Be Better Than Buffett
Beat Wall Street at Its Own Game
About two weeks back, something I wait for all year finally happened.
Warren Buffett sent out his annual letter to Berkshire Hathaway shareholders. And just like all the years before, it was chock-full of sage advice and interesting information.
Every year, the Oracle of Omaha personally pens a letter that’s sent to all shareholders of the company. It includes all the standard information about the company’s current financial position.
In it, Buffett discusses the prior year’s investments and returns. He contemplates where the company plans to head in the coming year and how it’ll accomplish those goals.
But Mr. Buffett also uses his annual letter as a pulpit from which to provide advice about both investing and life. And he’ll tell some fun stories about his personal life from time to time, too.
It’s one of those stories that led to me write this article today...
Hedge Funds: Fact vs. Fiction
Several years ago, Bloomberg Businessweek published one of its best issues yet — and certainly its most accurate cover photo.
The main story for the month was about hedge funds and their actual performance. The title of the issue was “The Hedge Fund Myth.”
And this was the cover photo:
Mildly offensive? Perhaps. Funny? If that’s your type of humor, yes. Accurate? 100%.
Average investors and pretty much anyone who isn’t deeply entrenched in the financial world have this perception that hedge funds are why the rich keep getting richer.
They’re these magical money generators that are only accessible to folks with millions to invest. And they return massive profits year after year.
But that notion couldn’t be more incorrect.
Not What You Were Thinking
For starters, hedge funds gained fame in the late 1990s and early 2000s as their returns came in well above those of the stock market. But that was never the goal of a hedge fund — at least not back when they first came into existence.
Hedge funds earned their moniker because that’s what they were for: hedging.
In case you’re not completely familiar with that term, hedging is simply a strategy to minimize losses when the market takes a turn for the worse.
It can be as simple as selling covered calls to boost your returns in flat and down markets. Or it can involve short positions on stocks or indices. It can involve future contracts, options trading, correlation analysis, and much, much more.
But the whole point of it is to protect your profits and lose as little as possible when some of your investments head in the wrong direction.
In fact, investment banks have entire sales and trading desks dedicated to hedging against losses. When I was working in that realm, one of those teams at my bank turned an astounding profit thanks to its investments. It was one of the very few teams to make substantial money for the company that year, too.
And every single person on that desk, from support analysts to traders, got canned a month or two later. It sounds crazy, right? I mean, why fire one of the few profitable teams at your firm?
But they were fired because making a profit wasn’t their job. They were supposed to be making sure we didn’t lose any money. And by making investments that gained so much in a year, they’d taken a risk with the firm’s money — the exact opposite of what they were supposed to be doing.
Like the hedging teams at major banks, hedge funds (in their true form) aren’t for making money. They’re for protecting it.
But, thanks to their hedges, when the markets began to get volatile in the late 1990s, leading to the dot-com crash, and the early-2000s, leading to the Great Recession, hedge funds were able to announce killer profits.
And everyone was sold. Hedge funds were the place to be. They were how to really make serious money. But, thanks to investment minimums, they were only a dream for much of the population.
The Cold, Hard Truth
The thing is, ever since those big money heydays, hedge funds have underperformed the heck out of the stock market. It’s actually impressive how poorly they’ve done when compared to an index like the S&P 500. It takes some work to do that badly in a bull market.
So, how poorly have they performed? And what’s this got to do with Warren Buffett?
Well, a little over 10 years ago, back in 2007, Mr. Buffett got the managers of a hedge fund, Protégé Partners, to make a little wager with him...
He bet $1 million that an S&P 500 index fund of his choosing could beat any hedge funds put up against it over the next decade. I have no idea why his counterparts took the bet. Maybe pride, since they ran one of those hedge funds Buffett was belittling.
Whatever the reason, they made the bet. And, as one of my colleagues eloquently put it, “it was a sucker’s bet.”
The managers at Protégé picked out a basket of hedge funds and tracked their performance over the next 10 years. Warren Buffett picked the Vanguard 500 Index Fund Admiralty Shares and tracked them.
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Those 10 years just ended. And Buffett is a million dollars richer.
The basket of funds returned an average annual profit of about 2.2% over the period. Buffett’s index fund gave investors an average of 7.1% per year.
The hedge funds were humiliated, and Warren’s point was made.
And that got me thinking, if those hedge funds that are run by trained and experienced financial professionals couldn’t beat the stock market, could anybody?
So, I did a little testing of my own. And let me tell you, I wish Buffett had made that bet with me...
Your Undisputed Champion
I compared the returns of the SPDR S&P 500 ETF (SPY) — an electronically traded fund that tracks the performance of the S&P 500 index (much like the Vanguard one Buffett picked) — over the past 10 years with those of Warren Buffett himself.
The result surprised me, to say the least. I guess it shouldn’t have, since Buffett himself made the bet that money managers can’t beat the stock market. But after years and years of hearing about what a great investor Warren Buffett is, I suppose I thought he could do anything.
And he can do a lot. But apparently beating the stock market isn’t one of those things.
Mr. Buffett’s Berkshire Hathaway gave investors a solid triple-digit gain over the past decade. Class A shareholders saw their investment grow by 132%, or about 8.6% per year. That’s pretty impressive. It beat the hedge funds handily. It even beat the Vanguard index fund.
But the SPY ETF gave investors a total return of 140%. That’s about 9% annually. It’s not much better than Berkshire’s return, but it is better. And I’d rather have $1.10 than just $1.
So, if Buffett can’t beat the market, nobody can. Right?
Wrong. So, so wrong.
After comparing Berkshire and the index ETF, I decided to see how my investment advice had stacked up against the greatest. Who knew? Maybe I could underperform the market a little less than the greatest investor of the 20th century.
And again, let me tell you, I was amazed by what I found...
The investment advisory service I run with my colleague Briton Ryle outperformed both the index fund and Berkshire Hathaway! And not just by a little bit, either.
After 10 years, investors who followed our strategy and advice saw their portfolios grow by nearly 650%! That’s more than four times more profits than either an index fund or Warren Buffett would have gotten you.
And what’s more impressive is that works out to an average annual growth rate of 21.87%!
That includes the worst market crash in recent history, by the way. At the depths of that, Berkshire shareholders were down 32%. That was better than anyone who’d bought SPY in January 2008. They were looking at a 38% loss.
The Wealth Advisory’s members? They were up 23%.
By the time the S&P was positive again, investors who followed our strategy and advice were up 115%. By the time Berkshire got back in the black, we were up nearly 300%.
So, I guess you can beat an index fund that tracks the stock market. And I guess you can beat your idol, too. Is this what they mean when they say the student has become the teacher?
Now, I’m not just telling you this to brag or give myself a pat on the back. I mean, maybe I’m bragging a little. I’m really impressed with myself, to be honest, and pretty pleased, too.
But the real reason I’m telling you this is because I want to make sure you realize that you don’t need hedge funds or money managers or millions to invest. You can do even better than Warren Buffett, the greatest investor of the past century, with just a little patience, a lot of research, and a hand from me and Brit.
And since The Wealth Advisory has been so resoundingly successful, I want to celebrate by letting you in on some of our best (and most closely guarded) investments and strategies for saving and growing lasting wealth.
Don’t wait another minute to start beating Wall Street at its own game. Every second you delay is a second you could be earning more profits than Warren Buffett himself.
To (growing) your wealth,
After graduating Cum Laude in finance and economics, Jason analyzed complex projects and budgets for the U.S. Army. Then, at Morgan Stanley, he led the assistants' team for the North American repo sales desk, responsible for hundreds of multibillion-dollar trades every day. Jason is the assistant editor for The Wealth Advisory income stock newsletter. He also contributes regularly to Wealth Daily. To learn more about Jason, click here.
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