Last fall, more than 300 professional investment managers were asked to vote for the top 10 money managers of the 20^th century. Warren Buffett was first on the list, named by 86.4 percent of the respondents.

Buffett of course is chairman and chief executive of Berkshire Hathaway, an insurance company in Omaha that has distinguished itself by making phenomenal investments in other companies. Berkshire Hathaway’s stock (Buffett does not believe in splits) has soared from $17.50 at the end of 1966 to $53,500 early in January.

That looks like an investor’s dream. But in the past 10 months, the stock is down 34 percent from its high of $81,100 last March. In a year in which Nasdaq stocks routinely doubled and tripled, in which the Standard & Poor’s 500 Index itself was up almost 20 percent, the investment manager of the century socked his shareholders with a big loss.

If you could meet the minimum price for a share, would you buy Berkshire Hathaway stock today after that loss? If you had bought it a year ago, would you keep it now? If not, why not? Why would you pass up an opportunity to hire the most outstanding manager of the past century? Would one disappointing year make you lose your confidence? If so, you would have bailed out long before you reaped the rewards of having Buffett working for you.

Imagine that at the end of 1971, somebody convinced you that Buffett would be the best investment manager of the next 30 years, and that you invested $10,000 in Berkshire Hathaway stock at the start of 1972. By the end of 1974, your investment would have fallen to $5,708. You could have tracked a similar investment in the Standard & Poor’s 500 Index, and seen it drop to $7,456 in the same three years.

If you hung on, hoping for a market recovery, you saw it in 1975, when the S&P 500 Index rallied, with a gain of 37.2 percent, wiping out its previous three years of losses. But your stock, run by this future manager of the century, dropped further that year. At the end of 1975, your Berkshire Hathaway stock was worth only $5,422, while an S&P 500 Index account would have been worth $10,229.

For most investors, 1975 would have been the last straw. They would have been forgiven by most people for losing patience with Buffett and bidding him a hearty goodbye. That’s too bad, because in 1976, Berkshire Hathaway was up 147 percent, vs. a gain of 23.6 percent for the S&P 500 Index.

And if you followed those initial $10,000 investments year by year, according to figures in the following table, the investment in the S&P 500 Index would have been worth $323,842 at the end of 1998. The corresponding initial investment in Berkshire Hathaway stock would have been worth $9.9 million. By March 1999, it would have been worth $11.4 million.

But between March 1999 and the start of January 2000, you would have lost about $3.5 million. In 10 months, during a bull market. Do you have the stomach for that? At the end of 1999, by the way, the stock would have been worth $7.9 million, the S&P 500 Index account $386,991.

Here, from 1966 through 1999, are the annual returns of Berkshire Hathaway stock (Warren Buffett) and the Standard & Poor’s 500 Index.

Does 1999 mean that Warren Buffett has lost his touch? Were all those money managers wrong to nominate him as the best of the century? Not at all! Buffett is a great investor, but just like every other investor, his ultimate performance depends on the assets in which he invests.

Buffett is what could be called a "value" investor, one who buys out-of-favor stocks, at what he thinks are bargain-basement prices. Over the years, this has made a ton of money for his company. But value investing doesn’t track the returns of the overall market. This is why smart investors diversify.

In the table, you’ll see that in some years, Buffet’s returns were very different from those of the market. In 1968, the difference was nearly 72 percentage points. In 1971 Buffett beat the market by nearly 65 percentage points. In 1975, the market beat Buffett by 42 percentage points; in 1988, Buffett beat the market by about 43 percentage points. In 1999, the market beat Buffett by about 40 percentage points.

By itself, either Berkshire Hathaway or the Standard & Poor’s 500 Index over this period was very volatile. If you put them together, they often offset one another, for a smoother ride. But you can’t have the smooth ride if you ditch one of the asset classes that produces it.

 

 

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