Warren Buffett, the legendary investor behind Berkshire Hathaway, has built a reputation for market-beating returns.
Yet, recent performances have sparked a debate:
Can even the best beat the S&P 500 over the long term?
This question reveals deeper truths about investing in today’s dynamic landscape.
Since 1965, he has delivered an average annual return of 20.8%, significantly exceeding the S&P 500’s 10.5%.
However, while Berkshire’s stock price has kept pace with the S&P 500 in the last two decades, a shorter view paints a different picture.
Over the past three years, Buffett’s Berkshire has posted a 26% return while the S&P 500’s return is nearly 40%.
Why is Buffett struggling to beat the S&P 500?
- Berkshire’s sheer size: With a market capitalization exceeding $600 billion, finding undervalued companies capable of significantly moving the needle becomes increasingly difficult.
- Market efficiency: Information disseminates faster and companies become more transparent, opportunities for significant undervaluation shrink. Even seasoned investors like Buffett find it harder to unearth hidden gems.
Interestingly, Buffett himself acknowledges the increasing difficulty of outperforming the market and recommends S&P 500 index funds for long-term investors.
“In my view, for most people, the best thing to do is to own the S&P 500 index fund,” Buffett wrote in the 2020 Berkshire Hathaway shareholder letter. There are many S&P 500 ETFs, including a couple of the largest: iShares Core S&P 500 ETF (IVV) and SPDR S&P 500 ETF Trust (SPY).
The biggest factor is the power of simplicity—let’s explore why:
Diversification
The S&P 500 offers instant diversification and exposure to a broad range of industries. And similar index funds offer exposure to a broad basket of established companies, reducing the risk of missing out on hidden winners while minimizing the danger of picking future losers.
Cost-effectiveness
Actively managed funds and stock picking can come with high fees, eating into returns over time. Index funds, passively tracking an index like the S&P 500, offer significantly lower fees, allowing investors to keep more of their gains.
“Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation…Investors, on average and over time, will do better with a low-cost index fund,” Buffett wrote in his 2016 letter.
Accessibility
Index funds are readily available through most investment platforms, making them accessible to everyone, regardless of their investment knowledge or experience. This democratizes investing, allowing even first-time investors to participate in the market’s growth potential.
Emotional discipline
Actively picking stocks can be emotionally driven, leading to impulsive decisions and poor timing. Index funds remove the emotion from investing, encouraging a buy-and-hold strategy proven to be beneficial over the long term.
Bottom line
The debate around Berkshire Hathaway’s recent performance is a valuable reminder that even the most skilled investors face challenges in navigating the ever-evolving market.
“There are a few investment managers, of course, who are very good – though in the short run, it’s difficult to determine whether a great record is due to luck or talent,” Buffett said in his 2014 letter.
Buffet is no doubt a great talent.
But chasing the next “Buffett” seems like a very unfruitful venture in today’s market. Instead, adopting a balanced, long-term perspective is a better strategy.
You don’t have to take a purely passive approach. Investors can combine index funds with individual stock picks based on their risk tolerance and investment goals, creating a more tailored portfolio.
