The seductive Warren Buffett

By Felix Salmon
December 4, 2012

Andrew Ross Sorkin and Jim Surowiecki both had lunch with Warren Buffett recently: with this book, unlike the last one, Buffett is taking an active role in the book tour. And he’s staying on-message. Here’s Surowiecki:

The investing world is dominated by a manic-depressive style, in which the average mutual fund turns over nearly its entire portfolio every year. Yet Buffett has prospered by ignoring all this. As an investor, he’s known for his patience—he says that he likes holding stocks “forever”—and he prefers a few big bets to an endless number of small ones. “If you go from flower to flower, you have to find a lot of flowers to make a lot of money,” he told me. “There aren’t that many great ideas out there.”

And here’s Sorkin:

Warren E. Buffett was sitting across from me over lunch at a private club in Midtown Manhattan last week, lamenting the current state of Wall Street, which promotes a trading culture over an investing culture and offers incentives for brokers and traders to generate fees and fast profits.

“The emphasis on trading has increased. Just look at the turnover in all of the stocks,” he said…

Mr. Buffett, 82, is famous for investing in companies that he sees as solid operations and essential to the economy, like railroads, utilities and financial companies, and holds his stakes for the long run.

The heart of this is unexceptional: as every personal-finance columnist will tell you, trading costs just eat into your returns, you will almost certainly buy and sell at the wrong time (since you can’t time the market), and a buy-and-hold strategy doesn’t just save you time but also saves you money.

But there’s also another implication here: that a disciplined, fundamentals-based buy-and-hold strategy can outperform all the whiz-kids. (Sorkin: “When I asked, for example, if there were any private equity investors that he admired, he flatly replied: “No.””)

I’d love this to be true, but at heart I’m deeply skeptical that any strategy can consistently outperform, over decades. Buffett famously avers a distaste for being judged on Berkshire Hathaway’s stock-market returns, preferring to use its book value as a measure, but the fact is that Berkshire has underperformed the S&P 500 for the past 1 year, 2 years, 3 years, and 5 years. At some point, Berkshire still outperforms, but I’m not sure where that point is: I’m having difficulty finding a suitable total-return index so that I can be sure that I’m including the effect of reinvesting the dividends which the S&P 500 pays out but Berkshire does not.

To put it another way, the Buffett legend rests in large part on the hypothetical returns that you would have received if you bought Berkshire Shares decades ago, which very few people actually did. Buffett is a hugely successful investor, and there are a handful of early investors whom he also made extremely wealthy. But even Buffett himself has been saying for years that his future returns won’t be as good as his past ones.

All strategies eventually run out of steam. Some have longer legs than others: the fundamentals-based investing philosophy of Buffett, which he inherited from Ben Graham, worked for decades, while the clever excess returns that academics find hidden in the market tend to disappear as soon as they’re published. And in the world of quantitative investing, even unpublished strategies have ever-shortening shelf-lives.

The same is true outside the investing world, too, as the Obama campaign discovered with its fundraising emails. A good one would work — and then it would stop working, and a new one would have to be used. Alexis Madrigal draws the obvious conclusion:

Any detailed social media primer I give you would be out of date by the time I could finish writing it. Any operational headline writing strategy would stop working if everyone used it. Everyone clamoring for your attention on the web is trying to strike that perfect mix of familiarity and novelty. And that means the content techniques that work are necessarily recursive. You change what people like by doing whatever you do. Which then requires that you do something else, which then changes their tastes again.

To generalize: anything which works will eventually stop working, and the less intuitive it is, the more quickly it will stop working. Buffett had a good run, but at this point there’s really zero reason to believe that his kind of fundamentals-based value investing still gives anybody an edge. (On the other hand, simply being Warren Buffett does confer an edge: he gets to see a lot of opportunities which are unavailable to anybody else.)

In turn, that means that even looking for an edge is nearly always an exercise in disappointment. Most people who aspire to outperforming the market won’t. Is there any good reason to believe that you’re in the minority of people who will? Not really. Buffett is in that minority, but to state the obvious, you are not Warren Buffett. He might be approachable and folksy, but beware anybody who makes it look easy. It’s not easy: it’s really hard. And even Warren Buffett can’t consistently outperform the market any more, despite the fact that he has access to hundreds of billions of dollars from Berkshire Hathaway’s policyholders, which he can invest in a tax-sheltered manner.

As I said last week, stock-market investing is at heart a modestly expensive upper-middle class men’s hobby. Buffett is idolized within those hobbyist circles, and by America more generally: he’s just as assiduous about massaging his public profile as he is about picking companies. And admiring Buffett is fine. The problems arise when people try to emulate him.

Comments
16 comments so far

Felix, I still don’t understand your obsession with “beating the market”. You are living proof that index investing doesn’t work — in the middle of the market crash, when you should have been buying, you were talking about volatility, the evaporation of the “equity premium”, and the impossibility of positive returns.

You don’t need to beat the markets to invest successfully, you simply need to avoid stupidity. It is easier to avoid stupidity when investing in individual stocks than when investing in index funds.

Trying to beat the market is a fools’ game. My goal was and is to secure my financial future, a strategy that caused me to invest in bonds in 2007, in stocks in early 2009, and by deleveraging in 2012. I was never trying to beat the markets, simply asking myself, “How can I achieve 6% annual returns to achieve my goals with minimal risk?”

What actions did your investment philosophy lead you to take over the last five years? Were you truly selling out of the market in 2009-2010 as you preached in your columns?

Bonus question — if my goal is to achieve 6% annual returns with minimal risk, what is my remaining portfolio invested in today?

Posted by TFF | Report as abusive

http://blogs.reuters.com/felix-salmon/20 10/05/10/why-volatility-means-you-should -sell-stocks/

http://blogs.reuters.com/felix-salmon/20 10/05/20/revisiting-the-equity-premium/

…and if I had listened to you just three short years ago, you would have advised me to:

http://blogs.reuters.com/felix-salmon/20 09/04/06/how-stock-market-indices-underp erform/

“just pick a basket of stocks, and hold them forever, reinvesting dividends”

That last, at least, was sound advice…

Posted by TFF | Report as abusive

Interesting article but one crucial point is missing and that is Buffett is managing billions of dollars and universe of investment is very limited when dealing with that much cash. He has acquired Burlington Northern, Lubrizol, various newspapers and made billions of dollars for Berkshire yet the stock has not performed as well as the market. What can he do about that? In the short term the stock market is a voting machine but in the long term it is a weighing machine. He has said with 1 million dollars he could make 50 percent per year. That is an interesting statement from a man who only grows as an investor each year. I wouldnt’t doubt that, especially if you gave him all of American Business to decide from instead of practically a very small percentage.

Posted by jamestToler | Report as abusive

While it’s ok to compare Berkshire stock with the S+P or fund managers, you shouldn’t compare Buffet with them. Berkshire is more like a holding company, and while the stock may not be performing as well as the S+P over the last five years, I would bet that Buffet and Berkshire have made more money than they would have had they invested in stocks over that period. They buy companies or large shares of companies for income, and they don’t have the same goals as traders (I’m being nice and not calling them speculators).

Posted by KenG_CA | Report as abusive

If one looks up Seth Klarman’s letters from the 90′s, they’re very interesting. From today’s standpoint, he has dramatically outperformed the market, but during the 90′s he was being strongly outperformed by the S&P. Even in 2001, his fund’s total return did not yet catch up to the S&P, but from buying many cheap stocks after the bubble burst and because he didn’t lose money in the bubble, he eventuaully strongly outperformed the market.

That’s the common misperception about investing in equities. People say “long-term” when they mean 1-2 years. But historically, bear markets can last for much longer. Bull markets can last for quite awhile too, such as 96-00 and 68-73. You get the returns from investing in undervalued stocks, but the long-term is very looooong. The 1,2,3, 5 year comment does not do the strategy justice for that reason, and also why Buffett prefers to use book value.

Posted by mwwaters | Report as abusive

KenG, I don’t think anyone seriously looks to Felix for investment advice. He changes his mind more often than he changes his bespoke shirts. Why you hatin’?

Felix: You know as well as anyone that the three current ways of beating the market (two of which are long-term) as as follows:
1. Insider info
2. Fraud/churn
3. HFT
Of course, only one of these is “legal” in the legal sense (and it is–naturally and by design–unavailable to Muppets). But the risks of the other two strategies are very small and the payoff can be substantial. Sure beats working, I’ve heard.

Posted by Eericsonjr | Report as abusive

Well I find piggybacking on Buffett not a bad strategy. Over the last ten years Berkshire stock has appreciated 81% vs 50% for the S&P. Over five years Berkshire has declined 6.5% vs. 5% down for the S&P. Over one year Berkshire has risen 12.5% vs 13% for the S&P. If you factor in the costs even for a low cost index fund, I’d say over ten years Berkshire has clearly beaten the market and come very close to equaling it over the last five years and one year. I have never lost money purchasing a Berkshire stock at around the same price Buffett paid and holding it. His buying a stock is a good guarantee of its soundness. For higher returns I use a mixed bag of many biotech stocks; the winners more than pay for the losers.

Posted by Chris08 | Report as abusive

You recently labeled yourself as a “muni bond geek.” What do you think of Mr. Buffet’s investment in municipal bonds.

And, have you heard about longtime muni bond expert Dr. Philip Fischer’s white papers on eBooleant.com? I’d love to hear your thoughts on those. His forthcoming book, Investing in Municipal Bonds will be on shelves and Amazon from McGraw-Hill in early January.

Posted by OSusanna | Report as abusive

“[As] every personal-finance columnist will tell you … you will almost certainly buy and sell at the wrong time”

Nonsense. If it were true you could just observe dumb money and take the other side of the trade, and “almost certainly” make money. (And then lots of people would do that, the trade would either turn into a volatile mess or disappear entirely, etc.) That’s just pap the columnists toss out to make readers anxious enough to keep reading them.

The problems with personal finance and buying and selling at the wrong time have nothing to do with timing the market (profiting in expectation) and everything to do with having the right portfolio (staying balanced and maintaining a consistent risk profile). And as TFF points out, your personal finance implications over the years have exhibited exactly this disregard (“THINGS HAVE CHANGED! MODIFY YOUR PORTFOLIO!”). There have been some indications that portfolio theorists need to readjust their inputs, but nothing on the order of what you’ve suggested.

Posted by absinthe | Report as abusive

Buy and hold also minimizes taxes and Buffett is one of the kings of tax avoidance. Capital gains taxes create a “lock in” effect. The capital gains tax creates an incentive for investors such as Buffett to avoid selling lower return investments and reinvesting in higher return investments. Without a capital gains tax, it is unlikely Buffett would hold his investments as long as he does.

Posted by MiltonRecht | Report as abusive

@TFF, If you have after tax money to invest (most people don’t) then look at some of the higher yielding MLP’s like Linn energy (LINE). For Pre-tax money I’d check out Digital Realty Trust (DLR), they’re basically a data-center management company pretending to be a REIT. I bet they’ll grow pretty good and pay you while you watch!

If you can spend two hours a month looking at individually held investments, (which I think you do having read about a hundred of your well thought out posts), then I would consider playing with 25% of your life’s saving on an ultra diversified pool of binary outcome stocks. Put in the search terms “longtimefollower yahoo finance” in google and read everything that guy has ever posted. I’ve been looking at his stuff for several years now and his game (which I now actively try to emulate) is to buy companies which are often on the brink of death and usually trade for

Posted by y2kurtus | Report as abusive

May look at some of those ideas, y2kurtus, but not sure they are in my comfort zone. Staying in my comfort zone is more important at this point than returns.

But thanks!

Posted by TFF | Report as abusive

Salmon,

You should be teaching in college with all the other market efficent theorists. In response to your comment of …”Buffett had a good run, but at this point there’s really zero reason to believe that his kind of fundamentals-based value investing still gives anybody an edge”. You are right, 60 years is a good run.

I’m not sure where you grew up but some village is missy their idiot.

Posted by sdunl | Report as abusive

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