Warren Buffett’s Biggest Mistake

Warren Buffett recently said the worst mistake he ever made was buying New England textile business “Berkshire Hathaway” in 1962.

Perhaps that was his worst mistake, but we think something else is Warren Buffett‘s biggest mistake.

hedge funds vs. mutual funds

He started his career as a hedge fund manager by charging his clients a 25% performance fee above a 6% threshold. The arrangement helped him accumulate 24% of his hedge fund’s assets in 13 years. Later, he stopped the fee schedule and began to work virtually for free for his clients. If one considers that portfolio size actually drags on performance, Warren Buffett may have essentially paid out of pocket to manage other people’s money.

But that’s not the biggest mistake he ever made. He essentially prevented $100 Billion of his own net worth from being donated to the public.

Warren Buffet was a hedge fund manager with over 32% annual returns and 19% annual alpha between 1957 and 1968. He generated that alpha by working hard. He was due his fair share for that. Meanwhile, Warren Buffett’s investors weren’t penniless either; they were millionaires who owed most of their wealth to Buffett.

A hedge fund manager is technically a laborer. Economic calculations show that the historical average share of labor in economic output is about one-third. The remaining two-thirds belongs to the capitalists. So, it would be quite normal for a hedge fund manager to demand one third of the profits for his labor. Since the market wasn’t so competitive in the early 60′s, Buffett may have been able to demand more than a third, considering his investors probably had no better alternative.

Insider Monkey, your source for free insider trading data, calculated Warren Buffett’s hypothetical earnings if he were to have charged a 25% performance fee above a 6% threshold. We also assumed a high-water mark, i.e., Warren Buffett would not start collecting performance fees until he recoups his losses from previous years. For example, in 1958 the Dow Jones returned 38.5% and Buffett’s hedge fund returned 40.9%. After excluding the 6 percentage points (the threshold) of the 40.9% return, we are left with 34.9% of return that is subject to the performance fee. Twenty-five percent of the 34.9% goes to Warren Buffett for his services, which is 8.725 percentage points. So Buffett’s clients would have gotten a net return of 32.175%. This is what Buffett meant when he was criticizing hedge fund managers for charging fees when the markets are rising. Buffett had an average alpha of 19% between 1957 and 1968. This means that he owed 21.9 percentage points of the 40.9% return to the overall rise in the market. In one sense, he was criticizing what he did 50 years ago.

What was good about Buffett’s performance scheme is that he didn’t charge any performance fees if his performance fell below the 6% threshold. So, had Buffett returned -10% in a year, he wouldn’t have charged any performance fees that year, and he wouldn’t have charged any performance fees the next year until he recouped all of the previous year’s losses.

Warren Buffett Hedge Fund Performance Fees

 

Based on the compensation scheme described above, Buffett would have ended up owning 78.75% of Berkshire’s stock -  3 times more than what he owns right now. We assumed that Buffett owned 24% of Berkshire at the beginning of 1977. That means Buffett would have been more than 3 times as rich as he is today. If only he hadn’t worked for free for the past 33 years…

On the other hand, if you think Warren Buffett gave most of his wealth to poor people, you are mistaken. As you can see from the above calculations, Warren Buffett and his unbelievable alpha gave 70% of his wealth to other extremely rich people – Berkshire Hathaway shareholders.

Warren Buffett supports the notion that the extremely wealthy (people like he) should donate most of their wealth to serve the greater good. But by working for free for nearly 33 years, he saved his wealthy clients nearly $100 Billion, the same $100 Billion that he could have donated as part of his master (and truly genius) plan.  That’s Warren Buffett’s biggest mistake ever.

Previous Warren Buffett Article:
Did Warren Buffett Hire Todd Combs Because David Einhorn Was Too Expensive?

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

10 Cities with High Demand for Nurses

6 of the Worst Greeting Card Messages Ever Crafted

6 Ways to Make Money in ArcheAge and Build Your Empire

10 Foods To Eat To Lower Cholesterol Levels

The 10 Most Hated Television Characters of All Time

The 30 Worst Halloween Costume Ideas Ever Brought to Horrible Life

10 Vocational Skills in Demand Today with Jobs Waiting to be Filled

10 Best Places to Visit in Central and South America

The 10 Greatest Empires in History Which Nearly Conquered the World

The 6 Cheapest Boarding Schools In America 2015

5 Clear Reasons LoL is Better than DotA, Continues to Rule MOBAs

The Only 9 Teams with a Chance to Win the Super Bowl

The 15 Most Common Phobias in America that Induce Fits of Panic

Top 6 Least Expensive Tourist Destinations in 2014

Jim Goetz, Peter Fenton, Jim Breyer: Top 6 Venture Investors for 2014

Top 15 Billionaires in 2014

5 Pitfalls To Avoid When Buying a Franchise

Top 20 Medical Schools in the US – 2014 Rankings

4 Business Strategies that Turned Jamie Oliver into the World’s Richest Chef

6 Qualities That Make You A Good Team Player

10 High Paying Seasonal Jobs in America this Holiday Season

The 10 Busiest Shipping Lanes in the World

5 Most Valuable Brands in China

The 10 States with Highest Substance Abuse Rates Crippling Their Populace

The Top 10 Things to Do Before You Die That Will Echo for Eternity

The 10 Best Selling Items on Etsy

Top 10 Things to Do in Tokyo, the Greatest City in the World

10 Mistakes on Social Media that Can Harm You and Will Probably Get You Canned

The 10 Best Cities to Find Jobs in 2014

The 10 Most Controversial Songs Of All Time to Hit (and get Banned from) the Airwaves

The 20 Biggest IPOs in US History

The 10 Best Places to Visit in Mexico that Are Beautiful and Safe

7 Bad Habits that Age You Beyond Your Years

The 40 Best Fortune Cookie Sayings That Will Leave You Bemused, Befuddled, or Beguiled

10 Foods to Eat Before a Workout to Make Every Drop of Sweat Count

The 5 Best Documentaries On Netflix You Must See

The Most Heartwarming and Inspirational Story Of This Halloween Season, It Will Make You Cry and Jump For Joy

10 Best Party Songs of All Time to Bring the House Down With

5 New World Order Conspiracy Theories that Will Strangle the World

The 10 Highest Rated Movies of 2014

The 10 Largest Container Shipping Companies in the World

The 10 Largest Armies in the World: Who Should We Be Afraid Of?

Best Warren Buffett Quotes on Money You Need to Hear

The 10 Highest Suicide Rates by Profession

The 20 Most Underrated Movies of All Time

The 10 Fastest Growing Companies in America

The 10 Biggest Outlet Malls in USA

The 5 Most Popular Rap Songs of All Time

The 10 Countries that Eat the Most Meat

The10 Most Expensive Countries to Fly To

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!