2004: How does Buffett think about asset allocation?

AUDIENCE MEMBER: Hi, I’m Bob Klein (PH) from Los Angeles.

You’ve touched on the issue of asset allocation — capital allocation — in response to previous questions. But I wonder if you could elaborate from a risk management perspective. Wall Street and financial planning firms charge a lot of money for their asset allocation models, say, 50 percent stocks, 40 percent bonds, et cetera.

I know you take a more opportunistic approach to building your portfolio and managing risk, as you mentioned by — as you illustrated — by your junk bond example.

And so I just want you to hammer out how you use price and value as a tool of risk management and asset allocation as opposed to coming at it with a pre-conceived idea of how much should be allocated to each asset class.

WARREN BUFFETT: Yeah, we think the best way to minimize risk is to think. (Laughter)

And the idea that you have — you know, you say, “I’ve got 60 percent in stocks and 40 percent in bonds,” and then have a big announcement, now we’re moving it to 65/35, as some strategists or whatever they call them in Wall Street do.

I mean, that has to be pure nonsense. I mean, 60/40 or 65/30 — it just doesn’t make any sense.

What you ought to do is have — your default position is always short-term instruments. And whenever you see anything intelligent to do, you should do it. And you shouldn’t be trying to match up with some goal like that.

I found it entertaining — I was just reading yesterday in an article, I think it was, about the two fellows at Google and all of the problems they’re going to have because they’re each going to get a few billion dollars. I mean, it was — I want to send a sympathy card. I almost went down to Hallmark store because this article went on — they’ve got this terrible problem and that terrible problem and they’re going to need lawyers, and they’re going to need financial — they don’t need anybody.

Those guys are smarter than the people that are coming to them. And they do not have a big problem, and they are very capable of thinking it through themselves.

The people that have the problem are the people who want to sell their services to them and are going to have to convince them that they have a problem.

But so much of what you see when you talk about asset allocation — it’s just merchandising. It’s a way to make you think that if you don’t know how to determine whether it should be 60/40 or 65/35, that you need these people. And you don’t need them at all in investing.

Most of the professionals that tell you that you’re going to get in great trouble unless you listen to them and sign up for their services, you know, they’re good at selling, but —

It’s what my brother-in-law — former brother-in-law — that worked at the stockyards used to say was that people would bring in cattle or something. And I’d say to him, you know, “How do get the farmer to employ you to sell to Swift or Armour or Cudahy instead of the guy right next to you. I mean, you know, a cow is a cow and Armour’s going to buy it the same way.”

And he gave me this disgusted look and he said, “Warren, it’s not how you sell them, it’s how you tell them.” Well, there’s a lot of that in Wall Street.

Charlie?

CHARLIE MUNGER: Yeah, people have always had this craving to know the future. You know, the king used to hire the magician or the forecaster and he’d look in sheep guts or something for an answer as to how to handle the next war. And so there’s always been a market for people who purported to know the future based on their expertise.

And there’s a lot of that still going on. It’s just as crazy as when the king was hiring the forecaster who looked at the sheep guts.

And people have an economic incentive to sell some nostrum. It can be sold over and over and over again.

The really interesting figures are when you combine the underperformance of the market, say, by the mutual fund industry, which is probably a couple of points per annum. And that understates it.

Now, if you take all of the investors in the mutual funds who are constantly whipsawing from one fund to another by a bunch of brokers who want commissions, now you take a sub-normal performance and it goes on another three or four percentages points due to the shuffling of the mutual fund investments.

So the poor guy in the general public is getting a terrible result from contacting the experts. And these guys are hitting the Scout troop and the Community Chest drive and are locally reputable people.

I think it’s disgusting. It’s much better to make a living by being part of system that delivers value to the people who are buying the product. But nobody refrains from creating gambling casinos or something, on my theory.

If it’ll work to make money, why, we tend to do it in this country.