Should I bet it all on Buffett?

Secrets of a dream retirement

Last year, I invested $50,000 of my retirement money in Berkshire Hathaway shares. I'm now trying to decide whether I should put a lot more of my savings into Berkshire or into a diversified portfolio of stocks, funds or ETFs instead. What do you think? -- Dennis C., Indianapolis

I have the greatest respect for Berkshire Hathaway chairman and CEO Warren Buffett. I admire him not just for his stellar investing record -- Berkshire shares have gained 21.6% annually from 1965 through 2014 versus 9.9% for the Standard & Poor's 500 -- but also for the folksy wisdom he imparts about business, investing and life in his annual letters to shareholders.

So I have no problem with you owning Berkshire (BRKB) shares (most likely the B shares, which recently sold for $144 a share, or roughly 1,500th of the value of the A shares, which recently traded for $217,118).

Indeed, many years ago I invested a small amount in Berkshire shares that I later sold for a tidy profit (and I've chided myself ever since for not hanging onto them longer).

That said, I don't think it's a good idea to invest too much of your retirement savings into Berkshire. As a rule, it's not wise to concentrate more than 10% or so of your stock holdings in the shares of any single company. Assuming you have an otherwise well-diversified portfolio, I suppose you could make a case for pushing that percentage to 20% or so for a unique company like Berkshire Hathaway. But I wouldn't go beyond that.

Why? Two reasons.

First, when you buy shares of Berkshire Hathaway, you are not only getting a huge portfolio of securities, but 59 operating businesses as well -- everything from a brick maker to a railroad. You're also buying Buffett's skill in overseeing those holdings and acquiring new ones.

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If you're going to make any single investment the cornerstone of your stock holdings, that investment ought to be very broadly diversified. Ideally, I think it should track the overall U.S. stock market. It doesn't have to mirror the market exactly, but it's weightings in small-, mid- and large-cap holdings, growth and value shares and different industries and sectors should generally adhere to those of the market overall.

That's why a total stock market index fund or an ETF is an excellent core holding for individual investors. You get virtually all publicly traded U.S. stocks in one fund, and you get them in the exact proportion each represents of the market's total value.

Berkshire Hathaway certainly has a wide range of holdings. Buffett describes the company as possessing "an unmatched collection of businesses" and "an extraordinary diversity of earnings, premier financial strength and oceans of liquidity." But, for better or worse, it doesn't have the breadth of a total stock market index fund.

For example, just four stocks -- Wells Fargo (WFC), Coca-Cola (KO), American Express (AXP) and IBM (IBM, Tech30) -- account for roughly 60% of the company's investment portfolio. As for its operating companies, they tend toward cyclical businesses (manufacturers, retailers, a railroad), as well as finance and insurance operations.

Don't get me wrong. Buffett has been incredibly successful at growing his shareholders' capital in a prudent manner, in particular by identifying companies that have a special niche that allows them to generate consistent profits. But owning Berkshire doesn't give you the same broad exposure to the overall economy and the market as you get from a total stock index fund or ETF.

The other reason I don't recommend investing all or most of your retirement savings in Berkshire is that it's unclear how much longer Buffett, at age 84, will remain at the helm of Berkshire.

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That's an important consideration because you're not buying Berkshire's past; you're buying its future. Writing in this year's letter to shareholders, Berkshire vice chairman Charlie Munger said that Berkshire would "almost surely remain a better-than-normal company for a very long time" even if Buffett left tomorrow and even if his successors were "of only moderate ability."

He then went on to assure shareholders that his successors' abilities would be more than moderate, calling the two people who have been bandied about to succeed Buffett, Ajit Jain and Greg Abel, "world-leading" performers.

Munger's assessment of Berkshire's future may very well be right on. But the fact remains that Berkshire's success is largely due to Buffett. And people invest in Berkshire not just for the collection of companies and managers he's assembled to date, but for his expertise in overseeing the company and putting his insights to work in investing the huge amount of cash Berkshire generates each year. (Indeed, one academic study attributed Berkshire's performance as much to Buffett's prowess at acquiring new businesses as to picking stocks.)

I'm not suggesting the whole shebang will fall apart post-Buffett. But it's an open question as to whether its extraordinary success will continue.

Bottom line: Riding Buffett's coattails may seem like an easy and effective way to invest your savings and doing so might very well work out just fine. But I still recommend you take a more disciplined and systematic approach: assess your risk tolerance and then build a portfolio of low-cost broadly diversified stock and bond index funds or ETFs that jibes with your appetite for risk.

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If you need help creating such a portfolio, you can consult an adviser (although you want to be sure you don't mitigate the effect of the index funds' or ETFs' low costs by overpaying for the investment advice).

If you then want to put a modest portion of your equity stake into Berkshire shares, fine. While you're at it, you may also want to read through his shareholder letters and apply some of his observations on investing and life to your own retirement planning.

But don't tie your retirement security to the fortunes of just one company or one man, even if that man is the talented Mr. Buffett.

Are you living your dream retirement? On track to get there? Tell us what dream retirement means to you and what you did to get there and you could be featured in an upcoming CNNMoney story.

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Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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