Why Investing Like a Thousandaire Might Make More Sense Than Investing Like a Millionaire

1950s Warren Buffett was a lot different than today’s version, and not just because he was a million years younger. Younger Buffett was putting his cash to work in companies like Sanborn Maps, Dempster Mills, Hochschild, Kohn & Co., and, of course, Berkshire Hathaway — but back when it was a crummy textile company in the business of making men’s suit liners.

We all know what happened next. Realizing the strategy wouldn’t scale, Buffett adapted and began looking for wonderful companies trading at fair prices. The above investments were punted in exchange for names like Disney, The Washington Post, Gillette, Coca-Cola, and, most recently, Apple.

This begs an interesting thought experiment. Buffett has admitted numerous times over the years that the pivot to larger companies wasn’t really by choice. Yes, he was influenced by Charlie Munger (who advocated such a strategy), but it really came to be because he had too much capital to play in the world of microcaps.

As evidenced by the quote above, Buffett remains confident he could earn fantastic returns on small amounts of capital. He continues to think this despite the world of microcap investing changing significantly since he spent much time there.

I’m fairly confident a 30-year-old Buffett would continue to post stellar returns hanging out on the pink sheets. He’d probably be looking at undervalued markets around the world too, which are easily accessible to anyone with an Interactive Brokers account and the ability to use Google Translate.

This all begs two interesting questions:

1. Why don’t more young investors copy Buffett?

2. Is Buffett’s claim remotely realistic for the average investor?

Let’s tackle each of them.

Copying a young Buffett

Your author firmly believes most investors have an incomplete picture of a young Warren Buffett. They picture him reading the newspaper or talking to his buddies, taking a somewhat more relaxed stance, much like the public persona he puts out today. He shows up, makes a couple of investments, drops a few folksy quips, and then goes to play bridge with Bill Gates.

In reality, Buffett put today’s hustle culture to shame. He offered to work for Ben Graham for free. His famous investment in GEICO came after he went down to the company’s HQ on a Saturday and talked insurance with a VP who happened to be working. He was relentlessly hustling after dinner and on weekends.

He kept this up even to the point where it impacted his family life. He’d make an appearance at dinner, make a token effort to talk to his kids, and then disappear into his study with a stack of Moody’s Manuals. He wasn’t just skimming them, either. He started at the As and worked his way to the Zs. Then, when he was done, he started all over again.

He didn’t just do this over a six month sprint, either. He did it over decades, finally settling down a little bit when his wife effectively left him.

My point is this: most people want Buffett’s results, without putting in the countless hours of hard work. They quote The Oracle and will loudly declare his way is the best way to invest. And then they pile into large cap tech because everyone on Twitter says so, ignoring the fact Buffett was nowhere near his time’s version of tech stocks.

There’s also the unpopularity in owning those kinds of stocks. Dirt-cheap value stocks are that way for a reason; they all have something wrong with them. Investors must dig through the crap and find the not-so-bad ones. Why bother when you can get pretty good returns owning crowd favourites like large-cap tech, consistent dividend-paying blue chips, or similar names? Why sort through all that crap to find a few pieces of slightly better crap?

There’s also degrees of difficulty to think about. A diversified portfolio of Canada’s six largest banks returned about 10% per year over the last 25 years. An exceptional (read, one in about a hundred) Buffett-style investor can do about 20% per year. Another 2-3 per hundred can put up 15% per year. Many will cluster around the 10-12% per year range, with the bottom half pulling down the average

Unless you’re really confident you’re in that top 1-4%, why not take an easy 10% long-term return and get a more productive hobby? Many deep value investors — including your author — come to that realization and adapt their style. Besides, a 10% return combined with a 30+ year investing timeline is all it takes to get pretty wealthy.

So, in short, more people don’t copy a young Buffett because:

1. It’s an unpopular way to invest

2. They don’t want to do the work

3. They’re not skilled enough to achieve excess returns

Can anyone copy the results?

I’ll come right out and say it. Anyone who thinks they can earn 50% per year consistently on a million dollars is out of their mind. It simply isn’t possible over a long period of time.

It seems to me that a 15% annual return is the best us mere mortals can achieve and, to be completely honest, you have to be a pretty extraordinary investor to achieve that consistently over the long-term. I’m talking one in a hundred, and that might even be aggressive.

Short-term exceptions will always exist, so don’t bother filling up my comment section with them. A friend’s-brother’s-nephew might be able to buck the odds for a few years, but reality always wins over the long haul.

However, I do think the results are achievable if we limit the amount invested and the return expectations. Forget about 50% and $1M; let’s talk about $50-$100k and 15-20% annual returns. Because I think that’s achievable to the average investor who wants to put the work in.

Here’s what I’d do to accomplish 15-20% annual returns on $50-100k. It consists of:

1. Using a tax-free or tax-deferred account (RRSP or TFSA)

2. Investing your money in periodic special situations — specifically odd lot tenders

3. Repeat with your spouse’s account

For example, on May 4th Dream Office REIT announced it sold part of its stake in Dream Industrial to fund the repurchase of its undervalued shares. Dream Office offered $15.50 per share to shareholders who wanted to sell their shares back to the company, a huge premium compared to the sub-$13 price immediately before the offer.

Shares immediately shot up to close to $15 each, before settling in the $14.50 range.

These tender offers work like so. The company has a certain amount to spend on the buyback. If more investors participate than there is money available, then each investor gets pro-rated. This is exactly what happened with the Dream offer, with each investor getting about 40% of their shares acquired.

But here’s where these offers get interesting, and where there’s small amounts of money to be made. Most of these offers have odd lot provisions, which protect investors with fewer than 100 shares from being pro-rated. The strategy then becomes pretty simple:

1. Buy 99 shares

2. Tender your shares

3. Lock in your risk-free profit

Here’s the problem. This doesn’t scale worth anything. The Dream situation would have yielded a profit of approximately $1 per share, or $99. Do it in your spouse’s account as well and you’re looking at a $198 profit.

I know a lot of people who don’t even get out of bed for $198.

The good news is there are usually quite a few of these each year, meaning I think it’s very possible to earn consistent returns of 15-20% on an investment of $50,000.

But is it worth all the hassle? A 15% return on $50,000 is $7,500 per year. That’s a decent amount of money, but you’ll spend at least a few hours per week researching these things. It becomes a part-time job, which is exactly why most people don’t bother researching small caps in the first place.

Your author basically has all the time in the world. I’m a full-time investor who happens to spend some time writing you all a few times a week. And I’m not even sure it’s worth the effort. So if I’m not sure, why would anyone with a full-time job even bother?

The bottom line

Ultimately, it comes down to this.

There are all sorts of schemes available to potentially eke out a few extra percentage points in return. You can invest in tiny microcaps trading at dirt-cheap valuations. You can look to other markets around the world. Or you can employ a special situations style.

But there are numerous problems with such strategies. They’re very difficult to scale. Investing in tiny stocks comes with unusual risks, and ultra-cheap stocks are usually that way for a reason. In addition, some of these microcap investors will enter into a position, share it on Twitter, and have enough influence to increase the stock price. It’s not a pump and dump — these guys do tend to hold for a while — but it certainly does help. The average investor doesn’t have that advantage.

In other words, there’s no such thing as a free lunch in finance. It’s all about trade-offs. And, at least for me, I’m not terribly interested in dealing with those tradeoffs. Especially when I can still get pretty decent long-term results by putting my cash in boring dividend stocks.

If you enjoyed this piece, consider upgrading your membership. For just $15 per month (or $150 per year) you get two posts per week (2,000+ words each) on specific Canadian dividend stocks, access to model portfolios, and much more!