Warren Buffett is famed for his investment wisdom and folksy life advice and we really enjoy reading his annual letter to shareholders of Berkshire Hathaway. In the 2013 letter, he doesn’t stray far from his usual buy-and-hold and diversification strategies, but we picked out a few gems that we believe financial advisors should take to heart.
Keep Your Costs Low
It’s no secret that Buffett is a fan of the low-cost approach to business and investing. The advisory space is experiencing major downward pressure on profit. To survive in this environment, advisors have to regulate their costs. Segmenting your clients and offering different service levels can illuminate exactly how much your clients are costing you while enabling you to allot more time to your best accounts. Prudent investments in technology and outsourcing aspects of your business can help you lower costs while maintaining high standards of service.
Focus on the Playing Field, Not the Score Board
Buffett writes, “games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard.” He tells investors to forget about price fluctuations and focus on the earnings potential and future productivity of their investments.
This philosophy is also applicable to practice management. Don’t focus too much on the daily ups and downs of your business. Instead, think about your long-term strategy and how well your business is growing. There are dozens of hot advisor niches that are getting a lot of press right now. You can drive yourself crazy by trying to jump on a hot trend instead of asking yourself the big questions: Where do I want to be in five years? What’s the actual revenue potential of this niche? Does this niche fit my personality, expertise, and hopes for the future? Ultimately, what’s important is the sustainable long-term productivity of your business.
Learn From Your Mistakes
Buffett is rightly famed for his investing acumen, but he’s also capable of making some major mistakes. In his letter, he admits to a pretty big blunder when he bought about $2 billion of Energy Future Holdings debt after a 2007 leveraged buyout. With a probable EFH bankruptcy on the horizon, Berkshire Hathaway was forced to sell the debt for a fraction of its purchase price, bringing the total pre-tax loss to $873 million. While Buffett doesn’t go into his decision-making process, he does say that he bought the debt without consulting his business partner Charlie Munger. “Next time,” he promises, “I’ll call Charlie.”
What’s the takeaway for advisors? Even with a lot of research, due diligence, and the best of intentions, you will make expensive mistakes. Diversify your client base and service offerings so that a single error or bad bet won’t take down your whole practice. Most importantly, identify where you went wrong and set up systems to avoid making that kind of mistake again.
Understand Your Circle of Competence
Buffett cautions readers to recognize the “perimeter of [their] ‘circle of competence’ and stay well inside of it.” Advisors should know their area of expertise and focus on building on that instead of chasing profits by moving out of their core competencies into an area they don’t know well.
While that certainly doesn’t mean you can’t diversify your practice, you should consider each new service area carefully and ensure that you can learn (or hire) the expertise you need. In the long run, you’ll do better being very good at a handful of things rather than mediocre at everything.
You’re Not Warren Buffett – Nor Are Your Clients
By the most recent estimates, the Sage of Omaha is worth in the neighborhood of $60 billion, so he must be doing something right. However, his instructions to the trustee of his estate left some industry veterans scratching their heads. Specifically, he wants his wife’s cash inheritance to be split 90/10 between a Vanguard S&P 500 index fund and short-term government bonds.
Buffett explains his move thusly: “I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals.” Ok, he’s doubling down on his beloved passive indexing philosophy. But, what about risk? Sure, someone with billions in the kitty may be able to tolerate the wild swings a 90% to equity allocation will experience, but can anyone else?
Risk management is one of the most importance services you offer your clients and it’s critical to adequately explain this to clients, especially when their portfolio is trailing the S&P 500.
The Warren Buffett bottom line is this: Control your costs, think carefully about your long-term goals before making any major decisions, and focus on your core competencies.