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Missing Warren Buffett

Numerous scholarly studies have documented the relative poor performance of professional money managers compared to the market averages, such as the Standard & Poor's 500. In essence, about 80% of professional money managers do worse than the main benchmark indexes. "'When someone says, 'I intend to beat the market,' the market he is talking about is not some neutered beast; it's the sum of all the smartest, toughest minds in this business," says Charles Ellis, the long-time pension and investment consultant. "When you come to market to sell, the only buyers you'll find are the ones who are thrilled that you just came into the cross hairs on their sniper scopes." Rex Sinquefield, a long-time finance maven, famously remarked: "There are three classes of people who do not believe that markets work: the Cubans, the North Koreans, and active managers." (It looks like Cubans are opening up more to markets, so in the future it may just be the two classes.)

Of course, the typical Wall Street response is to invest with the small number of actively managed mutual funds that do well over time. Some people do consistently beat the market. Look at Warren Buffett, the Sage from Omaha. Shareholders in his holding company Berkshire Hathaway have earned a compound average annual gain of 20.3% from 1965 through 2008. That's double the 10.3% performance of the main market benchmark, the Standard & Poor's 500-stock index--even after a disastrous 2008 for Berkshire Hathaway.

I'm not going out on a limb when I say conventional wisdom is right: Buffett is an investing genius. If you enjoy basketball like I do, he's the money equivalent of Michael Jordan, LeBron James and Kobe Bryant all rolled into one. He has what Sir Winston Churchill called "the seeing eye, the ability to see beneath the surface of things, to know what is on the other side of the brick wall, to follow the hunt three fields before the throng." Still, there's a mystery at the core of what Buffett does. His investment methods and philosophy are well known. He lays them out in clear language and folksy anecdotes in his widely-read annual letter to shareholders. His exploits have been covered in depth over the years in books, magazine articles and newspaper profiles. Yet he still leaves everyone else far behind in the investment sweepstakes.

Yet there's a critical element to what he does that even he can't explain. Nobel laureate Paul Samuelson says that John Maynard Keynes--himself an astute investor--once said, "Really, you should buy one stock at any one time. The best one going. And when it's no longer that, replace it by the new best." Well, silly as those sentences sound it pretty much sums up what Buffett has done in the postwar era. It's a trick few of us can emulate.

The question is, can you pick the next Warren Buffett to manage your money when he is just starting out in the business? Who among the thousands upon thousands of men and women just starting their professional careers managing money in mutual funds, managed accounts or some other type of investment vehicle will be the next Buffett? The odds are that at least a handful will consistently beat the market over the next half century and that if you invest with him or her in their 20s you'll pocket a handsome sum of money by the time they reach their 60s. But who? The boilerplate is right: Past performance is no guarantee of future performance. It's as hard--if not harder--to pick the next superstar as it is to choose a stock that will soar in value year after year.

One of my favorite stories is about Warren Buffett. Somebody had moved to Omaha, and a neighbor came by to say hello. He had big glasses and wore a well-worn suit. He asked if the neighbor wanted to invest with him. He managed some money. Well, there was no way he was going to invest with this unpreposssing person.

That person was Warren Buffett. If he had invested with him he would have been a millionaire several times over.

I was reminded of this story the other day when I was searhing through some old emails. I came across this one. I had told this story on the radio:

Hi Chris,

.... I enjoyed your Warren Buffett anecdote about the neighbor who turned Buffett's investment proposal down. From reading Roger Lowenstein's marvelous book, "Buffett: The Making of an American Capitalist", I can tell you that the neighbor may well have been Tom Keough, who later became President of Coca Cola. Keough was a neighbor of Buffett's in Omaha for a short time in the late 1950's, and according to Lowenstein declined Buffett's invitation to join the Buffett Partnership. But so did a lot of other neighbors and friends...

For most of us, indexing is the way to go.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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