19 ms·

The 1975 Buffett memo that saved the Washington Post's pension

120 points by peter123 13y ago

lutusp 13y ago
A quote from Warren Buffet: "In addition to the ones benefitting from short-term luck, I believe it possible that a few [stock portfolio managers] will succeed—in a modest way—because of skill." Yes, but with an appropriate degree of scientific skepticism, the "skill" assumption could actually be chance. And Occam's razor argues that chance is the more likely cause, not skill. For 100 stock fund managers buying and selling stocks, statistics tells us that 50 of them will do better than the market averages (and 50 will do worse). And a few of the managers will do very well indeed, but not because of skill. In fact, one can design a blind computer model that buys and sells stocks randomly, using pseudorandom numbers to make the decisions, and half the accounts will come out ahead of the averages, and a small number will do much better than the averages, just as in real life -- all because of chance. More here: http://arachnoid.com/equities_myths http://arachnoid.com/equities_myths
- moments 13y ago
  Thank you for the interesting link. >statistics tells us that 50 of them will do better than the market averages (and 50 will do worse) This is a common misunderstanding, but actually 50% will do better than the median not the average. Averages can be dominated by extreme events, so more than 50% can do better (or worse) depending on the skew.
  - gnaritas 13y ago
    Median is an average, as is mean and mode. Saying median not the average makes no sense. You mean median not the mean. All three are different kinds of averages.
    - moments 13y ago
      I never realized that the median is an average... interesting. So any average can be dominated by extreme events, except the median average. Then we are discussing averages, in general. So, the common misconception would be: -Averages are dominated by the median, and deviation from the mean is symmetric.-
  - lutusp 13y ago
    > This is a common misunderstanding, but actually 50% will do better than the median not the average. If the market were skewed to the degree that a symmetrical normal distribution wasn't a realistic model, then (assuming a particular skew) beating the median would be child's play, but it also wouldn't produce returns different than the average portfolio -- that average portfolio that sits at or near the mean, not the median. Another way to say this is that, if a skewed distribution peaked at some mean value M (the value on the curve that has a zero first derivative), and if there was a pathological, nonsymmetrical tail at the right or left that shifted the median value, the majority of portfolios would remain at the mean value in spite of the asymmetry.
- mdkess 13y ago
  What is the market? A bunch of fund managers. So your critique about not beating the median like saying half of all hockey players are worse than the median and so hockey is just a game of chance. You have to fix your prior. Track performance for some period of time. Then track the winners. This will show whether it's a game of skill or chance.
  - dredmorbius 13y ago
    The hockey analog doesn't hold if you can replace any given player with a stochastic robot, which is what stock picker programs (and dart-throwing monkeys) have demonstrated.
  - valisystem 13y ago
    You have to adjust your evaluation with the volume. If you're heading for the winning team, then alright, good intelligence on performance will be rewarded. But if you are three investors on the entire competition, it is very likely that skills advantage fades, since all your competitors have strong (if not mandatory) incentive to get top intelligence on the investment. In the end, your performance will be average, and your value earnings volumes will be your share of the entire market value creation for the invested period.
  - lutusp 13y ago
    > What is the market? A bunch of fund managers. This is like saying all personal relationships are limited to prostitutes. One can buy stocks directly, or invest in index mutual funds that don't have managers, for the reason that no management is required. > Then track the winners. This will show whether it's a game of skill or chance. But that's been done -- the WSJ Dartboard Contest showed that the experts don't do better than throwing darts at a list of stocks. http://online.wsj.com/article/SB10001424127887324504704578410864000872642.html http://online.wsj.com/article/SB1000142412788732450470457841... My point is that buying and holding an index fund, and relying on long-term market growth instead of phony expertise, is a much better approach to equity investment.
  - conanbatt 13y ago
    The market is NOT a bunch of fund managers. Its a representation of the state of assets being debt/credit or company shareholding. The market does not do better because there are fund managers, it does better if the underlying assets increase in value. All the other fluctuations are based on expectancies of those assets and arbitration. It is entirely possible for 100% of fund managers to do below the market average, as fund managers dont own 100% of the market. It is also likely they have a losing bet against a market, as active fund managers employ resources in their operations, by trading and actively managing a portfolio, usually in the form of fees, and potential downsides on extra taxation as well. Tracking "the winners" is the most fallacious and common attempt at gauging how good a fund manager or a stock is doing. Bernie Madoff was one of the winners for decades. Past results give no expectation to the future, which is so misleading given that the most common tool to show the value of a stock is a chart of how it did before, as opposed to how the company is doing (which require reading the statement). I suggest reading "The Intelligent Investor". It is by far the best book on this topic out there , and it has enough layman terms and concepts that are very easy to understand once you expose yourself to them.
- haliax 13y ago
  > For 100 stock fund managers buying and selling stocks, statistics tells us that 50 of them will do better than the market averages (and 50 will do worse). 50 will do better/worse than the MEDIAN of that GROUP OF 100 fund managers, not the market averages.
  - rayiner 13y ago
    Fund managers as a whole underperform market indexes.
    - dylangs1030 13y ago
      To expand on this point, Benjamin Graham gives an excellent layman's breakdown of why pursuing an index almost always prevails against trying to "beat the market" in The Intelligent Investor. If you're looking to make money with the market, and you're not looking for a particularly high amount, and time is not an issue, an index fund is the way to go.
  - lutusp 13y ago
    > 50 will do better/worse than the MEDIAN of that GROUP OF 100 fund managers, not the market averages. Oh, the managers will do worse than the market averages, because even if they avoid dumb moves, they will charge you for the privilege of managing your portfolio. My original remark was meant to measure their performance before fees, as the WSJ Dartboard Contest did it (a contest in which the managers weren't able to keep up with market averages). EDIT: for a symmetrical distribution, a distribution for which a classic Gaussian curve is appropriate, the median and the mean are the same.
    - beambot 13y ago
      Indeed, 50 may do worse than the market... but it's not because of a faulty appeal to "statistics." haliax is pointing out that 100 fund managers may not be an unbiased sample. It's perfectly possible to find a biased sample of 100 individuals capable of beating the market (eg. a group of 100 insiders trading illegally). EDIT: The "correct" thing to say is... "Based on evidence, fund managers do not outperform the market. Therefore, in a random sampling of 100 fund managers, we would expect 50 to underperform the market." This assumes (1) there is such evidence (likely?) and (2) that 100 is a sufficiently large sample to overcome the error bounds.
- ploomans 13y ago
  Warren Buffett once wrote an article about the points you are making: http://www.tilsonfunds.com/superinvestors.pdf http://www.tilsonfunds.com/superinvestors.pdf. Interesting read
  - MarkMc 13y ago
    This comment deserves more votes. Buffett's argument in favour of skill is very persuasive, not to mention genuinely funny. Here's an extract: -------------------------------------- I would like you to imagine a national coin-flipping contest. Let's assume we get 225 million Americans up tomorrow morning and we ask them all to wager a dollar. They go out in the morning at sunrise, and they all call the flip of a coin. If they call correctly, they win a dollar from those who called wrong. Each day the losers drop out, and on the subsequent day the stakes build as all previous winnings are put on the line. After ten flips on ten mornings, there will be approximately 220,000 people in the United States who have correctly called ten flips in a row. They each will have won a little over $1,000. Now this group will probably start getting a little puffed up about this, human nature being what it is. They may try to be modest, but at cocktail parties they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvelous insights they bring to the field of flipping. Assuming that the winners are getting the appropriate rewards from the losers, in another ten days we will have 215 people who have successfully called their coin flips 20 times in a row and who, by this exercise, each have turned one dollar into a little over $1 million. $225 million would have been lost, $225 million would have been won. By then, this group will really lose their heads. They will probably write books on "How I turned a Dollar into a Million in Twenty Days Working Thirty Seconds a Morning." Worse yet, they'll probably start jetting around the country attending seminars on efficient coin-flipping and tackling skeptical professors with, "If it can't be done, why are there 215 of us?"
    - lutusp 13y ago
      > Buffet's argument in favour of skill is very persuasive, not to mention genuinely funny. Thanks for posting this -- it's first-rate. The fact that it corresponds exactly to my personal views can't be a factor, of course. :)
- tome 13y ago
  You can say that about many things. Do Musk and Messi have "skill" or is their success just chance?
  - lutusp 13y ago
    For some things, a real scientific experiment isn't possible, because there's isn't enough control. Equities is one of those things. For equities, when you see a performance that beats the market averages, it wise to assume it's because of chance, not genius. Also, there are any number of convincing scams meant to distort one's thinking. My favorite is one I call "Miracle Man", in which a manager mails you six perfectly correct monthly predictions, all in advance of the real market they predict, then asks to take over your portfolio. Hard to believe, but it's a scam, it isn't real: http://arachnoid.com/equities_myths/index.html#Miracle_Man http://arachnoid.com/equities_myths/index.html#Miracle_Man
- fleitz 13y ago
  The problem is fundamentally that fund managers consume a large portion of the returns, after you factor the cost of the fund manager the result is negative. To put it succinctly: On average fund managers reduce ROI. As an alternative measurement, if you take the funds managed by most managers and look at the portfolio 1 year ago the fund would be better off with the previous year's portfolio. (This time mostly because of transaction costs)
  - lutusp 13y ago
    > The problem is fundamentally that fund managers consume a large portion of the returns, after you factor the cost of the fund manager the result is negative. Yes, a point I make in my article, but didn't make in my post. Fund managers are very difficult to justify.
- deleted 13y ago
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- wheaties 13y ago
  There are managers who excel at investing money and unlocking value. Just because most managers in assets and investment vehicles afforded by those whose worth is not of a sufficient level does not mean they do not exist. People who can, do. They happen to charge 2 and 20 for the privilege of working your money.
  - lutusp 13y ago
    > There are managers who excel at investing money and unlocking value. From a scientific standpoint, that is false. You need to realize that it's not possible to show (prove, demonstrate) that such stories arise from anything but chance. A certain number of people are going to do very well because of chance, and some of those people are going to try to pose as experts. But don't take my word for it -- instead, think. If there really was a surefire way to beat market averages, it wouldn't remain a secret for long, then everyone would practice it, then that "system" would become the norm -- the market average performance. And if there really was a way to beat the market averages, if it was possible to make a huge sum of money systematically without risk or uncertainty, using a scheme other than chance, businesspeople (who are not fools) would refuse to raise capital using equities. If you think hard enough, you will realize why there cannot be a deterministic, legal system to beat the market. There's always insider trading, but that's illegal for a reason. > Just because most managers in assets and investment vehicles afforded by those whose worth is not of a sufficient level does not mean they do not exist. They do not exist. I just proved it. If you didn't understand the above proof, read it again.
    - im3w1l 13y ago
      >But don't take my word for it -- instead, think. If there really was a surefire way to beat market averages, it wouldn't remain a secret for long, then everyone would practice it. Not if it's costly. By that I mean what if there is a market oracle that can pick tomorrows winners, but you have to pay X dollars to pull the crank and get the info. In that case, it could be possible to "beat the market" in the sense that your stocks overperform, but you do not actually beat the market if you factor in the cost of the oracle. Real world example: http://www.cnbc.com/id/100809395 http://www.cnbc.com/id/100809395 >A closely watched consumer confidence number that routinely moves markets upon release is accessed by an elite group of traders, for a fee, a full two seconds before its official release, according to a document obtained by CNBC. Another situation would be that you could overperform the market if you hired thousands of employees that analysed the markets, but not so much that you could pay their wages and still win. It could also be the case that some people have a comparative advantage. Maybe they have certain skills that enable them to win were other people cannot.
- klodolph 13y ago
  > For 100 stock fund managers buying and selling stocks, statistics tells us that 50 of them will do better than the market averages (and 50 will do worse). If you're going to simplify things, take out the numbers because the numbers are wrong. For example, let's suppose that there are six companies you can invest in, and six managers who each invest in one company. One company grows 600%, and the other five declare bankruptcy. Average growth is 16%, but only 1 in 6 managers beat the average. The other thing that's wrong is that you use the term "statistics" where you mean "probability theory". Probability theory describes how many managers you'd expect to beat the average. Statistics describes how you'd test this.
  - lutusp 13y ago
    > If you're going to simplify things, take out the numbers because the numbers are wrong. The numbers are exactly right. The problem lies with your example in which businesses either grow without bound or go bankrupt. In the real world, and typically, half of investors do better, and half do worse, than the market average. > The other thing that's wrong is that you use the term "statistics" where you mean "probability theory". Since one forms the foundation of the other, that's a distinction without a difference, especially when conversing with people who think there are secrets of the winners. The ideas are very simple, and specifying which aspect of statistics gives the most detail is hardly worth specifying. http://en.wikipedia.org/wiki/Probability_theory http://en.wikipedia.org/wiki/Probability_theory Quote: "As a mathematical foundation for statistics, probability theory is essential to many human activities that involve quantitative analysis of large sets of data."
    - jholman 13y ago
      You're mistaken on both counts, even though your top-level point is essentially correct. On the first count, you're mistaken because there's no reason to assume that the distribution is symmetric. This doesn't damage your point, but as klodoph says, your actual example numbers are not necessarily representative. You'll note that this minor mistake in your comment has attracted a legion of minor corrections, all of them correct, all of them missing (or at least ignoring) your most-important point. On the second count, that's like saying that math is the foundation of computing, and so the two are indistinguishable. klodolph is correct that the two are different, and it doesn't affect your point at all, so you should acknowledge the minor correction and stick to the relevant point. More generally, did you notice that your top-level comment was basically saying "Warren Buffet is wrong about this aspect of investing"? You could be right, but it's not likely. I believe the reason for this mistake is that you may have have misread this sample of Buffet's thinking (and your overall claims as I understand them may actually agree with and Buffet as I understand him). (In my humble understanding) Buffet claims that there may or may not exist investors who have superior (or inferior) skill, but that in MOST cases the results are due to luck, and "skilled" investors are mostly indistinguishable from lucky investors. Although I have not seen you agree or disagree with this claim, I note that all of your arguments are consistent with this. Your arguments revolve around being unable to determine which are which, after the fact; so do Buffet's! I further note that it seems ludicrous to claim that there do not exist anti-skilled investors, and thus all other investors will be more skilled than the mean skill level, and that this probably won't matter, because luck will drown it all out. My overall points here are: * I agree with your high-level claims (as I understand them) about money-managers * I believe Warren Buffet, in this letter to Katherine Graham, agrees with your high-level claims * nearly every commenter in these threads agrees with your high-level claims * the comment by wheaties is a counter-example * some of the minor details of your points are technically wrong or confusing, in ways that invite nit-picking, but do not impact your actual argument On the other hand, starting on page 15 (of 19), Buffet suggests (and advocates) an alternative (his #5) that is NOT fully respectful of the efficient market hypothesis. So your position is not Buffet's entire position (though I see from your Equities Myths page that you have noticed this, and you suggest that perhaps Buffet is nothing except lucky).
- jrs235 13y ago
  No. For 100 stock fund managers buying and selling stocks, statistics tell us that 50 of them will do better than the average of them (than the lower 50). To assume half will do better than the market is a failure of logic, assuming non stock fund managers are allowed to buy and sell too. Please qualify and clarify what you actually mean.
dredmorbius 13y ago
Meta: QZ is utterly unreadable to me on both desktop and mobile. Fortunately there's Readability.
- nether 13y ago
  More meta: the article uses lowercase l to represent the digit 1.
  - dredmorbius 13y ago
    Perl can do that in Underwood compatibility mode (obscure Perl Journal cover reference...).
- tagawa 13y ago
  Same here. I come to the comments first hoping for a non-QZ link.
- jholman 13y ago
  Plus, the entire article is blogspam. It should be flagged as such (edit: and resubmitted, since the letter itself is interesting). Actual letter (plus some other blowhard commentary) at: http://finance.fortune.cnn.com/2013/08/15/warren-buffett-katharine-graham-letter/ http://finance.fortune.cnn.com/2013/08/15/warren-buffett-kat...
maerF0x0 13y ago
and yet he himself is an example of exactly the opposite mentality. He has been an outlier manager for decades and would have been a great choice of manager for anyone he would take money from. He effectively takes new money whenever his holdings pay dividends and reinvests it successfully. Roughly speaking he's returned 100% (vs 50% for the Sp500) in 10yrs giving about a 7.2% return rate. He consistently beats the market and then claims that "managers" cannot.
- redschell 13y ago
  Buffett is an interesting character. From this article, it would appear that he sees himself as some kind of entrepreneur/investor/manager hybrid than as a pure money manager. http://dealbook.nytimes.com/2012/12/03/for-buffett-the-long-run-still-trumps-the-quick-return/ http://dealbook.nytimes.com/2012/12/03/for-buffett-the-long-... If you go on to read anything about activist investors, like Carl Icahn, you get the feeling that the only way to beat the market is to tamper with it.
- marcosdumay 13y ago
  Yep, but he does not invest on a fund.
- MarkMc 13y ago
  Not quite - I think his point was that money managers with very large sums to invest cannot beat the market. He made that claim almost 40 years ago, and more recently his own record clearly contradicts it. So perhaps he no longer holds such a view... Edit: It looks like Buffett had changed his view by 1984 [1]: "Size is the anchor of performance. There is no question about it. It doesn't mean you can't do better than average when you get larger, but the margin shrinks." [1] http://www.tilsonfunds.com/superinvestors.html http://www.tilsonfunds.com/superinvestors.html
  - e12e 13y ago
    Or, perhaps the stock market doesn't reflect value, and insider trading (in one form or another) is the norm, not the exception?
  - 13y ago
beefxq 13y ago
Tell that to the hedge fund billionaires. Oh wait, knowledge networks, I guess it's all just insider trading.
jmcgough 13y ago
This is why investing in an index fund is a great decision. When you rely on more active management, you pay higher fees, and your returns are likely to be about average (or worse). With an index fund you can take a healthy return, mitigate risk by diversifying well, and pay a fraction of the fee (which equates to hundreds of thousands of dollars over 30-40 years from the added growth).
- aet 13y ago
  Better yet, be the one charging the fees.
yumraj 13y ago
It's interesting that this article states "Buffett, then just 44 years old" while in the tech industry 44 years old is considered...
- jlgreco 13y ago
  I would expect similar language to be used if this were instead an article about something Donald Knuth said when he was 44. The "just" reflects the public familiarity with the 82 year old Buffett.
porter 13y ago
Warren Buffet also said: "I’d be a bum on the street with a tin cup if the markets were always efficient”
- refurb 13y ago
  I think one particular problem with the strong-form efficient market hypotheses is this: A stock should already be priced for all of the publicly available information. However, that information has to be analyzed and interpreted. That's the catch. "Today company XYZ announced their purchase of Chinese company ABC." There are probably many different ways to interpret that information. Maybe the purchase will result in increased profit, maybe it will bankrupt the company. Nobody knows. If all public information were easily interpreted, i.e. if X happens the stock will drop by 5%, then the markets probably would be efficient.
  - jacques_chester 13y ago
    The EMH doesn't propose that participants have future knowledge. It says that current prices reflect current information and that in the long run, all participants regress to the mean.
    - eli_gottlieb 13y ago
      Well yes, but he's still correct. Not all participants accurately gauge what the available information means for their positions, and even for those who do, figuring it out takes time.
D9u 13y ago
I remember reading a quote from a top trading executive which went something like the following: "Only a fool plays the stock market without insider information."
robotcookies 13y ago
The title is incorrect because Buffett doesn't say playing the market is futile. In fact, he clearly states he believes a few will outperform due to skill (but that you can't distinguish which outperformers did so on skill versus luck). What he does say in the quoted part is that a large fund of say 20 billion likely can't outperform due to it's size. That is a big difference from saying that it's futile to play the market (since not everyone is trying to invest 20 billion). It's also similar to what other investors like Peter Lynch believed.. that smaller investors have an advantage over the large funds. This isn't made clear at all in the linked page. As far as I know, Buffett has always felt efficient market theory is wrong and that a few could beat the market on skill. There's also nothing in the linked quote that contradicts this (just the title that suggests it). So the title is clearly deceptive. It suggests that Buffett did not believe in investing skill at a younger age and only changed his stated beliefs after becoming a very successful investor.
- gfodor 13y ago
  To paraphrase Buffett it's quite nice to have your "opponents" be taught the efficient market hypothesis is a fact, you can't beat the market, etc since its essentially stacking the deck even more in the favor of skilled individual investors.
- hsitz 13y ago
  I mostly agree. But "playing the market" as its normally understood involves trying to make money on the market within a fairly short time frame, by buying low and selling high. I believe Buffett has many times said that the market is a casino in the short run (playing the market) but becomes an accurate "weighing machine" over the long run (buying and holding for five, ten years or more). E.g., http://www.youtube.com/watch?v=-aYEOsZgRm8 http://www.youtube.com/watch?v=-aYEOsZgRm8 So in that sense Buffett does think "playing the market" is a loser's game (that's played by "speculators", not "investors"), though I don't think that's specifically addressed in the linked letter.
- jacques_chester 13y ago
  > Buffett has always felt efficient market theory is wrong People often refute the EMH without understand that it is a family of hypotheses, from the Strong to the Weak form, with a great deal of subtlety in their concept and meaning. Buffet's argument in the linked excerpts is actually pretty close to a weak form of the EMH: all participants start with broadly similar information and capabilities, so performance naturally regresses to the mean. Here's my favourite discussion of the EMH: http://skepticlawyer.com.au/2013/05/29/bubble-trouble-all-information-is-not-equal/ http://skepticlawyer.com.au/2013/05/29/bubble-trouble-all-in...
nickff 13y ago
There is no evidence that mutual funds (or any other active managers) can outperform the stock market.[1] This can be explained by the strong form of the efficient markets hypothesis; "In strong-form efficiency, share prices reflect all information, public and private, and no one can earn excess returns." [2] [1] http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150_advanced_investments/Luck%20versus%20Skilll%20in%20the%20Cross%20Section%20of%20Mutual%20Fund%20Returns.pdf http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150... [2] http://en.wikipedia.org/wiki/Efficient-market_hypothesis#Strong-form_efficiency http://en.wikipedia.org/wiki/Efficient-market_hypothesis#Str...
- jcnnghm 13y ago
  The market is definitely not strong-form efficient. If it were, you wouldn't have any price movement attributable to earnings surprises, because the private information would already be priced in. More importantly, markets are only efficient because some people are researching and trading to the true underlying value. The whole reason markets are supposed to be efficient is because if they are not, there is an opportunity to make riskless arbitrage profit, which someone will exploit.
  - nickff 13y ago
    Strong form efficiency does not imply perfectly predictive of all future events. Such a claim would imply that no durable good could increase in price at a rate higher than the federal funds rate plus some risk premium (haircut).
jholman 13y ago
I had a funny thought reading the letter (the actual letter at Forbes, not the vacuous qz.com summary). The letter is type-written, with nice tables and footnotes. That probably means that it was either hand-written by Buffet or by a secretary (or stenographed or whatever), and then given to a typist to format. In turn that means that some random lowly typist got to snoop on all this premium investment advice, that 20 years later would be becoming common wisdom. I wonder if she (I assume a typist in the 70s would be female) noticed and appreciated it, perhaps acted on it.
- marvin 13y ago
  Probably not. It's a sad fact that women are on average disinclined towards risk-taking, and investment is a classical risk-taking activity. This effect must have been even more pronounced in the 70s.
r0s 13y ago
The factor I think he missed: All those managers timing trades in their random way has a randomizing effect on the system overall. But I'm not an economist, any ideas if or how that influence manifests?
- YokoZar 13y ago
  In aggregate, it wouldn't much matter since randomness would cancel itself out. So broad index funds wouldn't see that volatility. At shorter scales, however, randomness like that would add volatility to individual stocks, so you'd see more random results for returns among small portfolios -- thus creating quite a few genuinely lucky fund managers.
deleted 13y ago
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beambot 13y ago
Quoting from page 13: A further problem is that in no case were the superior records (returns) I have observed based upon institutional skills which could be maintained despite changes in the faces. Rather, the good results have been accomplished by a single individual or, at most, a few, working in fairly specialized areas in which the great bulk of investment money simply had no interest. So... he seems to predict a bleak future for Berkshire's returns after his departure as well?
- ISL 13y ago
  He's been planning for his retirement/demise for a very long time. He's pretty good at playing the long game, so I wouldn't bet against him.
gvr 13y ago
His point is that playing the market is "speculation", not investing. He differentiates this with "investing", where you simply try to assess the intrinsic value of a stock, and if the stock is trading at a significant discount to it, then you buy it. Further, once you've bought it, you keep it. You don't try to time the ups and downs of the market, buying moving and out of the position quickly. Since this is how Buffett likes to invest, one of his key principles is investing in owner-operators or people that are behaving as such. You want the executives of the company to treat it as if they owned all the stock and could never sell it. Because when you have the people running the company worrying about next quarter, you're not worrying about next decade. Also related, Buffett's two key rules to investing: Rule #1. Never lose any money Rule #2. Never break rule #1
rl12345 13y ago
I read all this 1975 dated letter and while I enjoyed every piece of it, this phrase contained in the very last page is what caught my attention the most: "Conventional approaches to money management should not be expected to produce above average results." It basically means that if you want to perform better than your competitors you logically should act differently from them. As in distancing yourself from the status quo. I can see this advice being spot on for startups as well, it has everything to do with thinking outside of the box and redefining the rules of the game. Good ole Warren nailed it decades ago.
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d23y 13y ago
If what he says here is true, the parents of every kid on the planet should test their child for some aptitude in this area--at least a little--because learning your kid was preternaturally adept at, basically, "Making a Lot Of Money" would be the most important thing that ever happened to the kid. Also wouldn't it have been one of the most sensational "news events" of all time, if nothing else, when someone honestly reported Someone Has Found the One Weird Trick To Becoming Really Rich, And It Always Works If You Do It Right. The rise in billionaires I surely would have heard about, at least. So what's the catch? Why can't I just go and study this book and make a lot money if I think I'm smart, now that I've read this article?
- lutusp 13y ago
  > So what's the catch? The catch is that testing people for an unexplained adeptness at making money in equities is essentially certain to produce a handful of "successes" that arise from chance, not talent. Given a pool of ten million investors, all playing the market, and all making random picks, it is certain that a handful will succeed spectacularly because of chance. I know because I have modeled this sort of thing with computer programs, each of which produce "winners" simply by making random picks. With a large enough population, some will "succeed" spectacularly, through chance. Those successes will find it hard to accept that their success arose from chance rather than genius, just as happens in real life. > Why can't I just go and study this book and make a lot money if I think I'm smart, now that I've read this article? If there really was a book that contained secrets to beat the market, secrets that worked, that were reliable, that anyone could put into practice, businesses would abandon equities as a way to raise operating capital. After all, why should they line the pockets of a bunch of non-productive speculators? What possible incentive would they have? The only reason the equities market works is because investors get a fair return on their investment, consistent with the risks they take, and businesses get operating capital at a reasonable rate as well. Both parties to the transaction get a fair deal. All this talk about making a killing in stocks using "secrets of the winners" overlooks the fact that, if it were possible, if someone could really make a fortune by something other than blind luck, reliably, deterministically, the market would collapse. And for the life of me, I can't understand why people find this so hard to understand.
Mikeb85 13y ago
The title is misleading, but Warren Buffett is right. The more money you manage, the harder it is to beat the market as a trader. However, if you're playing with a modest amount of money, you can play the market, since moving small amounts of money around is much easier than say, 20 billion...
Pitarou 13y ago
I love this line: > Wall Street abhors a commercial vacuum. If the will to believe stirs within the customer, the merchandise will be supplied -- without warranty.

120 points by peter123 13y ago

A quote from Warren Buffet: "In addition to the ones benefitting from short-term luck, I believe it possible that a few [stock portfolio managers] will succeed—in a modest way—because of skill." Yes, but with an appropriate degree of scientific skepticism, the "skill" assumption could actually be chance. And Occam's razor argues that chance is the more likely cause, not skill. For 100 stock fund managers buying and selling stocks, statistics tells us that 50 of them will do better than the market averages (and 50 will do worse). And a few of the managers will do very well indeed, but not because of skill. In fact, one can design a blind computer model that buys and sells stocks randomly, using pseudorandom numbers to make the decisions, and half the accounts will come out ahead of the averages, and a small number will do much better than the averages, just as in real life -- all because of chance. More here: http://arachnoid.com/equities_myths http://arachnoid.com/equities_myths

moments 13y ago
Thank you for the interesting link. >statistics tells us that 50 of them will do better than the market averages (and 50 will do worse) This is a common misunderstanding, but actually 50% will do better than the median not the average. Averages can be dominated by extreme events, so more than 50% can do better (or worse) depending on the skew.
- gnaritas 13y ago
  Median is an average, as is mean and mode. Saying median not the average makes no sense. You mean median not the mean. All three are different kinds of averages.
  - moments 13y ago
    I never realized that the median is an average... interesting. So any average can be dominated by extreme events, except the median average. Then we are discussing averages, in general. So, the common misconception would be: -Averages are dominated by the median, and deviation from the mean is symmetric.-
- lutusp 13y ago
  > This is a common misunderstanding, but actually 50% will do better than the median not the average. If the market were skewed to the degree that a symmetrical normal distribution wasn't a realistic model, then (assuming a particular skew) beating the median would be child's play, but it also wouldn't produce returns different than the average portfolio -- that average portfolio that sits at or near the mean, not the median. Another way to say this is that, if a skewed distribution peaked at some mean value M (the value on the curve that has a zero first derivative), and if there was a pathological, nonsymmetrical tail at the right or left that shifted the median value, the majority of portfolios would remain at the mean value in spite of the asymmetry.
mdkess 13y ago
What is the market? A bunch of fund managers. So your critique about not beating the median like saying half of all hockey players are worse than the median and so hockey is just a game of chance. You have to fix your prior. Track performance for some period of time. Then track the winners. This will show whether it's a game of skill or chance.
- dredmorbius 13y ago
  The hockey analog doesn't hold if you can replace any given player with a stochastic robot, which is what stock picker programs (and dart-throwing monkeys) have demonstrated.
- valisystem 13y ago
  You have to adjust your evaluation with the volume. If you're heading for the winning team, then alright, good intelligence on performance will be rewarded. But if you are three investors on the entire competition, it is very likely that skills advantage fades, since all your competitors have strong (if not mandatory) incentive to get top intelligence on the investment. In the end, your performance will be average, and your value earnings volumes will be your share of the entire market value creation for the invested period.
- lutusp 13y ago
  > What is the market? A bunch of fund managers. This is like saying all personal relationships are limited to prostitutes. One can buy stocks directly, or invest in index mutual funds that don't have managers, for the reason that no management is required. > Then track the winners. This will show whether it's a game of skill or chance. But that's been done -- the WSJ Dartboard Contest showed that the experts don't do better than throwing darts at a list of stocks. http://online.wsj.com/article/SB10001424127887324504704578410864000872642.html http://online.wsj.com/article/SB1000142412788732450470457841... My point is that buying and holding an index fund, and relying on long-term market growth instead of phony expertise, is a much better approach to equity investment.
- conanbatt 13y ago
  The market is NOT a bunch of fund managers. Its a representation of the state of assets being debt/credit or company shareholding. The market does not do better because there are fund managers, it does better if the underlying assets increase in value. All the other fluctuations are based on expectancies of those assets and arbitration. It is entirely possible for 100% of fund managers to do below the market average, as fund managers dont own 100% of the market. It is also likely they have a losing bet against a market, as active fund managers employ resources in their operations, by trading and actively managing a portfolio, usually in the form of fees, and potential downsides on extra taxation as well. Tracking "the winners" is the most fallacious and common attempt at gauging how good a fund manager or a stock is doing. Bernie Madoff was one of the winners for decades. Past results give no expectation to the future, which is so misleading given that the most common tool to show the value of a stock is a chart of how it did before, as opposed to how the company is doing (which require reading the statement). I suggest reading "The Intelligent Investor". It is by far the best book on this topic out there , and it has enough layman terms and concepts that are very easy to understand once you expose yourself to them.
haliax 13y ago
> For 100 stock fund managers buying and selling stocks, statistics tells us that 50 of them will do better than the market averages (and 50 will do worse). 50 will do better/worse than the MEDIAN of that GROUP OF 100 fund managers, not the market averages.
- rayiner 13y ago
  Fund managers as a whole underperform market indexes.
  - dylangs1030 13y ago
    To expand on this point, Benjamin Graham gives an excellent layman's breakdown of why pursuing an index almost always prevails against trying to "beat the market" in The Intelligent Investor. If you're looking to make money with the market, and you're not looking for a particularly high amount, and time is not an issue, an index fund is the way to go.
- lutusp 13y ago
  > 50 will do better/worse than the MEDIAN of that GROUP OF 100 fund managers, not the market averages. Oh, the managers will do worse than the market averages, because even if they avoid dumb moves, they will charge you for the privilege of managing your portfolio. My original remark was meant to measure their performance before fees, as the WSJ Dartboard Contest did it (a contest in which the managers weren't able to keep up with market averages). EDIT: for a symmetrical distribution, a distribution for which a classic Gaussian curve is appropriate, the median and the mean are the same.
  - beambot 13y ago
    Indeed, 50 may do worse than the market... but it's not because of a faulty appeal to "statistics." haliax is pointing out that 100 fund managers may not be an unbiased sample. It's perfectly possible to find a biased sample of 100 individuals capable of beating the market (eg. a group of 100 insiders trading illegally). EDIT: The "correct" thing to say is... "Based on evidence, fund managers do not outperform the market. Therefore, in a random sampling of 100 fund managers, we would expect 50 to underperform the market." This assumes (1) there is such evidence (likely?) and (2) that 100 is a sufficiently large sample to overcome the error bounds.
ploomans 13y ago
Warren Buffett once wrote an article about the points you are making: http://www.tilsonfunds.com/superinvestors.pdf http://www.tilsonfunds.com/superinvestors.pdf. Interesting read
- MarkMc 13y ago
  This comment deserves more votes. Buffett's argument in favour of skill is very persuasive, not to mention genuinely funny. Here's an extract: -------------------------------------- I would like you to imagine a national coin-flipping contest. Let's assume we get 225 million Americans up tomorrow morning and we ask them all to wager a dollar. They go out in the morning at sunrise, and they all call the flip of a coin. If they call correctly, they win a dollar from those who called wrong. Each day the losers drop out, and on the subsequent day the stakes build as all previous winnings are put on the line. After ten flips on ten mornings, there will be approximately 220,000 people in the United States who have correctly called ten flips in a row. They each will have won a little over $1,000. Now this group will probably start getting a little puffed up about this, human nature being what it is. They may try to be modest, but at cocktail parties they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvelous insights they bring to the field of flipping. Assuming that the winners are getting the appropriate rewards from the losers, in another ten days we will have 215 people who have successfully called their coin flips 20 times in a row and who, by this exercise, each have turned one dollar into a little over $1 million. $225 million would have been lost, $225 million would have been won. By then, this group will really lose their heads. They will probably write books on "How I turned a Dollar into a Million in Twenty Days Working Thirty Seconds a Morning." Worse yet, they'll probably start jetting around the country attending seminars on efficient coin-flipping and tackling skeptical professors with, "If it can't be done, why are there 215 of us?"
  - lutusp 13y ago
    > Buffet's argument in favour of skill is very persuasive, not to mention genuinely funny. Thanks for posting this -- it's first-rate. The fact that it corresponds exactly to my personal views can't be a factor, of course. :)
tome 13y ago
You can say that about many things. Do Musk and Messi have "skill" or is their success just chance?
- lutusp 13y ago
  For some things, a real scientific experiment isn't possible, because there's isn't enough control. Equities is one of those things. For equities, when you see a performance that beats the market averages, it wise to assume it's because of chance, not genius. Also, there are any number of convincing scams meant to distort one's thinking. My favorite is one I call "Miracle Man", in which a manager mails you six perfectly correct monthly predictions, all in advance of the real market they predict, then asks to take over your portfolio. Hard to believe, but it's a scam, it isn't real: http://arachnoid.com/equities_myths/index.html#Miracle_Man http://arachnoid.com/equities_myths/index.html#Miracle_Man
fleitz 13y ago
The problem is fundamentally that fund managers consume a large portion of the returns, after you factor the cost of the fund manager the result is negative. To put it succinctly: On average fund managers reduce ROI. As an alternative measurement, if you take the funds managed by most managers and look at the portfolio 1 year ago the fund would be better off with the previous year's portfolio. (This time mostly because of transaction costs)
- lutusp 13y ago
  > The problem is fundamentally that fund managers consume a large portion of the returns, after you factor the cost of the fund manager the result is negative. Yes, a point I make in my article, but didn't make in my post. Fund managers are very difficult to justify.
deleted 13y ago
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wheaties 13y ago
There are managers who excel at investing money and unlocking value. Just because most managers in assets and investment vehicles afforded by those whose worth is not of a sufficient level does not mean they do not exist. People who can, do. They happen to charge 2 and 20 for the privilege of working your money.
- lutusp 13y ago
  > There are managers who excel at investing money and unlocking value. From a scientific standpoint, that is false. You need to realize that it's not possible to show (prove, demonstrate) that such stories arise from anything but chance. A certain number of people are going to do very well because of chance, and some of those people are going to try to pose as experts. But don't take my word for it -- instead, think. If there really was a surefire way to beat market averages, it wouldn't remain a secret for long, then everyone would practice it, then that "system" would become the norm -- the market average performance. And if there really was a way to beat the market averages, if it was possible to make a huge sum of money systematically without risk or uncertainty, using a scheme other than chance, businesspeople (who are not fools) would refuse to raise capital using equities. If you think hard enough, you will realize why there cannot be a deterministic, legal system to beat the market. There's always insider trading, but that's illegal for a reason. > Just because most managers in assets and investment vehicles afforded by those whose worth is not of a sufficient level does not mean they do not exist. They do not exist. I just proved it. If you didn't understand the above proof, read it again.
  - im3w1l 13y ago
    >But don't take my word for it -- instead, think. If there really was a surefire way to beat market averages, it wouldn't remain a secret for long, then everyone would practice it. Not if it's costly. By that I mean what if there is a market oracle that can pick tomorrows winners, but you have to pay X dollars to pull the crank and get the info. In that case, it could be possible to "beat the market" in the sense that your stocks overperform, but you do not actually beat the market if you factor in the cost of the oracle. Real world example: http://www.cnbc.com/id/100809395 http://www.cnbc.com/id/100809395 >A closely watched consumer confidence number that routinely moves markets upon release is accessed by an elite group of traders, for a fee, a full two seconds before its official release, according to a document obtained by CNBC. Another situation would be that you could overperform the market if you hired thousands of employees that analysed the markets, but not so much that you could pay their wages and still win. It could also be the case that some people have a comparative advantage. Maybe they have certain skills that enable them to win were other people cannot.
klodolph 13y ago
> For 100 stock fund managers buying and selling stocks, statistics tells us that 50 of them will do better than the market averages (and 50 will do worse). If you're going to simplify things, take out the numbers because the numbers are wrong. For example, let's suppose that there are six companies you can invest in, and six managers who each invest in one company. One company grows 600%, and the other five declare bankruptcy. Average growth is 16%, but only 1 in 6 managers beat the average. The other thing that's wrong is that you use the term "statistics" where you mean "probability theory". Probability theory describes how many managers you'd expect to beat the average. Statistics describes how you'd test this.
- lutusp 13y ago
  > If you're going to simplify things, take out the numbers because the numbers are wrong. The numbers are exactly right. The problem lies with your example in which businesses either grow without bound or go bankrupt. In the real world, and typically, half of investors do better, and half do worse, than the market average. > The other thing that's wrong is that you use the term "statistics" where you mean "probability theory". Since one forms the foundation of the other, that's a distinction without a difference, especially when conversing with people who think there are secrets of the winners. The ideas are very simple, and specifying which aspect of statistics gives the most detail is hardly worth specifying. http://en.wikipedia.org/wiki/Probability_theory http://en.wikipedia.org/wiki/Probability_theory Quote: "As a mathematical foundation for statistics, probability theory is essential to many human activities that involve quantitative analysis of large sets of data."
  - jholman 13y ago
    You're mistaken on both counts, even though your top-level point is essentially correct. On the first count, you're mistaken because there's no reason to assume that the distribution is symmetric. This doesn't damage your point, but as klodoph says, your actual example numbers are not necessarily representative. You'll note that this minor mistake in your comment has attracted a legion of minor corrections, all of them correct, all of them missing (or at least ignoring) your most-important point. On the second count, that's like saying that math is the foundation of computing, and so the two are indistinguishable. klodolph is correct that the two are different, and it doesn't affect your point at all, so you should acknowledge the minor correction and stick to the relevant point. More generally, did you notice that your top-level comment was basically saying "Warren Buffet is wrong about this aspect of investing"? You could be right, but it's not likely. I believe the reason for this mistake is that you may have have misread this sample of Buffet's thinking (and your overall claims as I understand them may actually agree with and Buffet as I understand him). (In my humble understanding) Buffet claims that there may or may not exist investors who have superior (or inferior) skill, but that in MOST cases the results are due to luck, and "skilled" investors are mostly indistinguishable from lucky investors. Although I have not seen you agree or disagree with this claim, I note that all of your arguments are consistent with this. Your arguments revolve around being unable to determine which are which, after the fact; so do Buffet's! I further note that it seems ludicrous to claim that there do not exist anti-skilled investors, and thus all other investors will be more skilled than the mean skill level, and that this probably won't matter, because luck will drown it all out. My overall points here are: * I agree with your high-level claims (as I understand them) about money-managers * I believe Warren Buffet, in this letter to Katherine Graham, agrees with your high-level claims * nearly every commenter in these threads agrees with your high-level claims * the comment by wheaties is a counter-example * some of the minor details of your points are technically wrong or confusing, in ways that invite nit-picking, but do not impact your actual argument On the other hand, starting on page 15 (of 19), Buffet suggests (and advocates) an alternative (his #5) that is NOT fully respectful of the efficient market hypothesis. So your position is not Buffet's entire position (though I see from your Equities Myths page that you have noticed this, and you suggest that perhaps Buffet is nothing except lucky).
jrs235 13y ago
No. For 100 stock fund managers buying and selling stocks, statistics tell us that 50 of them will do better than the average of them (than the lower 50). To assume half will do better than the market is a failure of logic, assuming non stock fund managers are allowed to buy and sell too. Please qualify and clarify what you actually mean.

dredmorbius 13y ago

Meta: QZ is utterly unreadable to me on both desktop and mobile. Fortunately there's Readability.

nether 13y ago
More meta: the article uses lowercase l to represent the digit 1.
- dredmorbius 13y ago
  Perl can do that in Underwood compatibility mode (obscure Perl Journal cover reference...).
tagawa 13y ago
Same here. I come to the comments first hoping for a non-QZ link.
jholman 13y ago
Plus, the entire article is blogspam. It should be flagged as such (edit: and resubmitted, since the letter itself is interesting). Actual letter (plus some other blowhard commentary) at: http://finance.fortune.cnn.com/2013/08/15/warren-buffett-katharine-graham-letter/ http://finance.fortune.cnn.com/2013/08/15/warren-buffett-kat...

maerF0x0 13y ago

and yet he himself is an example of exactly the opposite mentality. He has been an outlier manager for decades and would have been a great choice of manager for anyone he would take money from. He effectively takes new money whenever his holdings pay dividends and reinvests it successfully. Roughly speaking he's returned 100% (vs 50% for the Sp500) in 10yrs giving about a 7.2% return rate. He consistently beats the market and then claims that "managers" cannot.

redschell 13y ago
Buffett is an interesting character. From this article, it would appear that he sees himself as some kind of entrepreneur/investor/manager hybrid than as a pure money manager. http://dealbook.nytimes.com/2012/12/03/for-buffett-the-long-run-still-trumps-the-quick-return/ http://dealbook.nytimes.com/2012/12/03/for-buffett-the-long-... If you go on to read anything about activist investors, like Carl Icahn, you get the feeling that the only way to beat the market is to tamper with it.
marcosdumay 13y ago
Yep, but he does not invest on a fund.
MarkMc 13y ago
Not quite - I think his point was that money managers with very large sums to invest cannot beat the market. He made that claim almost 40 years ago, and more recently his own record clearly contradicts it. So perhaps he no longer holds such a view... Edit: It looks like Buffett had changed his view by 1984 [1]: "Size is the anchor of performance. There is no question about it. It doesn't mean you can't do better than average when you get larger, but the margin shrinks." [1] http://www.tilsonfunds.com/superinvestors.html http://www.tilsonfunds.com/superinvestors.html
- e12e 13y ago
  Or, perhaps the stock market doesn't reflect value, and insider trading (in one form or another) is the norm, not the exception?
- 13y ago

beefxq 13y ago

Tell that to the hedge fund billionaires. Oh wait, knowledge networks, I guess it's all just insider trading.

jmcgough 13y ago

This is why investing in an index fund is a great decision. When you rely on more active management, you pay higher fees, and your returns are likely to be about average (or worse). With an index fund you can take a healthy return, mitigate risk by diversifying well, and pay a fraction of the fee (which equates to hundreds of thousands of dollars over 30-40 years from the added growth).

aet 13y ago
Better yet, be the one charging the fees.

yumraj 13y ago

It's interesting that this article states "Buffett, then just 44 years old" while in the tech industry 44 years old is considered...

jlgreco 13y ago
I would expect similar language to be used if this were instead an article about something Donald Knuth said when he was 44. The "just" reflects the public familiarity with the 82 year old Buffett.

porter 13y ago

Warren Buffet also said: "I’d be a bum on the street with a tin cup if the markets were always efficient”

refurb 13y ago
I think one particular problem with the strong-form efficient market hypotheses is this: A stock should already be priced for all of the publicly available information. However, that information has to be analyzed and interpreted. That's the catch. "Today company XYZ announced their purchase of Chinese company ABC." There are probably many different ways to interpret that information. Maybe the purchase will result in increased profit, maybe it will bankrupt the company. Nobody knows. If all public information were easily interpreted, i.e. if X happens the stock will drop by 5%, then the markets probably would be efficient.
- jacques_chester 13y ago
  The EMH doesn't propose that participants have future knowledge. It says that current prices reflect current information and that in the long run, all participants regress to the mean.
  - eli_gottlieb 13y ago
    Well yes, but he's still correct. Not all participants accurately gauge what the available information means for their positions, and even for those who do, figuring it out takes time.

D9u 13y ago

I remember reading a quote from a top trading executive which went something like the following: "Only a fool plays the stock market without insider information."

robotcookies 13y ago

The title is incorrect because Buffett doesn't say playing the market is futile. In fact, he clearly states he believes a few will outperform due to skill (but that you can't distinguish which outperformers did so on skill versus luck). What he does say in the quoted part is that a large fund of say 20 billion likely can't outperform due to it's size. That is a big difference from saying that it's futile to play the market (since not everyone is trying to invest 20 billion). It's also similar to what other investors like Peter Lynch believed.. that smaller investors have an advantage over the large funds. This isn't made clear at all in the linked page. As far as I know, Buffett has always felt efficient market theory is wrong and that a few could beat the market on skill. There's also nothing in the linked quote that contradicts this (just the title that suggests it). So the title is clearly deceptive. It suggests that Buffett did not believe in investing skill at a younger age and only changed his stated beliefs after becoming a very successful investor.

gfodor 13y ago
To paraphrase Buffett it's quite nice to have your "opponents" be taught the efficient market hypothesis is a fact, you can't beat the market, etc since its essentially stacking the deck even more in the favor of skilled individual investors.
hsitz 13y ago
I mostly agree. But "playing the market" as its normally understood involves trying to make money on the market within a fairly short time frame, by buying low and selling high. I believe Buffett has many times said that the market is a casino in the short run (playing the market) but becomes an accurate "weighing machine" over the long run (buying and holding for five, ten years or more). E.g., http://www.youtube.com/watch?v=-aYEOsZgRm8 http://www.youtube.com/watch?v=-aYEOsZgRm8 So in that sense Buffett does think "playing the market" is a loser's game (that's played by "speculators", not "investors"), though I don't think that's specifically addressed in the linked letter.
jacques_chester 13y ago
> Buffett has always felt efficient market theory is wrong People often refute the EMH without understand that it is a family of hypotheses, from the Strong to the Weak form, with a great deal of subtlety in their concept and meaning. Buffet's argument in the linked excerpts is actually pretty close to a weak form of the EMH: all participants start with broadly similar information and capabilities, so performance naturally regresses to the mean. Here's my favourite discussion of the EMH: http://skepticlawyer.com.au/2013/05/29/bubble-trouble-all-information-is-not-equal/ http://skepticlawyer.com.au/2013/05/29/bubble-trouble-all-in...

nickff 13y ago

There is no evidence that mutual funds (or any other active managers) can outperform the stock market.[1] This can be explained by the strong form of the efficient markets hypothesis; "In strong-form efficiency, share prices reflect all information, public and private, and no one can earn excess returns." [2] [1] http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150_advanced_investments/Luck%20versus%20Skilll%20in%20the%20Cross%20Section%20of%20Mutual%20Fund%20Returns.pdf http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150... [2] http://en.wikipedia.org/wiki/Efficient-market_hypothesis#Strong-form_efficiency http://en.wikipedia.org/wiki/Efficient-market_hypothesis#Str...

jcnnghm 13y ago
The market is definitely not strong-form efficient. If it were, you wouldn't have any price movement attributable to earnings surprises, because the private information would already be priced in. More importantly, markets are only efficient because some people are researching and trading to the true underlying value. The whole reason markets are supposed to be efficient is because if they are not, there is an opportunity to make riskless arbitrage profit, which someone will exploit.
- nickff 13y ago
  Strong form efficiency does not imply perfectly predictive of all future events. Such a claim would imply that no durable good could increase in price at a rate higher than the federal funds rate plus some risk premium (haircut).

jholman 13y ago

I had a funny thought reading the letter (the actual letter at Forbes, not the vacuous qz.com summary). The letter is type-written, with nice tables and footnotes. That probably means that it was either hand-written by Buffet or by a secretary (or stenographed or whatever), and then given to a typist to format. In turn that means that some random lowly typist got to snoop on all this premium investment advice, that 20 years later would be becoming common wisdom. I wonder if she (I assume a typist in the 70s would be female) noticed and appreciated it, perhaps acted on it.

marvin 13y ago
Probably not. It's a sad fact that women are on average disinclined towards risk-taking, and investment is a classical risk-taking activity. This effect must have been even more pronounced in the 70s.

r0s 13y ago

The factor I think he missed: All those managers timing trades in their random way has a randomizing effect on the system overall. But I'm not an economist, any ideas if or how that influence manifests?

YokoZar 13y ago
In aggregate, it wouldn't much matter since randomness would cancel itself out. So broad index funds wouldn't see that volatility. At shorter scales, however, randomness like that would add volatility to individual stocks, so you'd see more random results for returns among small portfolios -- thus creating quite a few genuinely lucky fund managers.

deleted 13y ago

[deleted]

beambot 13y ago

Quoting from page 13: A further problem is that in no case were the superior records (returns) I have observed based upon institutional skills which could be maintained despite changes in the faces. Rather, the good results have been accomplished by a single individual or, at most, a few, working in fairly specialized areas in which the great bulk of investment money simply had no interest. So... he seems to predict a bleak future for Berkshire's returns after his departure as well?

ISL 13y ago
He's been planning for his retirement/demise for a very long time. He's pretty good at playing the long game, so I wouldn't bet against him.

gvr 13y ago

His point is that playing the market is "speculation", not investing. He differentiates this with "investing", where you simply try to assess the intrinsic value of a stock, and if the stock is trading at a significant discount to it, then you buy it. Further, once you've bought it, you keep it. You don't try to time the ups and downs of the market, buying moving and out of the position quickly. Since this is how Buffett likes to invest, one of his key principles is investing in owner-operators or people that are behaving as such. You want the executives of the company to treat it as if they owned all the stock and could never sell it. Because when you have the people running the company worrying about next quarter, you're not worrying about next decade. Also related, Buffett's two key rules to investing: Rule #1. Never lose any money Rule #2. Never break rule #1

rl12345 13y ago

I read all this 1975 dated letter and while I enjoyed every piece of it, this phrase contained in the very last page is what caught my attention the most: "Conventional approaches to money management should not be expected to produce above average results." It basically means that if you want to perform better than your competitors you logically should act differently from them. As in distancing yourself from the status quo. I can see this advice being spot on for startups as well, it has everything to do with thinking outside of the box and redefining the rules of the game. Good ole Warren nailed it decades ago.

deleted 13y ago

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d23y 13y ago

If what he says here is true, the parents of every kid on the planet should test their child for some aptitude in this area--at least a little--because learning your kid was preternaturally adept at, basically, "Making a Lot Of Money" would be the most important thing that ever happened to the kid. Also wouldn't it have been one of the most sensational "news events" of all time, if nothing else, when someone honestly reported Someone Has Found the One Weird Trick To Becoming Really Rich, And It Always Works If You Do It Right. The rise in billionaires I surely would have heard about, at least. So what's the catch? Why can't I just go and study this book and make a lot money if I think I'm smart, now that I've read this article?

lutusp 13y ago
> So what's the catch? The catch is that testing people for an unexplained adeptness at making money in equities is essentially certain to produce a handful of "successes" that arise from chance, not talent. Given a pool of ten million investors, all playing the market, and all making random picks, it is certain that a handful will succeed spectacularly because of chance. I know because I have modeled this sort of thing with computer programs, each of which produce "winners" simply by making random picks. With a large enough population, some will "succeed" spectacularly, through chance. Those successes will find it hard to accept that their success arose from chance rather than genius, just as happens in real life. > Why can't I just go and study this book and make a lot money if I think I'm smart, now that I've read this article? If there really was a book that contained secrets to beat the market, secrets that worked, that were reliable, that anyone could put into practice, businesses would abandon equities as a way to raise operating capital. After all, why should they line the pockets of a bunch of non-productive speculators? What possible incentive would they have? The only reason the equities market works is because investors get a fair return on their investment, consistent with the risks they take, and businesses get operating capital at a reasonable rate as well. Both parties to the transaction get a fair deal. All this talk about making a killing in stocks using "secrets of the winners" overlooks the fact that, if it were possible, if someone could really make a fortune by something other than blind luck, reliably, deterministically, the market would collapse. And for the life of me, I can't understand why people find this so hard to understand.

Mikeb85 13y ago

The title is misleading, but Warren Buffett is right. The more money you manage, the harder it is to beat the market as a trader. However, if you're playing with a modest amount of money, you can play the market, since moving small amounts of money around is much easier than say, 20 billion...

Pitarou 13y ago

I love this line: > Wall Street abhors a commercial vacuum. If the will to believe stirs within the customer, the merchandise will be supplied -- without warranty.