kooyman says. “The decision they must make is to either invest in a company they don’t really know, or use a fund manager, where it’s very difficult to know who will outperform. So in terms of the average investor’s risk profile and in terms of what they know, their best bet is to go with the index.”
Words: Patrick Cairns