Buying the Market
By Jane Bryant Quinn
How often have you heard it said, ``Warren Buffett is buying XYZ
stock, so you should, too''?
How often have you heard it said, ``Warren Buffett is buying XYZ stock, so you should, too''?
He's one of the legendary investors of our time, and the second-richest man in the world (after Microsoft's Bill Gates). Owners of stock in his holding company, Berkshire Hathaway, clutch it like a talisman.
So it's practically heresy to suggest that, over the past decade, you'd have fared just about as well in a boring old index mutual fund, which followed the market as a whole.
Let me introduce you to the heretic: Larry Swedroe, head of research for Buckingham Asset Management in St. Louis, and author of ``The Only Guide to a Winning Investment Strategy You'll Ever Need'' (E.P. Dutton; $24.95).
From Jan. 1, 1990, to the end of February 2000, Berkshire Hathaway gained an impressive 17.3 percent a year, Swedroe says. But over that same period, the S&P index of 500 leading stocks rose an annualized 17.1 percent, with dividends reinvested. Buffett edged out the index, but by only 0.2 percent a year. And owning his stock was riskier than owning the market as a whole.
Investors in Berkshire are buying two types of business.
First, there's an investment portfolio. Berkshire owns a significant interest in various leading companies, including Coca-Cola, Gillette, the Federal Home Loan Mortgage Corp., American Express and The Washington Post Co. (The Washington Post distributes my column).
Famously, Buffett buys companies that he thinks are undervalued and that have a strong competitive advantage. Then he holds, for a very long time, ignoring market cycles.
Second, Berkshire owns and operates businesses. Its major subsidiaries include Geico, the sixth largest auto insurer in the U.S., and General Reinsurance Corp., one of the world's largest reinsurers.
General Re did badly last year, as did some of Berkshire's stocks. Buffett has seen many shining years. He outperformed the market in the 1980s, and in the early 1990s, too. But from 1996 through 1999, Berkshire rose by only half as much as the S&P, Swedroe says.
If you bought just a couple of years ago, you're probably sitting on a loss. The stock peaked in June 1998, at $84,000 a share. In mid-March 2000, it was selling at $41,300--down 50.9 percent. Over that same period, the S&P was up around 25 percent.
Then Berkshire bounced up, closing March 30 at $53,200.
It's a reminder that past performance doesn't predict future performance, even when you're investing with a legend.
In his annual report, released March 11, Buffett himself wrote that, for Berkshire Hathaway, ``truly large superiorities over (the S&P) are a thing of the past.''
In prior years, he said, he could beat the S&P ``because we could buy both businesses and stocks at far more attractive prices than we can now, and also because we then had a much smaller capital base.''
``When I started, anything I found could have an impact on performance,'' Buffett told me in an interview. ``Now, investments have to be big.'' That narrows his options.
Buffett doesn't buy tech stocks, by the way--not because he's a Luddite, but because he can't tell which companies have what he calls ``a truly durable competitive advantage.'' (He recently did take a small position in Microsoft.)
Going forward, Buffett believes that Berkshire's intrinsic value will again beat the gain from owning the S&P, but only ``modestly.'' Assuming, he adds ironically, ``that I have the same energy and brains.'' (Some of his investors are grumping that he's lost his touch.)
While Warren Buffett personifies active management of money, Swedroe believes in passive management--that is, indexing. Over time, most active managers do not beat the market, Swedroe says. So you might as well invest passively in the market as a whole, through low-cost index mutual funds.
In any period, some managers come out ahead. But they can generally be identified only in hindsight. If you pick a winner in advance, it's just as much luck as smarts.
So is Buffett that one winner, who made some mistakes? Is it just that the market doesn't favor his style of investing right now? Is his great success due to his business skills as much his investment skills (he often takes an influential management role in the companies he picks)? Has he had outstanding luck? Maybe a little bit of everything.
The argument for index funds is that you don't have to wonder if you're with the right manager at the right time, Swedroe says. You just buy the market, and wait.
Jane Bryant Quinn welcomes letters on money issues and problems but cannot offer individual financial advice.