1999: How should a passive investor invest?

AUDIENCE MEMBER: My name is Esther Wilson. I live in South Sioux City, Nebraska.

My husband and I will have some new money in the early 80s of our lifehood. We have a daughter, 50 years old, who will inherent anything we have.

My question is — I also have a four percent interest on a mutual fund that is non-taxable. Are there any better ways to invest our money? (Laughter)

WARREN BUFFETT: Well, those are tough questions. I mean, I — you know, I run into friends of mine all the time where they come into a lump sum at a given time.

And, you know, Charlie and I do not have great answers about investing sums of money for people who are not really active in the process.

I mean, if, as we said earlier, if we were working with small sums now, we would start looking at a whole bunch of very small situations and some things that we might know how to do on a small scale.

But for the average investor who wants to own equities over a 20 or 30-year period, we think regular investment in some kind of very low-cost pool of money, which might well be an index fund, probably makes as much sense as anything. But it’s important to keep the cost down.

You know, I have close to a hundred percent of my net worth in Berkshire. I’m comfortable with it because I like the businesses we own. And — but, you know, I didn’t buy it at this price either.

So I don’t like to go — I never recommend anybody buy or sell it. And, Charlie, do you recommend anything?

CHARLIE MUNGER: I think it’s — if there’s anybody in the room who thinks it would be very easy to come up with a one-liner for a great no-brainer investment tomorrow with a great slug of new money, I wish they’d come up and tell me what it is. (Laughter)

We don’t have any solution to that one. It’s harder for us now than it has been at other times.

WARREN BUFFETT: Yeah, there’s been a couple of times — in 1974 there was something in Forbes — in ’69, the reverse of that situation. And then, I think, I wrote an article for Forbes — I can’t remember exactly when it was — about how equities almost had to be more attractive than bonds at that time. And bonds weren’t that unattractive.

I mean, every now and then you can say you’re getting a great deal for your money in equities. Or sometimes you can say you’re getting a great deal for your money in fixed-income investments.

You can’t say that now, so what do you do? You know? In terms of new money, we find ourselves sitting and waiting for something and we continue to look.

But we are forced to look at bigger ideas. So if we were working with smaller funds we’d be much more likely to find something than we are in our present situation.

As Charlie says, we really don’t have any great one-line advice on it. I wish we did for you. Zone 4 —

CHARLIE MUNGER: I —

WARREN BUFFETT: Go ahead.

CHARLIE MUNGER: The real long-term rate of return from saving money and investing it has to go down, from recent experience in America, particularly equity-related recent experience.

The wealth of the world can’t increase at the kind of rates that people are used to in the American equity markets. And the American equity markets can’t hugely outperform the growth of the wealth of the world forever.

WARREN BUFFETT: Well, you —

CHARLIE MUNGER: We ought to have reduced expectations regarding the future, generally.

WARREN BUFFETT: Yeah, dramatically reduce them, because, you know — we mentioned earlier, 53 percent of the world stock market value is in the U.S.

Well, if U.S. GDP grows at four percent, five percent a year, with one or two percent inflation, which would be a pretty — would be a very good result — I think it’s very unlikely that corporate profits are going to grow at a greater rate than that.

Corporate profits, as a percent of GDP, are on the high side already and you can’t constantly have corporate profits grow at a faster rate than GDP. Obviously, in the end, they’d be greater than GDP.

And that’s like somebody said that New York has more lawyers than people. I mean — (laughter) — there’s certain — you run into certain conflicts with terminology as you go along if you say profits can get bigger than GDP.

So, if you really have a situation where the best you can hope for in corporate profit growth over the years is four or five percent, how can it be reasonable to think that equities, which are a capitalization of that corporate — of corporate profits — can grow at 15 percent a year?

I mean, it is nonsense, frankly. And people are not going to average 15 percent or anything like it in equities. And I would almost defy them to show me, mathematically, how it can be done in aggregate.

I looked the other day at the Fortune 500. They earned $334 billion on — and had a market cap of 9.9 trillion at the end of the year, which would probably be at least 10 1/2 trillion now.

Well, the only money investors are going to make, in the long run, are what the businesses make. I mean, there is nothing added. The government doesn’t throw in anything. You know, nobody’s adding to the pot. People are taking out from the pot, in terms of frictional cost, investment management fees, brokerage commissions and all of that.

But the 334 million [billion] is all that — is all the investment earns. I mean, if you want to farm, the — what the farm produces is all you’re going to get from the farm.

If it produces, you know, $50 an acre of net profit, you get $50 an acre of net profit. And there’s nothing about it that transforms that in some miraculous form.

If you own all of American — if you own all of the Fortune 500 now, if you owned a hundred percent of it, you would be making 334 billion. And if you paid 10 1/2 trillion for that, that is not a great return on investment.

And then you say to yourself, “Can that double in 5 years?” It can’t — the 334 billion — it can’t double in 5 years with GDP growing at 4 percent a year, or some number like that. It would just produce things that are so out of whack, in terms of experience in the American economy, it won’t happen.

So any time you get involved in these things where if you trace out the mathematics of it, you bump into absurdities, then you better change expectations somewhat.

Charlie?

CHARLIE MUNGER: There are two great sayings. One is, “If a thing can’t go on forever, it will eventually stop.” (Laughter)

And the other I borrow from my friend, Fred Stanback, who I think is here. “People who expect perpetual growth in real wealth in a finite earth are either mad men or economists.” (Laughter)