Buffett may be your best investment

Many investors can only look on with envy when Warren Buffett notes how his shareholders have seen an average of 20% annualized gains over the past 45 years. Even the best mutual funds pale by comparison.

 

In fact, only two funds are even on the horizon: Fidelity Magellan Fund (FMAGX), which has returned 16.3% a year, on average, during Buffett's chairmanship of Berkshire Hathaway (BRK.A, news, msgs), and Templeton Growth Fund (TEPLX), up 13.4% a year, according to investment researcher Morningstar.

 

Berkshire's Class A shares have delivered returns of 22% a year since 1965, based on market price, though Buffett prefers to judge gains according to book value, which stands at 20.3%.

 

Using Berkshire's market-price gains for fairer comparison with mutual funds, $10,000 invested with Buffett on Oct. 1, 1964 -- equivalent to about $60,000 in today's dollars -- would now be worth about $80 million.

 

The same amount in Fidelity's fund would have grown to about $9.1 million, while Templeton Growth investors would now have roughly $2.9 million.

 

The returns covered the 45 years through the end of 2009. During that period, the Standard & Poor's 500 Index ($INX) was up 9.3% on an annualized basis, on average -- meaning $10,000 would have grown to nearly $560,000. There were 145 mutual funds at the start of 1965.

 

The varying dollar amounts highlight the power of compound interest, where seemingly small differences in percentage points over a number of years can mean dramatic differences in what investors can earn.

 

Buffett has more structural freedom than mutual fund managers, so comparing their performance isn't apples to apples. But the differences also highlight the limits of mutual funds and particularly the short-term pressures that most managers face.

 

"Throughout his tenure, he's been a huge proponent of investors thinking of themselves as owners of companies rather than investors, (which fits his) extremely long-term approach," said Jonathan Rahbar, a mutual fund analyst at Morningstar, about Buffett.

 

"Mutual fund managers have incentive to do well on a year-in, year-out basis. If things don't go well for a year or two, they'll see outflows," Rahbar added. Outflows are investors and their money leaving a fund.

 

Fund ratings companies such as Morningstar might be part of this problem, Rahbar conceded, though he said his company focuses more on long-term performance. But according to one Buffett investor, the structure of the fund industry makes it harder to invest as he does.

 

"Mutual funds have to sell to institutions, who lump them into style boxes and expect them to be fully invested," said Timothy Vick, a senior portfolio manager at Sanibel Captiva Trust. "And those institutions review a manager quarterly, and they change some managers every year."

 

Short-term pressures lead many fund managers to trade frequently as they seek to gain an edge -- the average fund turns over its portfolio every year, according to Morningstar -- the antithesis of Buffett's approach.

 

Vick, the author of the book "How to Pick Stocks Like Warren Buffett," said his company typically wants portfolio turnover of no more than 10% to 15% -- holding a stock for eight to 10 years. Of the fund industry's 100% turnover average, he says, "it's like a gambling den."