MONEY Autos

WATCH: Secret Shopper at Cadillac Dealership Turns Out to Be Warren Buffett

Buffett was so pleased he sent a letter to GM CEO Mary Barra to compliment the service his daughter received at an Omaha Cadillac dealership.

MONEY Kids and Money

10 Celebs (Besides Sting) Who Cut Their Kids Out of their Wills

The former Police frontman made headlines when he said his kids won't get trust funds; these other millionaires and billionaires have also decided that their offspring won't inherit 100%.

Musician Sting
Sting doesn’t want his money to be “albatrosses” around his kids’ necks. Carlo Allegri—Reuters

So much for fields of gold. Looks like the six children of pop singer Sting won’t be getting much out of their old man, whose estimated worth has been placed at around $300 million.

The 62-year-old musician didn’t put this message in a bottle: He told the press. In an interview published this past weekend in England’s Mail on Sunday newspaper, Sting—f.k.a. Gordon Sumner—explained that he wasn’t planning on leaving any trust funds for his progeny. “I told them there won’t be much money left because we are spending it,” the paper reported him saying.

Beyond explaining that much of his money is already committed, the former Police frontman also said he wouldn’t want an inheritance to be “albatrosses round their necks.”

“Obviously, if they were in trouble I would help them,” he added. “But I’ve never really had to do that. They have the work ethic that makes them want to succeed on their own merit.”

He’s not the only celebrity who has decided against giving his entire fortune to his kids. Below are 10 other boldface names who’ve either said they’ll write their kids out of their wills or give them only a small slice of their very big pies. (Many of these folks are disinheriting their kids for humanitarian reasons.)

Of course, you don’t have to have mega-bucks to be concerned about how your kids will handle an inheritance. A fairly recent survey from WealthCounsel found that 35% of people are crafting their estate plans to avoid mismanagement of money by their heirs. But if that’s your worry, keep in mind that there are things you can do to ensure that your kid doesn’t squander your hard-earned funds.

  • Bill Gates

    Bill Gates
    Bill Gates Lucas Jackson—Reuters

    Estimated net worth: $78.6 billion

    On a Reddit “Ask Me Anything,” the Microsoft founder said that he thinks leaving his kids massive amounts of money would be no favor to them. Inspired by Warren Buffett, he plans to leave the vast majority of his fortune to charity—he has his own, The Bill & Melinda Gates Foundation. With Buffett, he has has encouraged other billionaires to give away their wealth.

  • Warren Buffett

    Investor Warren Buffett
    Warren Buffett Lucas Jackson—Reuters

    Estimated net worth: $65.1 billion

    The Berkshire Hathaway boss man hasn’t been shy about his distaste for leaving an inheritance to his family members. “I’m not an enthusiast for dynastic wealth, particularly when 6 billion others have much poorer hands than we do in life,” he reportedly said at a 2006 event following his announcement to donate the vast majority of his fortune. Since then, Buffett has pledged to give away a full 99% of his money to charity, and has encouraged other billionaires to give away at least 50% of their wealth through The Giving Pledge.

  • Michael Bloomberg

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    Michael Bloomberg Carlo Allegri—Reuters

    Estimated net worth: $34 billion

    The former Mayor of New York City, who made his fortune as owner of the financial information company that bears his name and who has two daughters in their 30s, signed Buffett’s and Gates’s Giving Pledge. In his letter, he said, “If you want to do something for your children and show how much you love them, the single best thing—by far—is to support organizations that will create a better world for them and their children.” The Bloomberg Philanthropic Foundation donates to various causes, ranging from health care to literacy.

  • Pierre Omdiyar

    EBay founder and chairman Pierre Omidyar
    Pierre Omidyar Tim Shaffer—Reuters

    Estimated net worth: $7.6 billion

    The eBay founder and father of three stated in 2001 that he and his wife would give away the vast majority of their wealth during their lives. “We have more money than our family will ever need,” he has written. “There’s no need to hold onto it when it can be put to use today, to help solve some of the world’s most intractable problems.” He and his wife started the Humanity United Foundation which supports anti-slavery nonprofits.

  • George Lucas

    Director George Lucas
    George Lucas Jean-Paul Pelissier—Reuters

    Estimated net worth: $4.9 billion

    After selling the Star Wars franchise to Disney for $4.5 billion in 2012, George Lucas—father to four—said that the proceeds from the sale would be donated towards improving education. That echoed his commitment to give up the majority of his wealth in his 2012 Giving Pledge letter: “As long as I have the resources at my disposal, I will seek to raise the bar for future generations of students of all ages.”

  • Ted Turner

    Turner Enterprises Inc. Chairman Ted Turner
    Ted Turner Phil McCarten—Reuters

    Estimated net worth: $2.2 billion

    In 1990, Turner set up the Turner Foundation, which gives grants on environmental causes, as a family foundation so that his children could also be involved in charitable work. He then launched the United Nations Foundation with an initial pledge of $1 billion back in 1997. The media mogul writes, “At the time of my death, virtually all my wealth will have gone to charity.”

  • Simon Cowell

    Judge Simon Cowell
    Simon Cowell Mario Anzuoni—Reuters

    Estimated net worth: $500 million

    Last year, the X Factor judge and music mogul, who has a 16-month-old son, told the press that he doesn’t believe in passing on wealth from one generation to another. Rather, he plans to leave his money to charity, likely benefiting “kids and dogs.”

  • Kevin O’Leary

    Television personality and businessman Kevin O'Leary
    Kevin O'Leary Gus Ruelas—Reuters

    Estimated net worth: $300 million

    The Canadian businessman and investor, known for being a judge on the ABC series Shark Tank, said in an interview that he isn’t planning on passing any wealth on to his kids. “If you don’t start out your life with the fear of not being able to feed yourself and your family, then what motivates you to go get a job?” he said. “Fear motivated me, and it will motivate them.” He said that once they’re educated, he’ll kick his kids out of the nest, though he says he will set up generation-skipping trusts for his grandkids and great grandkids.

  • Jackie Chan

    Actor Jackie Chan
    Jackie Chan Eric Gaillard—Reuters

    Estimated net worth: $140 million

    The 60-year-old actor has said that he will leave his wealth to charity, and none of it to his son. “He can make his own money,” he reportedly told the press. Chan is a UNICEF Goodwill Ambassador, campaigns against animal abuse and started the Jackie Chan Charitable Foundation, which supports education and disaster relief.

  • Nigella Lawson

    Nigella Lawson
    Nigella Lawson Stefan Wermuth—Reuters

    Estimated net worth: $15 million

    The celebrity chef, who divorced advertising tycoon Charles Saatchi last year, reportedly told the British magazine My Weekly that once her kids finish college, they will have to work and support themselves. “I am determined that my children should have no financial security,” she was quoted as saying. “It ruins people not having to earn money.” But she denies that they’ll be cut out of her will entirely, saying she has no plans to leave them destitute and starving.

MONEY Retirement

Eco Disaster: Lessons from Greenpeace’s Currency Bet Gone Bad

The global peace and sustainability nonprofit lost a bundle betting on currencies. Here's what you can learn from the mistake.

Superstars from Tiger Woods to Warren Buffett tell us the secret to their success is keeping it simple. So why would a donor-dependent, globally recognized nonprofit take a macro-economic flyer on which way currencies will move?

More important: What can the disastrous Greenpeace International bet on the direction of the euro tell us about how we handle our own financial matters? Greenpeace, which is quite good at promoting peace and sustainability, is really bad at macro analysis. Sometime last year the organization lost $5.2 million—more than 6% of its annual budget—when it bet wrongly against a rising euro.

This large loss came to light only this week, and it’s too soon to know its full effect. The organization says a financial pro on its staff overstepped and has been fired, and that the loss will not lead to a penny being cut from its causes. Still, it’s hard to believe that at least some donors won’t bristle and hold back donations. The consequences promise to go beyond simple embarrassment.

One lesson here is that currency speculation is a tricky business and best left to hedge fund managers like George Soros. If you must engage in currency bets alone, do so with only a small fraction of your savings and through straightforward international government bond funds. These pay interest in local currency and thus represent a foreign exchange bet. You might also consider a currency ETF from leaders CurrencyShares and WisdomTree.

The bigger lesson, though, is that it really does pay to keep things simple when investing. As Buffett writes in this year’s annual letter to shareholders:

You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”

Complexity is all around us. Exotic mortgages sunk millions of homeowners in the Great Recession. Unimaginably arcane financial derivatives contributed to the demise of Lehman Bros. and downfall of Bear Stearns, among other investment banks, during the financial collapse. Even bankers didn’t know quite what they were doing—not unlike the hapless, rogue finance staffer making a wrong-way bet on the euro for Greenpeace.

Individuals can make things as difficult or as easy as they want when they save and invest. Annuities are especially hot right now. Many people shy away from them because they believe all of them to be complex, and many others end up in the wrong type of annuity (and many other insurance products) because so many truly are complex. Yet for most people just looking to lock up guaranteed lifetime income, the venerable immediate or deferred immediate annuity are a sound and simple option.

Likewise, you can prospect for the hottest stock funds, only to be disappointed once you plunk down your dollars and see them eaten away by lackluster returns and high expenses—or you can choose low-fee diversified stock index funds, or maybe a target-date mutual fund, sleep well, and check back in just once a year to rebalance. Why layer chance on top of investment risk? You are good at something else, not macroeconomic analysis.

Reports suggest that the wayward Greenpeace employee was not nest feathering but trying to do the right thing for the future of the organization. Still, it went bad—even for someone in finance. As with many endeavors, when it comes to money, better to do as Buffett says and just keep it simple.

MONEY Saving

Cheapskate of the Downton Abbey Scene: British Baroness’s Frugal Living Guide

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Downtown Abbey ©Carnival Film and Television Limited —©Carnival Film and Television Limited for MASTERPIECE

Yes, even wealthy aristocrats can be total cheapskates. And proud of it!

The July 2014 issue of the British society magazine Tatler has several interesting reads aimed at the upper crust. The articles carry such provocative titles as “Would You Take Your Son to a Prostitute? The Ins-and-Outs of Upper-Class Sex Education” and “How the Middle Classes Ruined Everything.”

Another story also seems to have the aristocratic set in mind, yet it’s getting quite a lot of attention from us schlubs who ruined everything. “How to Run a Stately Home on a Budget” is essentially a frugal living guide from Baroness Rawlings, the 75-year-old owner of a 13-bedroom, 38-acre country estate in Norfolk, currently on the market for around $10.5 million. The baroness’s money-saving tips, which include reusing everything from napkins to bread crust to newspaper and never throwing anything away, have been featured in a host of British publications, including The Telegraph, Express, and Daily Mail.

Lady Rawlings is a strong proponent of growing one’s own fruit, bargain hunting at auctions and on eBay, and leaving warm water in the tub after bathing (it will warm the room at no extra charge). She also takes issue with the common practice of throwing away “horrid little bars” of soap after they’ve been used by guests. “I give my guests a fresh bar,” she said. “But I reuse it afterwards. And it ends up in drawers and cupboards to keep moths away.”

While it may make news that someone so wealthy is simultaneously so frugal, Lady Rawlings is hardly the only person of means to be an unabashed tightwad. Fellow countrywoman the Queen Mother was supposedly too cheap to buy a TV for her Scottish castle, and she refused to replace raincoats that were nearly 30 years old. The frugal tendencies of Queen Elizabeth II and Prince Charles have also occasionally been on display, especially during the tough recession years, when buffets replaced banquets (the horror!).

Some of America’s super rich are also renowned for their penny-pinching habits—most famously, Warren Buffett, who lives a unfancy life in Omaha, Neb., in the home he bought in 1958 for $31,500. This is the man who is CEO of the fourth-ranking company on the Fortune 500. Dick Yuengling, Jr., the owner of Yuengling, the oldest American-owned brewer, is another very wealthy character who refuses to give up his cheapskate ways; he’s been known to drive a 2002 Taurus (bought used) and reuse Styrofoam cups.

The author Thomas J. Stanley has long chronicled the habits of the wealthy, and while the huddled masses may assume rich folks live wildly extravagant, spend-spend-spend lives, the truth is often just the opposite. In one of his surveys from a few years ago, Stanley found out that 75% of millionaires pay less than $20 for a bottle of wine, and 4 in 10 prefer wine that’s $10 or under.

Other studies have found that affluent people tend to use coupons more than those in poverty, and that rich people don’t buy on impulse and prefer quality over prestige in products, among other somewhat surprising habits.

But should these frugal, value-oriented habits really come as a surprise? A prudent, disciplined, savvy approach likely helped these well-off individuals gain their wealth. And without a prudent, disciplined, savvy approach to spending, even the richest folks out there could cease being rich. At some point.

MONEY Warren Buffett

One Weird Trick That Will Help You Beat the Market Like Warren

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Warren Buffett Ben Baker—Redux

Here's a no-brainer way to win with "Warren" stocks. It won't do you any good now, but it would have been brilliant in 1993.

My story, Inside Buffett’s Brain, is about the search by financial economists and money managers for persistent patterns in stock returns. Some of these patterns might help to explain why a handful of money managers, including Buffett, have done so well. The story is about more than Buffett, though. The hunt through past market data for potentially winning strategies is a big business, and has fueled the growth of exchange-traded funds (ETFs). So a word of warning is in order.

Here’s the result of astoundingly simple Buffett-cloning strategy I put together, inspired by a “modest proposal” from Vanguard’s Joel Dickson. All you have to do buy stocks with tickers beginning with the letters in “Warren.” (You have double up on the “r” stocks, natch.)

Winning with Warren NEW

This likely “works” in part because it’s an equal-weight index—meaning each stock in the W.A.R.R.E.N. portfolio is held in the same proportion. Traditional indexes like the S&P 500 are “capitalization weighted,” meaning they give more weight to the biggest companies in the market. Because smaller stocks have outperformed in recent years, equally weighted indexes have done pretty well compared to traditional indexes in the period in question.

So you might find out that you can also beat the market with an equally weighted basket of stocks whose tickers begin with the letters in your name too. Just cross your fingers and hope the trend doesn’t reverse in favor of blue chips.

Another reason why this trick worked is that it picks from among current S&P 500 names, which means the stocks on the list are already in a sense known winners. Companies that used to be small and then graduated to the S&P 500 are on list, and companies that used to be big and then got small or disappeared aren’t on the list. But you couldn’t know which companies those were in 1993.

This is obviously dopey, and no way to run your money. (And the ideas I wrote about are much, much more sophisticated than this.) But there’s a serious point here. ETFs are a great way to buy cheap, reliable exposure to the stock market. But these days most ETFs track not a simple well-known benchmark, but a custom index built upon rules which, if followed, are thought to give investors an edge. For example there are indexes which tilt toward companies with better-than-average sales, or which specialize in certain sectors or investment themes.

These indexes often have really impressive past performance. In theory. Based on “back tests” of market data, from before the index was actually in operation.

And of course they do. Today indexes are often created with an ETF launch in mind. So there’s not much point in building an index and marketing it if you don’t know that the strategy has already won. Unfortunately, knowing what’s already worked in the past doesn’t mean you know what will work in the future.

In fact, investors in new indexes are likely to be disappointed. Samuel Lee, an ETF strategist at Morningstar, explains that in any group of past winning strategies, a high number will have won just through sheer luck. The future average performance of those strategies is almost certain to decay. Because luck runs out.

MONEY Warren Buffett

Inside Buffett’s Brain

140530_HOME_Buffett_1
Warren Buffett Ben Baker—Redux

Math-minded researchers are attempting to distill the mind of the world's greatest investor. Even if they fall short of replicating Warren Buffett's craft—and they will—there are good lessons here about what it takes to beat the market.

Warren Buffett isn’t merely a great investor. He’s also the great investor you think you can learn from, and maybe even copy (at least a little).

Buffett explains his approach in a way that makes it sound so head-smackingly simple. The smart investor, he wrote back in 1984, says, “If a business is worth a dollar and I can buy it for 40¢, something good may happen to me.” This is particularly true if you add an eye for quality.

Buying good businesses at bargain prices — that sounds like something you could do. Or hire a fund manager to do for you, if you could find one with a fraction of Buffett’s ability to spot a great deal. Of course, the numbers say otherwise. The vast majority of U.S. stock funds fail to beat their benchmarks over a 15-year period.

Buffett’s long-run record makes him a wild outlier. Since 1965 the underlying value of his holding company, Berkshire Hathaway, which owns publicly traded stocks such as Coca-Cola and American Express , as well as private subsidiaries like insurance giant Geico, has grown at an annualized 19.7%. During the same period the S&P 500 grew at a 9.8% rate.

Buffett is “a very unexplained guy,” says Lasse Heje Pedersen of Copenhagen Business School in Denmark. But instead of chalking up Buffett’s success to what Pedersen calls Fingerspitzengefühl—German for an intuitive touch—the professor is out to explain the man through math. His research is part of a push among both academics and money managers to quantify the ingredients of investment success. The not-so-subtle hint: It may be possible to build, in essence, a Buffett-bot portfolio. No Oracle required.

In an attention-getting paper, Pedersen and two co-­authors from the Greenwich, Conn., hedge fund manager AQR claim to have constructed a systematic method that doesn’t just match Buffett, but beats him (Pedersen also works for AQR). This is no knock on the man or his talents, they say. Just the opposite: It proves he’s not winging it. Meanwhile, other economists say they have pinned down a simpler quantitative way to at least get at the “good business” part of Buffett’s edge.

A dive into this quest to decode Buffett, 83, certainly can teach you a lot—about Buffett’s investing and your own. Yet this story isn’t just about what makes one genius tick. It’s also about how Wall Street is using modern financial research, especially the hunt for characteristics that predict higher returns, to sell you mutual and ­exchange-traded funds. If you wonder how the world’s greatest investing mind can be distilled to a simple formula, you’re right to be skeptical. That’s one message even Buffett himself (who declined to comment for this story) would most likely endorse.

The Buffett equation starts with value, but not “bargains”

The AQR authors say a big part of “the secret behind Buffett’s success is the fact that he buys safe, high-quality, value stocks.” Hardly a surprise, since Buffett has been called the “ultimate value investor.” But the truth is that Buffett is no classic bargain hunter. Can an equation replicate this fact?

In his Berkshire shareholder letters, Buffett often writes about the influence of Ben Graham, his professor at Columbia. Graham is considered the father of value investing, a discipline that focuses on buying a stock when it is cheap relative to some measure of the company’s worth. Graham especially liked to look at book value, or assets minus debt. It’s what an owner would theoretically get to keep after selling all of a company’s property.

Economists have come to back this idea up. In the 1990s, Eugene Fama and Kenneth French showed that stocks that were cheap vs. book provided higher returns than old economic models predicted. (Fama shared the Nobel Prize for economics in 2013.)

Buffett certainly buys his share of textbook value plays: Last year Berkshire snapped up the beaten-down stock of Canadian energy producer Suncor at a price that was just a little above its book value per share. (The typical S&P 500 stock trades at 2.6 times book.) But since 1928, a value tilt would have brought investors only an extra percentage point or so per year. There’s more to Buffett than the bargain bin.

Buffett says so himself. He likes to cite the maxim of his longtime business partner, Charlie Munger: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” In his 2000 shareholder letter, Buffett wrote that measures including price/book ratios “have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business.” A stock being cheap relative to assets helps give you what Graham called “a margin of safety,” but what you really want a piece of isn’t a company’s property but the profits it is expected to produce over time.

Those anticipated earnings are part of what Buffett calls a company’s “intrinsic value.” Estimating that requires making a smart guess about the future of profits, which Buffett does by trying to understand what drives a company’s business. His arguments (at least his public ones) for why he likes a stock usually involve a straightforward story and are arguably a bit squishy on the numbers. Coca-Cola has a great brand, he says, and has customers who are happy to drink five cans a day.

“The best buys have been when the numbers almost tell you not to,” he said to a business school class in 1998. “Then you feel strongly about the product and not just the fact that you are getting a used cigar butt cheap.” Some economists, though, think there may be a way to get the numbers themselves to tell the story.

Predicting wonderfulness

Since the discovery of the value effect, as well as a similar edge for small companies, academics have looked for other market “anomalies” that might explain why some stocks outperform. The AQR team thinks that a trait it calls “quality” might explain another part of Buffett’s success. Their gauge of quality is a complex one that combines 21 measures, including profits, dividend payouts, and growth, but a lot of it certainly rhymes with what Buffett has said about the importance of future cash flows.

A better Buffett

There may be a far simpler way to get at this. Last year the University of Rochester’s Robert Novy-Marx published an article in the influential Journal of Financial Economics arguing that something called a company’s “gross profitability” can help explain long-run returns. He says a theoretical portfolio of big companies with a high combined score on value and profits would have beaten the market by an annualized 3.1 percentage points from 1963 through 2012.

Novy-Marx’s gross-profit measure is sales minus the cost of goods sold, divided by assets. That is different from the earnings figures most investors watch. It doesn’t count things like a company’s spending on advertising or a host of accounting adjustments, which might be important to Wall Street analysts trying to grasp the inner workings of a single company. “I view gross profits as a measure that is hard to manipulate and a better measure of the true economic profitability of a firm,” Novy-Marx says.

In a recent working paper he also suggests that gross profits may be an indicator a company has a quality prized by Buffett: a wide economic “moat.” Businesses with this trait (say, Coke’s brand) enjoy a competitive advantage that helps them defend their high profits against the competition.

Recently Fama and French confirmed that a profit measure similar to Novy-Marx’s also seemed to work. All of which adds to the case that Buffett’s value-plus-quality formula makes sense. But it doesn’t exactly describe what’s in the Berkshire portfolio.

A risky take on safety

AQR believes that there’s one more anomaly that Buffett exploits: safety. Here again, though, Buffett relies on a very particular kind of safety. Stocks that fall less in downturns—“low beta” is the ­jargon—are likely to be underpriced, says AQR. It has to do with investors’ reluctance to use borrowed money, or leverage in Wall Street parlance. When they want to increase potential returns, most investors don’t turn to leverage to amp up their market exposure. Instead, they buy riskier, “high beta” equities. That drives up the valuations on shares of high­fliers, giving cheaper, low-beta stocks an edge.

It’s unlikely Buffett ever asks what a stock’s beta is. (He often pokes fun at beta and other Greek-letter notions.) Still, he does tend to shy away from many of the glamour stocks bulls love. He famously avoided, for example, the Internet bubble of the late 1990s. “A fermenting industry is much like our attitude toward space exploration: We applaud the endeavor but prefer to skip the ride,” he wrote in 1996.

Don’t mistake Berkshire Hathaway for a safe stock, though. From the summer of 1998 through early 2000, Pedersen and company note, Berkshire shares fell 44% while the market rose 32%. What explains that? First, low beta doesn’t mean an investment won’t lose money—just that it won’t fall sharply in step with the market. (Gold, for example, is volatile but has a low beta to stocks.) Second, Berkshire concentrates on a fairly small group of stocks with big bets on certain industries, such as insurance. So if one sector stumbles, it has a large effect on the entire company.

Then there’s leverage, which Buffett isn’t afraid of. The AQR team says Buffett is a smart user of other people’s money, which increases Berkshire’s gains but can also magnify losses. This part of Buffett’s advantage also happens to be the one that would be hardest to replicate.

A big chunk of the Berkshire portfolio is in insurers it wholly owns. As Buffett has explained, this is an excellent source of cheap leverage. Insurers enjoy a “float”—they take in premiums every month but pay out only when someone crashes a car, gets flooded, or dies. For Berkshire, says AQR, this historically turned out to be like getting a loan for 2.2%, vs. the more than 5% the U.S. government had to pay on Treasuries over the same period.

Buffett was able to combine this cheap debt with another unique advantage: Even in down periods no one ever forced him to sell stock at fire-sale prices. Fund managers, on the other hand, face that risk all the time, and the ones who use borrowed juice have to worry about being hit by a cash crunch in a bad market. To simulate Buffett’s strategy in a far more diversified portfolio, the AQR model levers up 3.7 to 1, vs. Berkshire’s 1.6 to 1. As it turns out, it’s easier to build a Buffett portfolio in theory than to run a company like Berkshire in real life.

And Pedersen admits that quants can only hope to say what it looks like Buffett did. They can’t describe how his neural wetware figured it all out. “People say, ‘That’s not how Buffett does it,’ ” says Pedersen. “We agree. We don’t think that’s how he looks at it.” When Buffett bought Burlington Northern Santa Fe outright a few years ago, he was making an entrepreneurial bet on rising oil prices, reasoning that trains use less fuel than trucks. Great story. Hard to stick into a quantitative model.

1 Exp Buffett

Here come the robofunds

Finding factors that beat the market isn’t just an academic exercise. There is a huge rush to create funds exploiting one or another stock market anomaly. AQR, for instance, has launched funds using both low-volatility and high-­quality screens. Dimen­sional Funds, which runs low-cost index-like portfol­ios, has added a profitability tilt to some funds. (Novy-Marx recently began consulting for Dimensional.)

A trio of researchers at Duke has counted up to 315 new factors that have supposedly been discovered by academics, with over 200 popping up just in the past decade. They can’t all work—and the Duke team says that it is statistically likely that most of them won’t. What those factors all have in common is that they were discovered by looking backward.

Winning with Warren

As Joel Dickson, an investment strategist for the index fund giant Vanguard, says, “Predicting the future is a lot harder than predicting the past.” A cynic can easily mine past data for patterns. To dramatize that effect, Dickson put together data showing you could double the market’s return just by picking S&P 500 stocks with tickers starting with the right letters of the alphabet. If you like Buffett, try the WARREN stock portfolio above—click the image above to enlarge. (It “works” largely because holding stocks in equal proportion means a bigger bet on smaller companies, which happen to have had a good run.)

“Data mining is hugely pernicious, and the incentives to do it are high,” acknowledges Novy-Marx. He says profitability is nonetheless an unusually strong effect and simple enough that it’s not easy to game. Pedersen, likewise, says the safety factor is grounded in theory going back to the 1960s. In the end, though, you can never know whether what worked in the past will keep working in the future.

So what do you do with all this? Samuel Lee, an ETF strategist at Morningstar, says some of these new factors look promising. He has even called this a “come-to-Buffett moment” for academic finance. But he says it’s important to go in with modest expectations. Strategies that have had success are likely to look more average over time, especially once they are publicized and people trade on them. “Your main protection is just to keep fees low,” he says. “You can’t pay up for these factor tilts.” He says a factor-based fund charging as little as 0.70% of assets per year could easily see most of its performance advantage consumed by fees.

The quest to replicate Buffett’s strategies may be an attempt to improve the chances of success for active management. In the end, though, it helps illustrate how hard it is for most professional managers to truly outperform. Put simply, “Should a value manager be getting credit for having a value tilt in a value market?” asks Dickson, rhetorically. Likewise, if a combo of value, profits, and safety can explain a lot of what even the most dazzling managers do, and if it gets easier to simply add more of those elements with low-cost index funds, the fees of 1% or more that many active funds charge are hard to justify.

In short, it may not be worth it for you to try to find the next great money manager. This is a point that Buffett himself has made time and again. In a 1975 letter to Washington Post CEO Katharine Graham, he wrote, “If above-average performance is to be their yardstick, the vast majority of investment managers must fail. Will a few succeed—due to either chance or skill? Of course. For some intermediate period of years a few are bound to look better than average due to chance—just as would be the case if 1,000 ‘coin managers’ engaged in a coin-flipping contest.”

Of all the investment insights that Buffett has laid out over the years, perhaps the most widely useful one is found in his latest Berkshire shareholder letter. There, he says, his will leaves instructions for his trustees to invest in an S&P 500 index fund.

TIME

This Is Warren Buffett’s Biggest Weakness According to Warren Buffett

Berkshire Hathaway Inc. CEO Warren Buffett Interview
Warren Buffet Chris Goodney—Bloomberg/Getty Images

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Can you build one of the world’s most successful companies and also be a great boss? Warren Buffett may be one of the few executives to accomplish this feat.

In acquiring the dozens of companies that today make up his $315 billion Berkshire Hathaway, Buffett has never dirtied his hands much with the sort of cost-cutting, layoffs, and management shakeups that often follow acquisitions at other firms. While Buffett’s style of allowing even underperforming businesses to languish is part of what makes him so unique, it is also his greatest shortcoming, the Berkshire CEO and chairman admitted during the company’s annual shareholder meeting this past weekend in Omaha.

MORE: 6 things I learned at Buffett’s annual meeting

Asked by a shareholder to highlight his weaknesses, Buffett said that as a manager, he can be “sloppy.” “A pure weak point is, I’m slow to make personnel changes,” he said on Saturday. “There will be times when what you might call our lack of supervision of our subsidiaries means we’ll miss something.”

Without getting into specifics, he recalled one example. “We had a guy, we loved the guy, and it wasn’t killing us in our business, and how long before we went to somebody else?” (Neither he nor Berkshire’s vice chairman Charlie Munger, who sat beside Buffett on stage, could remember.) “We’ve waited too long on one manager sometimes,” Buffett said.

Buffett’s comments came amid grumbling from some investors gathered in Omaha that the Oracle is too hands-off and perhaps should take a page from activist shareholders like Pershing Square Capital’s Bill Ackman or turnaround specialists like private equity firm 3G Capital. Indeed, several questions from shareholders and analysts at Saturday’s meeting focused on whether Berkshire, which teamed up with 3G in 2013 to purchase ketchup maker Heinz (where management was then swiftly replaced), would adopt 3G’s “hands-on” approach for future acquisitions.

MORE: Buffett: We’d like to own more of Heinz

While Buffett praised 3G as a partner (“They’re smart, they’re focused; they’re very hard-working and determined.”) he also noted that “they’re never satisfied,” and defended Berkshire’s gentler way of doing things. For one, Buffett doesn’t like telling his subsidiaries that they need to get rid of employees or restrict their actions in other ways. “We’re not big disciplinarians,” Buffett said. As Munger put it, “By the standards of the rest of the world, we over-trust.”

So much does Buffett trust the CEOs of Berkshire companies that he doesn’t keep close track of how much money they send him and when, or bother to double-check that a company even exists. He’s never visited Forest River, the Indiana-based recreational vehicle manufacturer that Berkshire owns, for example. “I hope it’s there,” Buffett joked. “I could see them saying, ‘What figure should we send Warren this month?’” he said, laughing. (“I don’t want to encourage managers of subsidiaries to do a different way of behaving, if they’re listening,” he added.)

When you leave companies alone to run themselves, sometimes things go wrong, Buffett acknowledged. But he took issue with critics who complain that Berkshire’s returns would be higher if Buffett ran a tighter ship. “What they won’t be able to measure is how much on the positive side we have achieved with so many other people because we gave them that leeway,” he said, noting that Berkshire doesn’t have in-house general counsel or human resources.

As for Ackman’s brand of activism, Buffett seemed almost offended by any likeness between Berkshire and the hedge fund manager. First, unlike Ackman, who has lately made headlines for his short position in Herbalife and hostile bid for Botox manufacturer Allergan, Buffett doesn’t short stocks or trade in derivatives. He’s also skeptical that activists’ recent success is sustainable, saying they’re usually looking to cause a short-term swing in a stock price, not permanent changes to improve a business. Munger, for his part, swore off investor activism in general, saying, “I don’t think it’s good for America.”

MORE: Warren Buffett, activist investor?

Will Buffett’s successor be the hard-line boss that Buffett isn’t? Don’t count on it.

One of Berkshire’s most valuable assets, Buffett and other investors reiterated over the weekend, is other businesses’ willingness to sell to Berkshire — often at lower prices than what private equity firms would pay — because they trust Buffett to mind the store. As hedge fund manager Whitney Tilson of Kase Capital Management put it on Friday, “Berkshire is like a museum, like the Met, where people will sell their most valuable art just because they know it’s going to be safe there.”

Added Buffett, “We keep promises, and that means we sometimes end up holding on to some businesses that haven’t lived up to expectations.”

TIME College Basketball

This is Who A Math Professor Thinks Will Win the NCAA Tournament

Stephen F. Austin v UCLA
From left: Nick Kazemi, Aubrey Williams and Noah Allen of the UCLA Bruins celebrate their 77 to 60 win over the Stephen F. Austin Lumberjacks during the third round of the 2014 NCAA Tournament on March 23, 2014. Donald Miralle—Getty Images

We asked a mathematician to run the numbers one more time, and everything came up blue and gold

In case it weren’t already clear from the astronomical odds (9.2. quintillion-to-1 if you were to pick entirely randomly), filling out the perfect March Madness bracket is an exercise in futility. And once that first game begins, everyone’s brackets are locked and all anyone with skin in the game can do is cross their fingers and hope their pick pays off.

With the money already on the table, it’s rare that prognosticators crunch the numbers again after the tournament’s opening weekend. But there’s no reason you can’t. So as the games resume, we put the question to Tim Chartier, a mathematics professor at Davidson College. Since 2009, Chartier has taught a course that instructs students in the art and science of bracketology. Last year, one of his students, Jane Gribble, a math major and member of Davidson’s cheerleading squad, used what’s known as the Massey method, which incorporates point differential as well as wins and losses into the algorithm, to finish in the 96th percentile of ESPN’s bracket challenge. The formula also correctly predicted that Louisville would win it all.

Not bad. So we asked Chartier to run the numbers again — this time incorporating the results of the tournament’s early rounds — to try and gauge who will emerge from the Sweet 16 to win it all. His verdict: The UCLA Bruins are most likely to win the April 7 National Championship game.

Turns out incorporating the tournament games was crucial. “You massively down-weight home wins,” Chartier says, explaining why UCLA emerged ahead of higher-seeded teams with better regular season records. “At this point, your ability to win at home isn’t as important.” Though the statistical methods for picking winners is virtually limitless (and you can even explore some of your own), UCLA came up as the eventual winner for several of Chartier’s models.

If UCLA’s title hopes still seem like a long-shot, it’s understandable. The Bruins will need to claw their way through top-seeded Florida (currently on a 28-game winning streak) and either Virginia or Michigan St. (Chartier’s data says Virginia) before reaching Arizona or Louisville (the professor’s numbers have the Wildcats by a hair) in the final. But the Bruins have been on a tear lately, edging out Arizona in the Pac-12 championship game and handily winning their first two tournament games thanks to stifling defense and the strong play of sophomores Jordan Adams and Kyle Anderson, who have averaged a combined 32 ppg this season.

And even the best algorithms, as Chartier is the first to note, are no substitute for a crystal ball. Very slim margins separate the tournament’s top teams and crazy things are known to happen. But sports fans are naturally inclined to hope. And the data offers plenty of reasons for UCLA to feel good about their chances.

MONEY Markets

Heed These Market Signs

Three key market indicators are flashing caution. photo: JUSTIN FANTL

As January goes, so goes the year, holds a Wall Street saw. And if the January indicator proves right again this time, investors have a lot to worry about: Stocks opened 2014 with a thud, dropping 3.6% in the first month.

Not that a decline is totally unexpected: Total returns for the Standard & Poor’s 500 have tripled in the past five years — that’s a year longer than the average bull run — and stocks have seemed due for a fall. Indeed, in our annual Investor’s Guide, MONEY warned of tough sledding ahead.

Still, bull markets have been known to defy the odds and linger long past their expected expiration date. Even the January indicator has been wrong four times out of 10 when it comes to predicting market drops — witness this year’s market bounce-back in February.

How, then, can you tell whether stocks’ earlier setback signals the end of the bull market or is merely a pothole on the road to higher prices? The following indicators have proved to be among the most accurate over time.

Related: How to take a stock loss on your taxes

Revenues are key

Stock valuations shot up last year in anticipation of a strengthening economy and growing corporate profits. And earnings did improve, rising just shy of 15% in 2013 for S&P 500 companies.

That stellar outcome, however, didn’t reflect true strength in the underlying businesses — revenues last year inched up 2.6%. Instead, earnings per share were partly inflated by cost-cutting initiatives and stock buybacks that reduced the number of shares outstanding, as companies took advantage of Fed-engineered low-rate financing.

For the market to keep advancing, says BMO Private Bank chief investment officer Jack Ablin, profits going forward need to be driven mostly by rising revenues.

Indicator to watch. Track S&P 500 revenues using the price-to-sales ratio (go to multpl.com). At 1.6, the P/S is now 15% above its historical average. Traditionally that’s been more likely to signal subpar returns ahead than a market drop: Since 1993, in the three years following a reading of 1.6, stocks have eked out average annual gains of 1%, says Ablin.

When to really worry. A P/S of 2 would be “a huge red flag” says Ablin. When the P/S peaked at 2.3 in early 2000, he notes, stocks lost 44% over the next three years.

See who’s at the party

When a bull has nearly run its course, fewer and fewer stocks participate in the rally, and new market highs are powered by a small number of companies. That was another warning in the year leading up to the dotcom bust of 2000: Only about 50 holdings drove the S&P 500′s record returns.

Indicator to watch. The advance-decline line tracks the number of stocks rising and falling, moving up when more stocks gain than lose. It typically peaks three to six months before a downturn, says James Stack, president of the InvesTech newsletter. For most of last year advances far outnumbered declines, but lately the reverse has been happening.

When to really worry. Sound the alarm bells if the advance-decline line moves in a different direction from market indexes — a phenomenon, known as divergence, that has proved even more telling than movements in the AD line alone, says wealth manager Barry Ritholtz.

In both 1973 and 1980, for example, the markets saw major divergences before crashes. Ritholtz points out, though, that so far this year the AD line has moved largely in line with the indexes.

Beware of overconfidence

“Be fearful when others are greedy,” Warren Buffett has famously said. It’s a reference to investors’ rotten record of market timing, with many historical examples (1990, 1999, and 2007, just to name three) of them piling into stocks just before a precipitous price drop. That’s why analysts often view investor sentiment as a contrary indicator.

Indicator to watch. The American Association of Individual Investors tracks bearishness among its members on a weekly basis (aaii.com/sentimentsurvey). At the end of last year AAII found that only 18.5% of investors were bearish, vs. a long-term average of 30.5%. Typically the market has delivered underwhelming returns the year after such a reading, but not losses.

When to really worry. Six of the nine times since 1987 that bearishness fell below 10.5%, stocks slumped within six months, says AAII’s Charles Rotblut, losing 15% over the next year. If that happens, bearishness will no doubt spike, and you can follow the other half of Buffett’s advice: “Be greedy when others are fearful.”

TIME Investing

Warren Buffett Richer Than Ever

Exclusive Portraits Of Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett
Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., speaks during an interview in New York, Oct. 22, 2013. Scott Eells/Bloomberg via Getty Images Scott Eells—Bloomberg/Getty Images

Berkshire Hathaway, the investing conglomerate helmed by Warren Buffett for more than 50 years, reaped a record $19.5 billion in profits in 2013 -- far exceeding analysts' expectations of $18 billion

Warren Buffett’s investing conglomerate saw record profits in 2013 of $19.5 billion, riding a wave of economic improvement in the United States, the company said in its annual report released Saturday.

Buffett’s holding company Berkshire Hathaway exceeded analysts’ expectations of $18 billion and saw significant gains over 2012, when it posted net profits of $14.8 billion.

The company’s stellar performance depends on well-known consumer goods and services that do well in economic boom times, as Buffett chiefly invests in established, large companies like Walmart, General Motors, American Express, and Coca-Cola.

Buffett’s annual shareholder letter, known for its rustic tone, emphasized his commitment to supporting American companies for the long term.

“Who has ever benefited during the past 237 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. And the dynamism embedded in our market economy will continue to work its magic,” the so-called “Oracle of Omaha” said in the letter. “America’s best days lie ahead.”

Berkshire purchased major assets of NV Energy and H. J. Heinz Geico, which “will be prospering a century from now,” Buffett said. Berkshire’s insurance company reported a $394 million operating profit in the fourth quarter.

Buffet’s conglomerate didn’t edge out the S&P 500, which grew at a phenomenal rate of 32.4% last year, while Berkshire saw a gain in per-share book value of 18.2%. Since 1965, Berkshire has seen a compounded annual gain of 19.7%, while the S&P 500 has increased 9.8%.

Buffett, 83, has helmed Berkshire for more than half a century and overseen its growth into a $288 billion holding company.

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