Why Warren Buffett Would Wait for the Second Marshmallow
In 2021, Investors Should Worry About Overpaying for Growth Relative to Value
Stock market exuberance often tempts investors to abandon long-term strategies in favor of instant gratification. Unfortunately, many of us are wired to prefer immediate rewards, often to the detriment of long-term success.
This brings to mind the classic marshmallow experiment you might remember from psychology class—or from YouTube. It’s a simple illustration of how hard it is to wait and why that self-discipline matters.
The Marshmallow Experiment
In the late 1960s, researchers at Stanford University conducted a now-famous experiment. They offered children two choices:
Receive one marshmallow immediately
Receive two marshmallows if they waited 15 minutes without eating the first one
Most kids said they’d wait, but in reality, two-thirds gave in and ate the marshmallow early. Only one-third successfully waited and earned the extra reward.
The study didn’t stop there. Researchers followed up 20 years later and found that the children who delayed gratification tended to be more successful across multiple areas of life. These findings have been replicated many times since.
A World Obsessed with Instant Gratification
Delaying gratification is hard. Humans aren’t wired for discipline, whether it’s children resisting sweets, teens managing a sleep schedule, or investors sticking with a long-term investment strategy.
In today’s world of Amazon Prime, instant coffee, and smartphones, patience is harder than ever. We no longer wait for dial-up connections; we expect everything now.
This mindset spills over into investing. The thrill of daily market news, short-term predictions, and hot stock tips often overshadows the simple, proven strategy of long-term investing. Investors are tempted to react to every headline instead of staying focused on what works over time.
The Evidence for Discipline
Most investors understand the benefits of long-term discipline, yet few practice it consistently.
Take value investing, the strategy of favoring cheaper investments over expensive ones. History shows that value investing often delivers higher returns than growth investing. The value premium is well-documented across markets and time periods.
Why? One explanation is that investors are drawn to fast-growing stocks and overestimate how long that growth will last. This leads to overpaying for growth relative to value.
But even with strong evidence, many investors abandon value stocks during inevitable periods of underperformance.
Learning from Warren Buffett
Consider the late 1990s. The internet boom reshaped markets, and boring value stocks were left behind. Even Warren Buffett, the most successful value investor of our time, saw Berkshire Hathaway lose over half its value in just 22 months until February 2000. During the same period, growth stocks doubled.
Critics questioned Buffett’s ability to adapt. But as history shows, those who stayed disciplined and patient were rewarded. Value investing rebounded, and long-term investors benefited.
Déjà Vu All Over Again?
Remember David Rolfe, chief investment officer at Wedgewood Partners and a longtime Berkshire shareholder? Frustrated with Buffett’s large cash position, he sold Wedgewood’s stake in Berkshire:
“Warren Buffett’s cash hoard of $125 billion continues to be a considerable impediment to growth, rather than our previous hard expectations of a valuable call option in the hands of one of the most elite capital allocators extant.”
Between 2009 and 2020, Berkshire’s cash position increased from $23 billion to $147 billion. Buffett’s patience during the longest bull market in history drew criticism, but his famous quote still holds true:
“The stock market is a highly efficient mechanism for the transfer of wealth from the impatient to the patient.”
Save Your Marshmallows
Just as many kids will eat the marshmallow before the 15 minutes is up, many investors will chase short-term gains and lose sight of their long-term strategy.
But the evidence is clear: disciplined investors, like disciplined children, end up more successful over time.
If you’d like to talk about your portfolio and how to stay disciplined, reach out to us at NEST Financial. We’re always happy to help you stick with the strategy that works.