Warren Buffett versus Modern Portfolio Theory

In this Ask The Expert With Larry Swedroe article, Zapp challenges the legitimacy of Modern Portfolio Theory citing Warren Buffett as a rule breaker.  So which is it, Modern Portfolio Theory or Warren Buffett? Here’s the question from Zapp:

Other than by taking the self-denigrating stance: “I am not an above average investor”, how can a person justify support of modern portfolio theory when there is a Warren Buffett in this world?

Answer From Larry Swedroe

That is an easy question to deal with. First, with thousands or millions of investors we should expect some to outperform the market every year and some to do so for many years, randomly. The question is: Is there any more persistence of performance than would be randomly expected. The evidence from hundreds of academic studies is there is not.

Warren Buffett Is Not Your Typical Investor

Another answer to the question is that Warren Buffett is not the typical investor. He is not like a mutual fund manager. He often buys companies and then manages them. He provides them with economies of scale, lower cost of capital and the benefits of his managerial wisdom. And when he takes large positions in companies he often gets a board seat. So perhaps his great returns are more a result of his managerial skills than his investment skills, or some combination of both.

Berkshire Hathaway Performance Versus General Market

When I got this question a few years ago I went to do a simple check on the performance of Berkshire Hathaway for the prior ten year period and then compared it to the five major U.S. asset classes of large, small, small value, large value and real estate. During that period BRK had underperformed all but the asset class of large stocks (as represented by the S&P 500) and had underperformed an equally weighted (20% each) portfolio of the five that was rebalanced annually by several percent.

So we know that Buffett had delivered great returns in the past but we don’t know that he will in the future. In fact, during that ten year period BRK underperformed. So now what would you forecast regarding the future?

Who Is The Next Warren Buffett?

The issue is this, we know that there will be some investor who produces “Buffett-like” returns in the future. The problem is we cannot identify them today. Unfortunately we can only buy tomorrow’s returns, not yesterday’s. And finally, what I tell investors is this: If you look in the mirror and you see Warren Buffett, go ahead and try to beat the market by picking stocks. But there is only one person who when he looks in the mirror sees Warren Buffett. The rest of us should simply accept market returns. If you do so you are virtually guaranteed, if you have the discipline to stay the course, to outperform the vast majority of investors, both individual and institutional.

By the way, What Wall Street Doesn’t Want You to Know contains a section called “Buffettology or Mythology” which addresses your question. Also, Wise Investing Made Simple contains the tale “When Even The Best Are Not Likely to Win the Game,” which indirectly addresses you question by looking at the results of large institutional investors who have access to the great money managers.


  • Mr. Swedroe’s opinions and comments expressed are his own, and may not accurately reflect those of the firm, nor Moolanomy and its owner.
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About the Author

By , on Feb 22, 2009
Larry Swedroe
Larry Swedroe is a principal and director of research at Buckingham Asset Management, LLC, an SEC Registered Investment Advisor firm in St. Louis, Missouri. He is also principal of BAM Advisor Services, LLC, a service provider to investment advisors across the country, most of whom are affiliated with CPA firms. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management or BAM Advisor Services. Before joining Buckingham in 1996, Larry served as senior vice president and regional treasurer at Citicorp and vice chairman of Prudential Home Mortgage. Larry is author of The Only Guide to a Winning Investment Strategy You'll Ever Need (updated and re-released in 2005), as well as six other books. Most recently, he authored The Only Guide to Alternative Investments You'll Ever Need (2008). Larry has started his own blog called Wise Investing at CBS Money Watch. Please check it out!

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Leave Your Comment (28 Comments)

  1. Larry Swedroe says:

    I give up.The evidence is important as these are NOT short periods. They are fairly long periods and it shows exactly what the literature shows–that even skilled based performance erodes–and you even have the hindsight of knowing how good his performance has been. We could go back and find many other examples of long success followed by miserable failures. Bill Miller is the perfect example–Fortune declared him greatest money manager after beating market 15 years in a row, something Buffett never did. Over and next three years he underperformed by 10, 12 and 18 %. So was he lucky or did he just take stupid pill three years ago?

    Pension plans and others all try to hire the next Buffett based on long positive records, yet they fail miserably. That is what the evidence shows–the markets are highly efficient.

    And BTW–if Buffett was so good why was he unable to outperform a simple passive asset class fund for the last 13 years?

    Since I have nothing more to say that will be my last comment on this subject anyway.

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