Every investor at some point has wished that they too could have the track record of Berkshire Hathaway. Please, let me disabuse you of that fantasy. Here are five reasons why you are not (and will never be) Warren Buffett.
1) You don’t have a time horizon of “forever.” Buffett is oft-quoted saying “Our favorite holding period is forever” (such as in the 1998 Berkshire shareholder letter). While this is a wonderful construct for Berkshire, it does not reflect real life for the rest of us. The rest of us retire, buy homes, pay for college education, pay off debt and make gifts to family and charity, forcing us to part with our investments eventually. We also (generally speaking) will gradually become more conservative with our portfolios as we age, eventually resulting in selling stocks.
2) Volatility matters to you, but not him. Buffett borrows Ben Graham’s “Mr. Market” analogy (one of my favorites) to remind us of the regularly absurd nature of the the markets and their participants. Market prices are wildly more volatile than earnings and dividends. Buffett and Berkshire have the privilege of ignoring this volatility and using it to their advantage. While individual investors can do this in a limited capacity (such as with a disciplined rebalancing strategy) downside volatility represents a real risk to retirees and foundations making regular distributions from their portfolios. It is worth noting that Berkshire Hathaway has never done the corporate equivalent – paying a dividend.
3) You don’t have a limitless supply of cash on hand. At the end of 2013, Berkshire Hathaway was sitting on $48 Billion (yes with a “B”) in cash and equivalents. $48 Billion. Because they are beholden to practically no one and benchmark their performance based on book value, Berkshire can afford to have a lot of cash around. It also helps to own dozens of companies that are throwing off cash on an ongoing basis and have never paid a corporate dividend. This cash reserve gives Berkshire the opportunity to wait for big downturns in asset prices and swoop in to pick up great companies at great prices. (It’s worth noting again that well diversified investors with a solid rebalancing strategy can do the same, but on a more limited basis).
4) You don’t have float. While Berkshire started off as a textile company and today is recognized as a massive conglomerate of industries, the real secret in the sauce is Berkshire’s portfolio of insurance companies. Many know that Berkshire owns GEICO, but other insurance subsidiaries include General Re, National Indemnity, Medical Protective and Wesco Financial. Insurance companies provide “free” leverage to Berkshire. The insurance companies collect premiums from policyholders, and Berkshire gets to use the cash until liabilities (claims) must be paid out. Float is the source of profit for all insurance companies, and having a skilled investor at the helm when deploying policyholder cash has been a huge part of Berkshire’s success. (There is a great piece on “Buffett’s Alpha” and the sources of Berkshire Hathaway’s returns here.)
5)You don’t get to make sweetheart deals with enormous banks. The financial crisis, in large part, was truly a liquidity crisis. Large financial institutions lost faith in one another, stopped lending to one another and the system seized. In September of 2008 Goldman Sachs was looking for capital. Buffett and Berkshire offered Goldman $5 Billion. For that, Berkshire received $5 Billion in preferred stock paying a 10% annual dividend. Right away this is expensive capital for a bank currently rated A-/Baa and paying under 3% on their 5-year bonds today. But the 10% yield wasn’t all that Berkshire got from the deal. They also received a warrant – a right to buy another $5 Billion of Goldman shares at $115 – a sweetheart deal considering GS was trading at $125 at the time. IN 2013 Berkshire and Goldman settled the option to buy, with Berkshire walking away with another nice profit on top of the 10% preferred yield. In the end, Buffett earned more than twice on his preferred/warrant investment than you or I would have buying GS on the open market at the time. When was the last time an investment bank asked you if it could borrow $5 Billion?
Buffett is legendary. Whether it is the result of skill, luck or leverage is a matter of debate. But the fact of the matter is you aren’t Warren Buffett, your opportunities aren’t Warren Buffett’s, your goals aren’t Warren Buffett’s and your results don’t need to be Warren Buffett’s. What you need is a disciplined investment strategy that you can stick to over the long term. All else is just good happy hour banter.