If everyone else is doing it,
don’t, Buffett says

The legendary investor says
high costs and stock fads can
lead to bad results

NEW YORK » One of the most widely read dispatches in the investment world may be Warren Buffett's annual letter to the shareholders of Berkshire Hathaway. In this year's edition, the man known as the Oracle of Omaha offered two tips for small investors: Don't overtrade, and don't abandon ship just because everyone else is jumping.

Looking back over the last 35 years, Buffett noted that American business has delivered terrific results, which should have made it easy for investors to earn juicy returns. But for many, it hasn't been so simple.

"All they had to do was piggyback corporate America in a diversified, low-expense way," Buffett wrote. "An index fund that they never touched would have done the job. Instead, many investors have had experiences ranging from mediocre to disastrous."

Buffett blamed investor missteps on three factors: high costs, often because investors trade excessively or spend too much on management fees; poor decisions based on tips and fads rather than solid research; and untimely exits from investment positions, usually after periods of stagnation or decline.

"Investors should remember that excitement and expenses are their enemies," Buffett told shareholders. "And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

It's a strategy that has worked well for Buffett's Omaha, Neb.-based conglomerate, which has posted an average annual gain of 21.9 percent since 1965 -- better than twice the return delivered by the Standard & Poor's 500 over the same period.

Berkshire and Buffett have had great success when it comes to "being greedy only when others are fearful." But maintaining such a strategy can be very hard, said Michael Mauboussin, chief investment strategist at Legg Mason Capital Management in Baltimore, and an adjunct professor at the Columbia Graduate School of Business.

"That's very plain, common sense advice," Mauboussin said. "But it's a very difficult thing to do."

Part of the difficulty comes from the fact that most major financial institutions -- and the financial media that cater to them -- focus on short-term performance. For small investors, having the conviction to resist being part of that group can be a huge challenge. But research has shown that portfolios with lower turnover rates perform far better in the long run. Less trading means lower costs, but also requires a strong stomach.

"It ... runs counter to the American way. In most endeavors, the more active you are, the harder you work at it, the better you do. Activity is equated to success," Mauboussin said. "But in investing, it's really not. Most of the great investors make very few decisions. It's kind of counter to the way most people think and operate."

Using a value-focused philosophy, Buffett has taken a long-term approach to building Berkshire's broadly diversified portfolio of businesses, which includes MidAmerican Energy Holdings, auto insurer GEICO, reinsurer General Re, aircraft fractional ownership subsidiary NetJets, manufactured homebuilder Clayton Homes, carpet manufacturer Shaw Industries, apparel maker Fruit of the Loom, Nebraska Furniture Mart and Dairy Queen.

Berkshire's nearly $38 billion stock portfolio includes a 12.1 percent ownership stake in American Express Co., and significant positions in the Coca-Cola Co., Gillette Co. and H&R Block Inc. On a weighted basis, the company had held its positions in these stocks for about 12 1/2 years. Berkshire also owns 18.1 percent of the Washington Post Co., an $11 million investment made in 1974 that is now worth an estimated $1.7 billion.

The company's underlying value is reflected in the price of its shares, which can be had in two flavors; A-class shares, which closed Friday at $90,625, down $75.00 as the market swooned over economic data, or B-class shares -- 1/30th of the size -- which slipped $6.00 to $3,001. Either will serve as a ticket to Berkshire's widely attended annual meeting in Omaha next month, and get you an 8 percent discount on GEICO car insurance, one of the many businesses Buffett plugs in his letter.

Berkshire's long-term performance, contrasted against last year's return, provides a lesson in itself. Despite his many successes, Buffett apologized in his 40th letter to shareholders for Berkshire's "lackluster" 10.5 percent book-value gain, which fell short of the S&P's 10.9 percent return for 2004.

One of the more interesting things about the letter was what it was missing, said Dreyfus Neenan, senior analyst at Morningstar Inc. Berkshire ended the year with $43 billion in cash equivalents, "not a happy position," Buffett wrote. The problem was that Buffett and his team, who love buying great companies at bargain prices, found a dearth of acquisition opportunities, and very few attractive securities to buy.

"Warren Buffett, being Warren Buffett, you know that's burning him up. He wants to make money," Neenan said. "So you have to ask yourself, if one of the best investors in history can't find any attractive investments, what does that say for the rest of us?"