Buffett proves why it’s so difficult to outpeform a market average over the long term.
The most important investment lesson to draw from Warren Buffett’s six-decade career managing Berkshire Hathaway is that even the best advisers and strategists can’t beat the market forever.
It’s important to focus on this investment lesson because hardly anyone else is doing so. Most of the articles memorializing Buffett’s phenomenal career have instead highlighted how much money you would have made if you had been lucky enough to invest in Berkshire Hathaway when Buffett started in the mid-1960s. While your cumulative (unannualized) return since then would be in the millions of percent, reporting that huge number does not help you become a better investor.
Pointing this out isn’t a criticism of Buffett’s incredible abilities. But it’s important to stress that an investor as successful as Buffett will eventually attract so much money from others that even he will find it difficult to repeat his prior successes.
Bar chart showing Berkshire Hathaway's trailing 20-year alpha relative to S&P 500 (annualized) from 1984 to 2024, decreasing significantly over time.
This is illustrated by the chart above, which plots Berkshire Hathaway’s trailing 20-year annualized “alpha” (its return relative to the S&P 500). In the mid-1980s, which is when the company under Buffett’s leadership first had a trailing two-decade history, its trailing 20-year alpha was close to 20 annualized percentage points. Hardly ever in the history of stock-market investing has an adviser performed this well for this long. But since the mid-1990s, Buffett’s alpha has steadily declined — hovering around zero for the past few years.
Buffett has long noted the difficulty of repeating his past successes with a portfolio as large as Berkshire Hathaway’s. He has acknowledged that it would be far easier for him to beat the market if he was managing a smaller portfolio, since many of the most undervalued companies he otherwise would find attractive are too small to make a meaningful difference to Berkshire’s bottom line.
A corollary lesson to draw from Buffett’s declining alpha: When looking for a mutual-fund manager or an investment adviser to manage your portfolio, you should favor someone with a stellar long-term track record who is still relatively unknown and manages a small portfolio.
This is a tall order, however, since a stellar multi-year track record almost always attracts a lot of investment capital. And if you start following an adviser before he has beaten the market over the long term, you incur an unacceptably high risk of picking someone whose good performance is just a flash in the pan.
For a reality check, consider whether you would have been at all interested in investing in Berkshire Hathaway stock at the beginning of Buffett’s career.
The first time his name was mentioned in the Wall Street Journal was on May 11, 1965, in an article reporting that the president and director of a Massachusetts textile company named Berkshire Hathaway had resigned because of “policy disagreements” with “certain outside interests” that had acquired a controlling interest. Those outside interests were the Buffett Partnership, Ltd., an Omaha, Neb.-based investment company run by none other than Warren Buffett.
The article said nothing more about who Buffett was or his partnership’s track record. On that basis, I doubt that any of us in 1965 would have given any thought to investing in Berkshire Hathaway.
The Journal’s first full-length profile of Buffett wouldn’t come until more than a decade later, in 1977. It wasn’t until the mid-1980s that references in the Journal about Buffett averaged more than once per month. Not until 1991 did these mentions total more than 100 for a calendar year.
Soon after, Buffett’s trailing 20-year alpha began to decline.
Buffett’s achievement is not that he overcame investing’s reversion to the mean, which is an irresistible force on Wall Street, but that it lasted so long. Almost all other managers lose their edge within a year or two.
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