Wondering which stocks to buy? Why not take cues from investing legend Warren Buffett and simply copy his portfolio? As of this past June, that would mean investing in Wells Fargo & Co., Coca-Cola Co., Wal-Mart Stores Inc., American Express Co. and Procter & Gamble Co., which are all in the billionaire's top 10 holdings.
You can see every last investment he makes, because his latest portfolio – worth $107,182,425,000 (U.S.) – is always available online, for anyone who cares to emulate it.
Mimicking the portfolio of a famous or even a not-so-famous individual is called copycat investing, also known as coattail investing or copy trading.
Mr. Buffett is not the only guru whose portfolio is exposed for the world to see. Websites such as GuruFocus.com, which track the stock picks and portfolio changes of some of the world's most successful investors, feature detailed portfolio breakdowns of George Soros, Carl Icahn, Mohnish Pabrai and dozens of others.
GuruFocus is based on the premise that investors can make far fewer mistakes – and lose a lot less money and possibly make a lot, too – by selecting stocks that leading investors have already researched.
It seems that copying Mr. Buffett's portfolio actually works. According to a 2008 paper called Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway, by Gerald Martin of American University's Kogod School of Business and John Puthenpurackal of the University of Nevada, Las Vegas, if you had mimicked Mr. Buffett's stock portfolio from 1976 to 2006 – with your trades occurring a month after his company, Berkshire Hathaway, publicly announced each move – you would have beaten the S&P 500 by an average of 10.75 percentage points a year.
That's remarkable. But while copycat investing sounds straightforward enough, it clearly comes with caveats.
"Generally speaking, there's never one-size-fits-all," says Kelly Ho, certified financial planner at Vancouver's DLD Financial Group Ltd. "I understand that when you're looking at these types of people it's easy to go, 'Warren Buffett is doing so well, I'll just copy what he's doing.'
"But it's impossible to replicate that. Warren Buffett bought into Coca-Cola when it was worth next to nothing. Essentially, market timing never works. Unless you bought in at the same time that these people had purchased their shares, you're not going to get the same results.
"Any time these recommendations are provided to the public online or wherever, the thing you have to remember is that's not their only strategy," she adds of all those wealthy investors. "They're doing a million different things coupled with that. They're just not disclosing that part."
People have to carefully consider their tolerance for risk and how well they would sleep at night, if at all, if they were to lose a significant amount of money with an inappropriate stock pick. And they also have to remind themselves that their individual circumstances are a world away from the daily concerns of billionaires like Mr. Buffett.
"It's a pretty safe bet that most investors are not Warren Buffett," says fee-only financial adviser Ryan Kerr of Ottawa's Astrolabe Financial Group Inc. "Mr. Buffett – or more specifically his company, Berkshire Hathaway – isn't worried about investing in RESPs, planning for retirement or funding an annual vacation. They look to buy undervalued companies and hold them until they feel they are overvalued.
"Even if your goals are long-term, it's unlikely your portfolio has the same kind of time horizon as theirs," Mr. Kerr says.
Just how well can you copy a target portfolio, anyway? Several factors will limit your ability to experience the same kind of returns, experts say. Top among them is trading costs.
"Institutional investors place larger orders and pay less than retail investors," Mr. Kerr says. "This is amplified if the target portfolio trades frequently."
Information lag is another one. Most institutional investors provide details on their holdings on a quarterly basis.
"The time lag between when the institution trades and when you become aware of their trades means that you may be late both to buy, when the price is rising, and sell, when the price is falling," Mr. Kerr says. You may even end up purchasing stocks that the person you're mirroring has already dumped.
Lack of diversification is also a potential problem. Institutional portfolios are typically much larger than the average investor's, meaning those will achieve better diversification.
There are other possible pitfalls. For one, there's more to managing your money than simply stock picking, notes Vancouver financial adviser Lynn Williams, owner and chief executive officer of the Lifestyle Protector. Once you reach high-net-worth status, most of your investment decisions will not be sheltered from tax consequences in a registered retirement savings plan or tax-free savings account.
"You need to ask yourself: Do you have the talent and discipline to understand the investment strategy and asset allocations of the target copycat? Will you be able to measure performance and rebalance while ensuring you don't trigger an unfavourable tax event? If you answer is no to either of those questions, you may reconsider a copycat strategy," Ms. Williams explains.
Another is the fact that past performance is not necessarily repeatable.
"My guess is that many copycat investors are looking for above-average returns while only having a conservative appetite for risk," Ms. Williams says. "We hear of the incredible success of Warren Buffett and we forget that his success has come after a lifetime of investing, not to mention a lifetime of lessons of what not to do."
If people are determined to give coattail investing a go, there are ways to do it wisely.
First, don't put all your eggs in one basket. "Let's not make that 100 per cent of your investment strategy," Ms. Ho says, adding that rebalancing is vital, whether it's done automatically for you or you're closely watching your portfolio yourself. "Even Warren Buffett's portfolio is rebalanced on a regular basis," she says.
Mr. Kerr agrees with Ms. Ho in that if someone absolutely wanted build a copycat portfolio they should use only a portion of their total portfolio to implement the copycat strategy. He suggests building a properly diversified, index-based portfolio and ensuring that the investments in the copycat strategy don't compromise your overall asset allocation.
A slightly different approach is to look at model portfolios on websites such as the Canadian Couch Potato. They are a little different from copycat investing in that they provide asset allocation strategies.
"This means they aren't trying to pick individual stocks to beat the market but instead seek to provide an appropriate allocation between asset classes, based on the investor's risk tolerance," Mr. Kerr says.
"Assuming you have an accurate understanding of your risk tolerance, the Couch Potato model portfolios can provide good guidelines for building a well-diversified portfolio using suggested index funds chosen with an eye toward keeping fees to a minimum."
When it comes to building a portfolio in the first place, you need to initially identify your own financial goals, time horizon and risk tolerance, Mr. Kerr says. If you're copying someone, be sure to practise your own due diligence and understand exactly what you're investing in.
"Once you've defined your objectives and constraints you can work to build a portfolio designed to meet your needs," he says. "The objectives and constraints of mutual fund managers, institutional investors or famous stock pickers are not likely to match those of the average investor. Unless your portfolio goals closely match those of the reference portfolio, their allocation can be inappropriate for your needs."