Warren Buffett was once asked how long he likes to hold his stocks; “My favourite holding period is forever”, he replied. This is classic buy-and-hold thinking, and it is one of the strategies that has made Mr. Buffett one of the richest people in the world.
Mr. Buffett’s strategy for buying stocks is low-maintenance, low-cost, and highly effective. It is also known as a buy-and-hold or passive investing approach. Why isn’t everyone buying stocks this way then?
Well, I hate to sound cynical here but no one makes money when you buy stocks directly and hold them for long periods like Buffett (except for the people like him that also do it). Brokers and financial advisers make their money through commissions, trailer fees (a fee paid to them by mutual fund companies), and management and/or consulting fees.
I like to know that my money is aligned with my interests alone, so I like to do as many things as I can myself. I bought my first stock at age twelve and worked in the financial services industry for many years. I have also made many expensive mistakes along the way. Here is my simple and frugal method for buying stocks like Buffett.
Legal: I speak here in only general terms about a low-cost strategy for buying stocks. This article is not advice, and should not be treated as such. Seek independent professional advice.
Step One – Determine Your Objectives, Risk Tolerance, and Portfolio Allocation
Basically this means setting goals, making sure you can sleep at night, and figuring out how much of your money should be in bonds, stocks, and cash. This might sound simple, but there are actually a lot of things to consider when figuring these things out. You can hire a professional to complete this plan for you for a negotiated fixed fee if you’d like.
Step Two – Recognize that Investing and Gambling are Different Things
Investing means putting your money to work to gain a profit. Gambling means throwing money out the window on a game of chance. Investing has a purpose of profit. Gambling is an entertainment. If you want to gamble, take only the money you are prepared to lose and go to a casino or buy yourself a scratch ticket. If you want to invest, recognize the distinction here.
Don’t spend your whole day watching the second by second changes in stock prices like you would watch the spinning cylinders inside a slot machine. You have a purpose, you have a plan, you’ve done your research – relax! The only prices that matter are the initial price you pay to buy your stock at and the price you get when you sell it.
Step Three – Buy Good Quality Companies that You Understand and Buy Them Cheap
I used to be a lot more interested in individual stock analysis. I used to use spreadsheets and charts and software. I used to buy expensive subscriptions to investment research magazines and would spend lots of money on books about investing and buying stocks. I did quite well using this method but, quite frankly, I have other things I’d rather do now (like spend time with my daughter).
One of my favourite approaches to buying stocks is to copy Warren Buffett. He has made tons of money as an investor and he has a team of top-notch experts to help him research stocks 24 hours a day. How can I possibly compete with that? Well, I can’t. I just copy him and try to buy his stocks at prices even cheaper than what he paid for them when I can (which is very rarely).
One of the ways I try to do this is by researching his annual and quarterly report filings. These reports detail the business activities of Berkshire Hathaway (Buffett’s holding company). The annual report, in particular, details holdings worth over $1 Billion, the number of shares owned, and the cost of these shares. Using simple division, you can figure out average cost per share. Here are my findings from 2011.
Here is one example of my strategy in action. I bought some US Bancorp at the time I wrote that post for $25.13 per share (and yes, I still own it). Warren Buffett’s average cost was around $30.76 according to my calculations and it was a relatively new acquisition for him. He continues to add to this position today and has increased his average cost to an estimated $34.31. This was one of the more recent opportunities where I had a chance to buy a stock for less than Warren Buffett. I feel pretty good about my investment.
While I’ll probably never be able to buy Coca-Cola at an average price of $3.25 like he did way back when, the fact that he has owned Coca-Cola for so long, that it has made him so much money, and that he continues to hold it as a core holding gives me confidence in it as a company. It’s easy to understand (they sell syrup that gets mixed with carbonated water), it is highly profitable, and it is one of the most (if not the most) recognized brand names in the world. It is a stable business with a big moat (this means that it’s really tough for a new company to enter the market and compete with Coca-Cola).
I do currently own shares in Coca-Cola I and plan on owning them forever. They’re my type of business.
On Index Funds
I would certainly be remiss in not mentioning index funds. An index fund is like a basket that holds a collection of investments like stocks, bonds, or mortgages, etc.. You can buy an index fund instead of buying each of the investments that it holds individually. This is a low-cost alternative for you to diversify your holdings easily and effectively.
Using index funds will give you the same rate of return as the investment that it is replicating (like the Dow Jones Industrial Average or the S&P 500) minus the fund’s management fees (which are often quite low for index funds because there is relatively so little to do to manage them). As such, if the Dow goes up, the value of your index fund also goes up by the same amount (minus the fees, of course). Pretty simple.
Further adding to the appeal of index mutual funds is that they almost always beat funds that are actively managed by portfolio managers. This is due in large part to the fees that are charged by the fund.
In short, index funds can certainly be a powerful part of any portfolio. They are not the focus of this post, however, so let’s move on.
Step Four – Minimize Fees by Using Share Purchase Plans And Dividend Reinvestment Plans
As I mentioned, I normally buy stocks with the intention of holding them forever. This virtually eliminates the substantial costs of commissions and other fees.Buy Stocks Directly From The Company using a Share Purchase Plan
Many companies allow investors to purchase shares directly from them using what is called a Share Purchase Plan (or SPP). Yeah, that’s right, open an account with their company registrar and transfer agent and send them a cheque. They will buy you shares at no cost or very little cost.
Want to buy more shares or set up a regular purchase plan? No problem. They can do that for you as well at little or no cost.
This is a big advantage for small investors that want to build up their stock holding gradually over time. It also helps remove some of the market risk by spreading out your purchases (also known as Dollar Cost Averaging).
Reinvest Your Dividends into Buying More Shares using a Dividend Reinvestment Plan (DRIP)
Many companies pay their owners (shareholders like you and me) a portion of their profits. This payment is called a dividend and it is often (but not always) paid out quarterly (every three months). These dividends can be paid out to you in cash or used to buy you more shares (and tiny fractions of a share) using something called a Dividend Reinvestment Plan (or DRIP). They normally do this for free.
This allows you to take complete advantage of the awesome power of compounding (in this case, earning dividends on your dividends) when growing your wealth. The calculation of fractional shares ensures that each fraction of a cent is being put to good use on your behalf. Oh yes, and its normally done for free.
How to Find Out More and Sign Up
Go to a company website and look for a link that says “Shareholders” or “Investors”. It is probably somewhere near the bottom and may not be super obvious so take your time and look hard. Click that link when you find it.
You’ll then probably find a link called “Shareholder Services” or something similar. Click that and you should be directed to a page that gives you all the details. You will also probably find a link to their company registrar and transfer agent which will have all of the details that you need to get started.
Computershare is one example of registrar and transfer agent that does this work on behalf of companies like Coca-Cola. Here is an example of an Investment Plan Brochure that explains the details of the Coca-Cola plan.
Step Five – Then What?
Well … not much really. Be patient and wait for your wealth to grow. You should also review your plan with your financial adviser at least once a year and more frequently if your circumstances change in a big way (e.g. the birth of a child, marriage, divorce, buying a home, a job promotion or demotion, disability, etc.), but that’s about it. It may sound boring, but it sure has made Warren Buffett a lot of money. As a frugal investor, this low-maintenance, and low-cost approach to buying stocks suits me just fine.
What approach do you use when investing? Which approach has been the most or least successful for you?
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Author: Jason Milburn Google