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The one instance when you should ignore Warren Buffett

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A reader recently wrote to challenge my belief in diversification, citing a couple of accomplished investors who said, in effect, that anybody who diversifies an investment portfolio must be an idiot or a moron.

The statements came from billionaire entrepreneur and television personality Mark Cuban and from Charlie Munger, vice chairman of Warren Buffett’s Berkshire Hathaway
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If they are right, then I’ll plead guilty, because I’m a firm believer in diversification — both for myself and for almost all the investors I’ve helped over the past half-century as an adviser and educator.

Diversification is one of the most important steps every investor should take. Tons of evidence is on my side — and I’ll share some of it with you.

Warren Buffett is chairman and chief executive of Berkshire Hathaway and is probably this century’s most widely admired investor. He provides investors with what I think is a mixed message about diversification.

On the one hand, he runs a multinational conglomerate holding company that owns a portfolio of interests in media, real estate, transportation, food, insurance, housing, clothing, retail, aerospace, banking, utilities, restaurants and technology — among other things.

That list does not make a strong case against diversification.

On the other hand, Buffett has been quoted repeatedly over the years as putting down the concept of diversification.

For example: “Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.” Instead, Buffett recommends index funds for most investors, especially ones that follow the S&P 500 index
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I’ll return shortly to the notion of “those who know what they’re doing.”

But first, let’s look at Berkshire Hathaway: Since 1965, the company’s stock has compounded at more than 20%, and that’s the story most investors know.

However, that history goes back 56 years. Let’s look at some more recent results.

At Morningstar, I found the following comparisons, which use the Vanguard 500 Index Fund
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as a proxy for the S&P 500, as of Dec. 14, 2020:

Most recent five years: S&P 500 15.3%; Berkshire Hathaway 11.7%.

Most recent 10 years: S&P 500 13.8%; Berkshire Hathaway 10.9%.

Most recent 15 years: S&P 500 9.5%; Berkshire Hathaway 9.3%.

Berkshire Hathaway certainly has diversification, with full ownership or stakes in about 50 companies. Those stakes were carefully chosen by Buffett.

But the company’s returns in the recent past have failed to match those of the S&P 500, which includes 10 times that many companies, including plenty of dogs.

One thing I know is that even a 0.5 percentage point increase in return can easily be worth $1 million to an investor over a lifetime.

In the past five years, Berkshire Hathaway lagged the S&P 500 by more than seven times that much. In the most recent 10 years, the difference was nearly six times that much.

In these comparisons, more diversification (500 companies) had a higher payoff than less diversification (50 companies).

There’s a second element here, one that can also be worth $1 million or more over an investing lifetime: Active management vs. passive management, as in index funds.

Millions of investors are drawn to the lure of active managers who seem to have “something special.”

Recall Warren Buffett’s statement that diversification “makes very little sense for those who know what they’re doing.”

Confident that he knows what he is doing, Buffett does not practice full diversification. But over the past 15 years, his knowledge did not produce superior returns.

I used to give regular talks to high-school students, and my talk included this question: Would you rather invest like a millionaire, or like a poor person? These young people were all smart enough to want to emulate millionaires.

Poor people, I told them, typically invest in a few stocks, while millionaires invest in thousands of stocks.

Today any investor can own parts of hundreds or thousands of companies through low-cost index funds and exchange-traded funds.

Just for fun, think back 15 years ago, to the last weeks of 2005. Imagine somebody had suggested that Berkshire Hathaway should replace everything it owned with one simple investment: an index fund tracking the S&P 500 index.

Most people would have scoffed at such a ridiculous idea, and the majority of Berkshire Hathaway shareholders probably would have sold their stock and taken their money elsewhere.

When it comes to active managers, Buffett is as good as they come. But the natural optimism of human nature tricks our brains into thinking we know more than we actually do. I don’t think Warren Buffett is immune to that.

As an investor and a teacher, my job is to harness the probabilities of success.

Nearly a century of investment returns tells me that a diversified portfolio of stocks and asset classes is much more likely to pay off than a portfolio that relies on a much smaller number of stocks chosen by managers who, in Buffett’s words, “know what they are doing.”

So today we have two lessons in one: First, diversify. Second, use passive management instead of active management.

Index funds relieve investors like us from the burden of “knowing what we’re doing.” Index funds let us do well — in fact they almost guarantee it — despite our ignorance.

Here are the very worst 40-year compound returns in several U.S. asset classes over the past 92 calendar years, from 1928 through 2019:

• Large-cap blend stocks (the S&P 500, in other words) 8.9%

• Large-cap value stocks 8.8%

• Small-cap blend stocks 10.7%

• Small-cap value stocks 11.6%.

To repeat: Those are the worst long-term returns.

Each of those asset classes is accessible to today’s investors in low-cost index funds and ETFs.

Buffett seems to believe that “knowing what you’re doing” involves picking stocks and businesses.

My own definition of “knowing what you’re doing” includes diversification, using passive management, and understanding asset classes such as the four I just listed.

For any investor with several decades left, a terrific portfolio can be built with equal parts of ETFs or index funds representing those four asset classes. That’s simple and inexpensive. And history suggests it carries a high probability of success.

To my mind, that’s the opposite of what a moron would do.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.



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‘I could live on my Social Security and still save money’: This 66-year-old left Chicago for ‘calming’ Costa Rica — where he now plans to live indefinitely

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Editor’s note: This article was first published in September 2019.

A school break changed 66-year-old Martin Farber’s life forever.

In 2007, his daughter — who at the time was attending Illinois State University — decided she wanted to spend a college holiday volunteering in Costa Rica and staying with a local family, he explains. She came home raving about the experience, so, in 2008, Farber — who at the time was living in Evanston, Ill., just outside Chicago, and selling cars — took his first trip there.

“It was a big surprise to me — bumpy roads, dogs barking in the streets,” he says. “I wasn’t enamored at first.”

But as his daughter began traveling there more and eventually moved there for a year, he took additional trips to Costa Rica. It quickly grew on him — in particular, the people. “The Costa Rican people are warm, open and friendly. I felt less invisible in a strange country in a strange town where I didn’t speak the language than I did in Evanston.”

And the more time he spent there, the more it impacted him: “On one of my trips there, I thought: My daughter’s life makes more sense than mine,” he says. “There was nothing wrong with my life, but I felt that my life was out of context with who I’d become. … I would have bills and make money to pay them, but that had ceased to be satisfying,” he recalls. “I knew I needed to change my life — there was no more joy in what I was doing.”

What’s more, when he’d return from his Costa Rica trips, people noticed. “I would come back, and my friends and therapist would say: You seem better after you go,” he says with a laugh.

A view from the hot springs near Martin Farber’s home in Costa Rica.


Martin Farber

So in 2014, he packed up and moved to Orosi — a picturesque, lush small town with waterfalls and hot springs a little over an hour’s drive from San Jose — promising himself he’d stay for two years. It’s been five, and he now plans to stay in Costa Rica indefinitely. (Though Farber notes that, to him, “it’s not a retirement; it’s a chance to lead a new and different life.”)

Here’s what his life is like, from costs to health care to residency to everyday life:

The cost: While many expats spend way more living in Costa Rica, Farber says: “I could live on my Social Security and still save money.” He says “a person can live on $1,200 per month, two people on $2,000.” The key, he says, is to live more like he does and as the Costa Ricans do — in a modest home, eating local food and purchasing local goods.

Indeed, Farber himself spends just $300 a month for rent (he rents a home from a friend who moved recently and gave him a good deal), roughly $225 a month on groceries and just $50 a month total on water and electricity (the temperate climate in Orosi means you rarely need heat or air conditioning). The veteran Volkswagen
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salesman saves money by not owning a car (those over 65 ride municipal buses for free), which can be a significant expense in Costa Rica; for his cellphone, “I pay as I go … roughly $10 may last me a couple weeks or more,” he says, adding that “many people handle there their cellphones this way. You can get them recharged anywhere.”

His major expense is travel: He goes back to the U.S. to visit his mother in Florida several times a year and lately has spent part of the summer in Chicago helping out a friend with a dealership there. He also spends a good amount of money on health care. He says that while flights can be had for as little as $350 roundtrip during offseasons, the cost can be much higher the rest of the year.

In the saddle.


Martin Farber

Health care: Farber, who has permanent resident status in Costa Rica, says he pays about $90 per month to participate in the country’s health-care system — adding that the health care he’s received has been very good. (A 2018 study of health-care quality and access in more than 190 nations ranked Costa Rica No. 62.)

When he developed a detached retina, though, he paid for the procedure out of pocket so that he didn’t have to wait for the required surgery, he says — adding that the entire procedure cost him about $5,000. “I would have had to have waited four days,” he says, if he had not paid to expedite matters. “That might have been fine, but it might not.” And he adds that the quality of care depends on where you get it in the country.

Lifestyle: Though Farber says that he “moved here with no goals and no agenda,” he’s found plenty to do. “I take Spanish lessons two days a week for two hours a day. It’s been great. I never thought I would acquire a usable language in my 60s,” he says. He also rides his bike all around the area, does some writing and belongs to a community group that undertakes projects to improve the area.

And he often simply takes in nature, which he says has been an essential part of why he feels calmer and more relaxed in Costa Rica than in the U.S. “I live at 3,000 feet but in a valley surrounded by coffee fields and lime trees and water. At night, if I open the windows, I can hear the river rushing by,” he says. “It is very calming … hundreds of trees everywhere … you know the Earth is alive.”

The historic Iglesia de San José de Orosi.


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Cons: “I don’t want to overglorify. It’s not without its problems,” Farber says of Costa Rica. “There are social problems and downsides.” He notes that crime and petty theft can be a problem (“I am cautious,” he says of his approach) and seem to have increased since he moved there, and adds that he misses out on some cultural things because of where he lives. And, he says with a laugh, “I can’t order Thai food at 9 at night.” But, he adds: “These are trade-offs — in the afternoon, I get to walk in the coffee fields and see flocks of parrots.”

Residency: To qualify for Costa Rica’s pensionado visa, expats must prove that they have a pension of at least $1,000 coming in each month. (Here are the details of that program.) Once you have lived in Costa Rica for three years, you can apply for permanent residency. Farber used a lawyer to help him figure out the ins and outs of residency options; his entire path to permanent residency took about a year, he says.

The bottom line: “After five years I am still amazed and surprised that I made the decision to lead a life I never thought I would,” he says. And while he may not stay in Orosi forever — “the town doesn’t have an ambulance, [and] I don’t know what it will be like to be 80 there,” he says — he does plan to stay in Costa Rica in no small part because of the people and sense of community. “I have the feeling that life is good here,” he says. “It’s hard sometimes, but we are all in it together.”



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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path

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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path

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