Buffett a Victim of His Own Success

Buffett a Victim of His Own Success

In 2007, Warren Buffett made his famous bet with the hedge fund Protege Partners.  He bet $1 million that Protege’s hedge fund investments would not be able to outperform an S&P 500 index fund over the next decade.  Nine years into the wager, Protege needs a miracle to win.

As you probably know, Buffett is an investment legend.  Since 1965, his company, Berkshire Hathaway has earned a 21% annual return for investors.  His ability to deliver returns over the past 50+ years has been truly astonishing.  For the sake of comparison, in those same 52 years, the S&P 500 has returned an average of 9.77% annually to investors.  The magic of compounding makes the hypothetical returns to an investor over this timeframe even more remarkable.

  • A $100 investment in the S&P 500 in 1965 would have been worth $12,754 at the end of 2016*.
  • A $100 investment in Berkshire Hathaway would have been worth $1,973,587!

From 1975 to 1989, Buffett’s Berkshire returned an average of 43% annually to investors.  Let that sink in for a moment.  43%…annually.  For 15 years.  43%.

Berkshire returned 129% in 1976, 102% in 1979, 94% in 1985 and 85% in 1989.  It had just one losing year during this timespan (1984 [-2.67%]) and beat the S&P 500 by an average of 31% per year.  Insane!

Buffett’s record is tough to beat.  One has to wonder, if Warren is so good, why didn’t he stake his own performance against Protege?  Maybe he knows something…

Reverting to the Mean?

As it turns out, Warren Buffett’s investing prowess has slowly become a victim of its own success.  2016 marked the first time in history that the rolling 15-year returns of Berkshire Hathaway fell below those of the S&P 500 (8.41% vs 8.48%).  Since the peak in 1989, the spread between 15-year returns of Berkshire and the rest of the market has continually narrowed.

Berkshire vs S&P

So what is happening to Warren?  Is he the latest example of the paradox of skill?  If he were starting a business today, would he have the same confidence in his ability to deliver massive shareholder value as he did in 1965?

The sheer size of the Berkshire today ($420 billion market cap) makes it much harder to move the needle than it was in 1970.  However, Buffett’s value philosophy inspired a cult following of investors who have now become his competition.  In a way, his own success may be partially responsible for an inevitable reversion to the mean.  Only time will tell.  If I had to bet, though, odds don’t favor anybody repeating what Buffett has done over the past 50 years.  I’m pretty confident he’d tell you the same thing.

* For a buy & hold investor, Berkshire’s outperformance over the S&P 500 would be greater than stated due to taxes owed on dividend payouts on the S&P 500 (The Impact of Taxes on Investor Returns).

Further Reading…

The Stock Market is a Distraction

When Average is Superior

At Ariadne, I work closely with families and individuals to organize their finances and utilize their resources to design a life they love.  If you are interested in a straightforward, no-gimmick approach to financial planning that focuses on you and your needs, don’t hesitate to get in touch.  I’d be happy to have a conversation.


Tim Brennan

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