What makes Warren Buffett’s investment legacy so iconic, and how has his advice shaped the world of investing? In this episode, we delve into Warren Buffet's investment philosophy and the lessons he offers everyday investors. In our conversation, we unpack the impact of his investment strategies on the financial world, debunk common misconceptions, and discuss how his strategies have changed over time. We also examine the structural barriers to replicating his success, the complexities of scale and changing market dynamics, and the parallels between his approach and modern asset pricing models. Discover Warren Buffett’s astonishing historical returns, his perspectives on diminishing returns for active managers, and the misunderstood nuances of his advice regarding index funds. Gain insight into academic research on Warren Buffett’s success, his pragmatic view on cash holdings, and his opinion on the value of dividends for investors. Tune in to learn about the world's greatest investor and how you can apply his wisdom to your own portfolio!

Key Points From This Episode:

(0:04:55) Warren Buffett’s legacy and Berkshire Hathaway's performance history.

(0:13:04) The problem of diminishing returns to scale and finding skilled active managers.

(0:18:37) Reasons Buffett repeatedly advises most investors to choose low-cost index funds. 

(0:23:14) Why identifying skilled managers before they outperform the market is impossible.

(0:30:15) Research explaining Buffett's success using multi-factor asset pricing models.

(0:35:30) Insight into why Berkshire Hathaway holds large cash reserves as part of its strategy.

(0:44:02) Buffett’s views on dividends and why his focus remains on reinvestment.

(0:48:16) Why diversification concentration is a bad strategy and Buffett's investing superpower.

(0:57:07) Aftershow: Ben’s experience of being on The Wealthy Barber podcast.

(0:58:07) Reviews and feedback from the episode with Randolph Cohen and Michael Green.

(1:04:58) Changes to our year-end episode format and what listeners can expect.

Read the Transcript

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from three Canadians. We are hosted by me, Benjamin Felix, Chief Investment Officer at PWL Capital, Dan Bortolotti, Portfolio Manager at PWL. Capital, and Mark McGrath, Associate Portfolio Manager at PWL Capital.

Mark McGrath: Welcome. Episode 335.

Ben Felix: 335. That's it.

Dan Bortolotti: Let's do it.

Ben Felix: Yeah, let's do it. I think this is a cool topic. We're going to talk about Warren Buffett. That's the meat of the episode. Then in the after-show, we'll chat a little bit about the Mike Green and Randy Cohen episode, which got lots of interesting responses from listeners. Before we get into the show, I do want to mention that we have a webinar coming up on December 17th at 12 pm Eastern time. We're calling it CPP by the Fire. It's a fireside chat about CPP insights into your Canadian Pension Plan.

Mark McGrath: Canada Pension Plan.

Ben Felix: Yeah, Canada Pension Plan.

Mark McGrath: I always say Canadian Pension Plan, and my friend on Twitter always corrects me that it's Canada Pension Plan, not Canadian Pension Plan, Ben. So, I'm trying to make sure I get that right.

Ben Felix: Yeah. When you get stuff wrong on Twitter, you're always corrected quickly.

Mark McGrath: Oh, absolutely.

Ben Felix: It's the place to get corrected.

Mark McGrath: I mean, I don't know. I never get it wrong.

Ben Felix: Yeah, I know. Not you. For me, though. It's different. The webinar is hosted by Braden Warwick. You've probably seen this stuff before, just through PWL.'s channels. He's built this incredible tool, which I guess, we're also announcing right now. He's built a CPP tool that does detailed CPP projections. You put in all of your past earnings and any periods of disability, any periods of child-rearing, and it calculates your projected CPP benefit, but it does it in a way that's more detailed, as far as I know, than any other calculator that's out there right now. The big thing that it's doing that the existing CPP calculators are not is it's adjusting for the effects of wage inflation relative to CPI inflation, which are two different numbers that have different impacts on CPP benefits.

The outputs that it gives, I think, are also framed in a way that's more useful for decision-making about CPP. Some of the common outputs that are out there showed a break-even analysis, which is how long you'd have to live for taking CPP at a certain age to make sense. Instead, ours shows what's called the lifetime loss, which is at different ages, how much you expect to lose out on by taking CPP earlier. There's research showing that when you present people with break-even ages, it makes them more likely to take the benefit earlier with the outputs that we have, or I think more conducive to good decision-making. Anyway, so Braden built that tool.

Dan Bortolotti: It's so interesting, how if you phrase a question in two different ways, basically the same thing, but expressed as a loss versus gain, people make the opposite decision. It's very powerful for us as planners, not that we want to be manipulative, but to help people make better decisions, you have to frame questions in a way that they find intuitively satisfying.

Ben Felix: Totally. Braden spent a ton of time building this tool, really digging into how CPP works to build the software, obviously. He's going to be sharing a bunch of insights both from what he's learned about CPP, but also, just little bits and pieces that you pick up by running different scenarios in this tool. Target audience for the webinar is near-retirees, probably useful for anyone, but near-retirees who are curious about their CPP benefits. It'll be particularly relevant for young professionals that are maybe helping their parents make CPP decisions could also be irrelevant.

From what we're seeing, a lot of financial advisors are finding this tool to be quite valuable. I know Adam, who runs Parallel Wealth, which is a family planning firm. He did a video doing a walkthrough. He didn't ask him to do this. He sent it to me after it was done, and said, “I'm going to post this.” He calls it the best CPP tool that's out there right now and does a whole walkthrough showing different features and scenarios. I was like, wow, that's really cool that he did that. People can watch that video if they want as well to see how the tool works, but then, of course, we'll also walk through it on this webinar.

Anyway, so that's Tuesday, December 17th, 2024, 12 pm. Eastern time. We'll post a link to sign up on our socials, hopefully, by the time this episode is out. Anything else before we jump into the episode, guys?

Mark McGrath: It'll be a good webinar. Braden is obviously brilliant. The tool's amazing. CPP is such a controversial topic because people like to simplify it to, “I could get better returns if I invested the money.” It is so, so much more complex than that. I fight people online about CPP all the time. What I will say is the people who understand CPP at a very, very deep level, I've yet to find somebody who understands CPP as well as somebody like, say, Braden, who also thinks it's a bad deal. I would encourage people who are really skeptical, or anti-CPP to sign up and listen to this because if nothing else, I think you'll get a different perspective on it.

Ben Felix: That's a great point. All right. Let's go ahead to the episode.

***

Ben Felix: All right, here we go. Episode 335. Our main topic today is what I've titled, "What About Warren Buffett?" As a rhetorical question as the title. I always get this question. I don't know about you guys, but I always get this question, when I'm talking to someone that doesn't follow our content, that maybe is newer to the concept of index investing is used to active management and all that stuff. As soon as I start talking about why index investing might make sense, I'm almost always met with the question of, "Well, what about Warren Buffett? If what you're saying is true, what does Warren Buffett's outcome tell us?" The premise of the question is, really, that if it's possible to beat the market to the extent that Warren Buffett has, and he's done it for longer than I've been alive, then why would anyone settle for market index returns when you could just invest in Berkshire Hathaway? Buffett's beating the market. Why would you settle for index funds?

Dan Bortolotti: It's certainly an objection that I've heard many times. The fundamental misunderstanding is index investing is the best strategy for most people, because it is always 100% impossible to beat the market. No one who knows what they're talking about would ever say that. Why do you think Warren Buffett is so famous? It's because he's the exception that proves the rule. We were knocking back and forth when we were preparing for the episode. It's really not much different from saying, "Of course, my nine-year-old is likely to play in the NHL. I mean, Wayne Gretzky played in the NHL. He was really great." Okay. The two cannot be connected. It's a weak argument, but there's a lot of subtleties that we'll get into today.

Ben Felix: It is a weak argument, but it's so common and it's so, I think, casually appealing, because Buffett's so well-known. Everyone's heard of him and everyone knows his investment philosophy-ish roughly. They think, “Well, I can just do that, if Buffett can do it.” But yeah, the Wayne Gretzky analogy is perfect.

The other thing that I find really interesting about this topic is that a lot of people claim to be students of Buffett. They claim to have read The Intelligent Investor, like Buffett has. They're going to look for undervalued stocks and all that stuff. If you actually listen to what Buffett says, I don't think that you would think that's what you should be doing. I think people if they do listen to Buffett, or if there are students of Warren Buffett, I think that they probably listened to him very selectively, at least based on what I see people saying online and elsewhere. I personally do read Buffett's shareholder letters every year. I think they're incredible. I think that he's very wise and has lots of very intelligent things to say. I also try and listen in on the annual meetings. They can be pretty long. If I don't listen, I'll read the transcripts afterwards, or at least skim through them.

I don't want to diminish Buffett's wisdom. I think he is incredibly wise. I think everybody should study what he says and what he does, but particularly what he says. Talk about why that distinction is important later. I think there's a lot of selective listening that happens when people use Buffett as a justification for not investing in index funds, or for being an active stock picker.

Dan Bortolotti: I would even take that a level further. I think as most people know, Warren Buffett's teacher was Benjamin Graham, who wrote a major textbook that's still read today. I think it was written in the 30s. Even Benjamin Graham later in his life, 40 years after that book was written, I found a quote from him in an interview where he basically said, “That all made sense in the 1930s, but these days,” by which he means mid-1970s, “the market has changed a lot. If it was possible to simply buy the market at a very low cost, well, you probably should.”

Of course, at the time, index funds barely existed. Certainly, weren't available to retail investors. Even the grandfather of value investing at the end of it said, "Markets are a lot different." That was 50 years ago. I can only imagine how they have become even more efficient since then.

Ben Felix: Yeah. It's super interesting. I was digging through old articles in the Journal of Portfolio Management. I just searched for index fund and looked for articles in the 1970s. Man, the academic debate in that journal about index funds at the time was crazy. Because now, it's generally accepted that index funds make sense for most people, at least in an academic sense. Back then, people were going back and forth about why they didn't make sense, or why they couldn't possibly make sense theoretically, and it's just fascinating. That time in the 1970s was definitely a period of changing thinking around that topic.

Dan Bortolotti: Well, nobody was slapping John Bogle on the back when he created the first index fund around that time. There wasn't all that many people saying, “John, what a great idea. Why don't we all do this?” They mocked him, as we know and 50 years later, he's been fully vindicated.

Mark McGrath: The other thing about Buffett that makes it very easy to listen to him selectively is he's such a great writer and speaker, and he's so quotable, 80% of all of the great investing quotes out there are Buffett.

Dan Bortolotti: It's so true.

Mark McGrath: Because he's so popular and so famous and his quotes show up in the news all the time, I think as investors, it's just so easy to just grab the ones that confirm your own biases and then use that to build your framework around, “No, I'm a student of Buffett.” To your point, Ben, they're not actually studying all of his shareholder letters and trying to actually mimic Warren Buffett. They're just using those quotes as ways to confirm their own behaviour.

Dan Bortolotti: It's a great point.

Ben Felix: Why are we talking about Warren Buffett? Since he took control of Berkshire Hathaway in 1965, that stock has returned an annualized 19.8% through the end of 2023. This is just from their last annual report, which nearly doubles the return of the S&P 500 over the same period. That's nuts. Over such a long period, over so many years that difference in annualized returns has resulted in enormous wealth for anyone who held. I can't remember what the cumulative return difference is, but it's ridiculous, multiple orders of magnitude, because it's such a long period.

I mean, it's obvious why you see that outcome. It's like, okay, well, I want that. I don't want the index return. Something that people don't realize, and I think, Dan, you might have mentioned that you didn't realize this either, is that Buffett has more recently, and I don't mean the last five years. For the last 22 years, Berkshire has underperformed the US market, the index, an index fund.

Dan Bortolotti: That definitely surprised me. I know that his early performance was better than his later performance. I had not realized it was a 22-year period of underperformance now.

Ben Felix: It probably surprised me, too, when I went and looked that up. I do want to reiterate that that's not a knock against Buffett. Buffett's incredible. We'll talk about why skilled managers don't necessarily always beat the market in the long run later. I definitely want to be clear that I'm not trying to be disrespectful of Buffett, or dismissive of what he's done, which is completely incredible. A reality that's important for this discussion is that Berkshire Hathaway has underperformed a Vanguard US equity index mutual fund, which is net of fees for 22 years, ending last of my update with the numbers, October 2024. I'm pretty sure that carries through to November as well.

Mark McGrath: Despite that, his performance from ’65 to 2023 is still 19.8%, nearly doubling the S&P 500. To your point about his earlier performance being just outstanding, even though he's underperformed for 22 years, it is still an unbelievable long-term return for Berkshire investors.

Ben Felix: Totally. Be interesting to see money-weighted returns, because obviously, he's managing more capital later, as we always often see with active managers that people tend to invest after the great performance. I don't know if we have that data. Buffett's aware of this. Of course, he is. He's brilliant. He knows that they've underperformed, and he was asked about it at a 2020 shareholder meeting. He tells a great story, as he always does, talked about how his best year ever managing money was in 1954, when he says in his words that he was managing peanuts, managing a relatively small amount of money.

He talks about how it's gotten harder to outperform with larger amounts of money. Berkshire's huge. It's a massive company. He actually explains in that part of that answer at the shareholder meeting that his advice to most people is just to invest in S&P 500 index funds. He talks about how he does believe that Berkshire is still a solid investment. Of course, he does. He also said he would not bet his life on whether they'll beat the S&P 500 over the next 10 years. Talk about how humble Buffett is. It's pretty incredible.

The other thing that he says in this answer that I find really interesting is that, well, there may be a few managers out there in Buffett's view, they can beat the market. It's really hard for anybody to identify them before the fact. The problem is, as with Buffett and Berkshire Hathaway, once it's obvious that they're good managers, they're going to run into the exact same problem. As we're talking about with Buffett and Berkshire, which is they get too large to continue their high performance. I think that's really the crux of problem in active management. There's this issue of diminishing returns to scale.

There can be skilled managers and there are skilled managers. If you talk to mutual fund managers or hedge fund managers, they're typically brilliant people. But that's not the problem. The problem is assets flow to skilled managers, which gives them larger and larger funds, which makes it harder for them to beat the market in the future. As with Buffett, yes, he's brilliant, yes, he's a great investor, yes, he was able to beat the market. But because Berkshire's gotten so large, that does not mean that he's going to continue beating the market forever.

Dan Bortolotti: Well, and as you said, Ben, the fact that Buffett is brilliant, or the top mutual fund managers are all brilliant, that isn't the problem. But it is the problem because they're all brilliant and they're all competing against each other. I'm sure Buffett would be the first one to tell you, it’s the Babe Ruth issue. I don't know how many people know baseball history, but when Babe Ruth was playing, he was so much better than everyone else. It was ridiculous. He out-homered entire teams, which is something that's inconceivable today. There isn't the same gap in skill between Buffett and his peers in 1954 and Buffett and his peers in 2024.

Ben Felix: The paradox of skill. As a talent pool gets more and more skilled, it gets harder and harder for anybody to outperform, which also speaks to Ben Graham's point that you mentioned earlier, Dan, about how in 1930, if you were really good, there weren't that many other really skilled managers and maybe you could do security analysis.

Dan Bortolotti: It was the Wild West back then, right? If you were one of the few people who had the skills of Benjamin Graham, you did great. But now that we have hundreds of thousands of people who have not only his skills but access to resources that he could have never had, the advantage just goes away.

Ben Felix: This point is made in a highly cited 2004 academic paper by Berk and Green. We had Jonathan Berk on the podcast and did talk about this paper. The authors describe an efficient market for manager skill. They basically suggest that investors will identify skilled managers based on their past performance and they will allocate to those managers up to the point that the manager can no longer beat the market. The result is that the most skilled managers have the largest funds, but their investors just earn returns in line with the risk that they're taking, probably less than fees, which of course, they could do much cheaper with an index fund.

Finding the rare, good active managers before they become too big, which is really what the key is here. It's like picking a stock. If you find a company that's really good that the market hasn't priced as good yet, you can buy that stock in profit. If you find a manager that's really good, but the market hasn't identified as good yet, therefore, they have a small fund, you can probably profit by investing with them. But that's not so easy. Finding them before the fact is not so easy. Then finding them after the fact, after they've delivered the returns, well, now everybody knows about it, and their fund is going to get large to the point where this issue that we're talking about becomes problematic. That's one thing. Diminishing returns to scale, that's a big problem.

Now, the other one that is interesting to think about, separate from diminishing returns to scale, is that by the time an active manager has a sufficient track record to prove that they're skilled, there's a good chance that they're close to retirement. Human lifespans are limited. Even if you find a really good active manager that nobody else for some reason has identified, by the time you identify them, by the time they have enough performance to say, “Hey, they're really good,” they're probably going to not want to work that much longer.

Buffett's obviously an anomaly. He's 94 and still working. But he has brought on successors. He’s not going to live forever. Ted Weschler and Todd Combs are the heir apparent at Berkshire. I have no doubt that they're brilliant. They were money managers before Buffett hired them. The interesting thing is they've both trailed both Buffett and the market since they've been managers at Berkshire.

Mark McGrath: It seems so obvious though, if it was easy even for skilled managers to identify the next skilled manager, we would have perpetual outperformance on certain funds. It would just show up as these funds continuously and persistently always beat the market because skilled managers can name the next skilled manager. We just don't see that. It's obvious that even people of Buffett's calibre have difficulty, great difficulty naming somebody who can perform to the same level that their investors have come to expect.

Dan Bortolotti: Another aspect to this too, and I would say this is not the case with Buffett, who, Ben, as you said, is an extremely humble guy, given his phenomenal track record. But there are a lot of cases of managers who have had some great success for a number of years and it's gone to their heads. Then they think everything they touch turns to gold and they make much lower quality decisions later in their career than they did early on when they were hungry. That's not an issue with Buffett, but it certainly is with a lot of other managers who perform over some moderate term and then fall off the cliff.

Mark McGrath: That's why he's the GOAT, right? He's done it for so long. I think it's Housel that says in his book, the reasonable returns over very long periods of time is what you're really aiming for. Buffett is the perfect example of great returns over a long period of time and it's made him the most famous and successful long-term investor in the history of humankind.

Ben Felix: Which makes the next point I want to bring out that much more interesting, which is that Buffett has been one of the single biggest advocates of index investing for most investors. He's come back to this repeatedly in his shareholder letters and at the shareholder meetings for decades. In the 1996 letter to shareholders, index funds weren't that big of a deal in 1996. But he explains in the letter, most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path is sure to beat the net results after fees and expenses delivered by the great majority of investment professionals, so in 1996. Now, since then, and even before then, there were academic papers looking at mutual fund returns, I think, from the 40s to the 60s as early as 1968, which is really when that literature started to develop.

Since 1996, when Buffett said that, that's of course, as most listeners will know, that's been proven to be true again and again, where active fund managers have continued to struggle to beat the market, especially at long horizons. There's still no evidence of persistence where even if you can pick an active manager that has done well in the past, they don't tend to be the ones that do well in the future, which could be true for two reasons. It could be true, because they were lucky over the first period, their luck ran out, or it could be true because of the diminishing returns to scale issue we talked about earlier, where they maybe were truly skilled, but their fund, because their performance gets too big and they can no longer beat the market. In either explanation, the empirical reality is that we do not see persistence in performance.

Buffett doesn't mess around on this. Like he says, and he talks about it, but he's got so much conviction in his views on index funds that in December 2007, he entered into a 10-year bet, which was at the time worth a million dollars. I think that they ended up investing the money and the proceeds ended up being worth more at the end. Anyway, it was at the time a million-dollar bet. He entered this bet with Protege Partners, with Ted Seides, actually, who's been a guest in this podcast, and we talked to him about the bet in that episode, which is pretty interesting to hear Ted's perspective on.

Protege Partners was an advisory firm very well versed in active manager selection and hedge fund selection. Buffett's bet was that Protege Partners could not pick funds that would beat the S&P 500 index fund over a 10-year period. Protege Partners picked five funds of funds, which contained an aggregate more than 200 hedge funds. An interesting point about the bet is that because they picked five funds of funds, those funds of funds throughout the period were also making active decisions about getting rid of managers they thought were going to underperform and adding new ones that they thought would outperform.

Now, as anyone that paid attention knows, Buffett won the bet very easily. You can argue that was because the specific time period, the S&P 500 did really well over that period. Fine. That may be true, but he still won the bet and it's still, I think, insightful. Buffett explains in his 2017 shareholder letter, after he'd won the bet, that he wanted to make the point that investors in aggregate are not getting their money's worth when they pay high fees for investment management and that most investors are likely better off simply investing in low-cost index funds. That was the bet. He put his money where his mouth was a little bit in that case, but then he's also put his money where his mouth is in his will.

In his 2013 letter to shareholders, he explains that his advice to investing in index funds is essentially identical to certain instructions he's laid out in his will. One of the bequests in his will provides that cash will be delivered to a trustee for his wife's benefit and his advice to the trustee could not be more simple. This is a quote from Buffett, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.” That Buffett says, he believes the trust's long-term results from this policy will be superior to those attained by most investors, whether pension funds, institutions or individuals who employ high-fee managers. Buffett said this in 2013, I think I said.

There's been a ton of papers that have come out in the last five years showing that institutions, like endowments and pension funds that have allocated significant amounts to alternative investments like hedge funds and private equity and private real estate and private credit have materially underperformed low-cost index funds. Buffett knew what he was talking about, I guess, is what I'm saying.

Dan Bortolotti: That's a bit of a turnaround day from the past because there was a period, maybe a decade ago when people were upholding this Ivy League portfolio, these endowments that had had access to illiquid investments that you could only buy with huge scale, and that this offered those investors an edge versus the average retail schmuck like us who can only buy publicly traded securities. Now, it seems like, we've had a little longer period of time to look at it and maybe it wasn't really as advantageous as it appeared initially.

Ben Felix: I'll tell you what I think on that, Dan. I think it's analogous to what we're talking about with Buffett, where I think there probably were opportunities in venture capital and private equity and private real estate and other asset classes like that and in hedge funds, there probably were opportunities. There are cases, like Yale with David Swenson where they did very well investing those asset classes. But then everyone saw David Swenson doing so well and Harvard doing so well and they thought, “Wow, I want to do that, too.” So, everybody started allocating to these asset classes and the amount of capital chasing venture capital, private equity, private credit returns just increased dramatically. I think, probably what we're seeing now is that any alpha that was there is gone.

There's a guy named Richard Ennis who writes about this. He's got a bunch of published papers in the Journal of Portfolio Management and related journals. He also writes for the CFA enterprising investor blog, where he summarizes his papers, but he previously ran a consulting firm for pension funds, so he knows what he's talking about in this space. All of his analysis has shown that over the last 15 years, it's really like post-global financial crisis 2008-ish that since then, all these alternatives have really stopped delivering what they were supposed to. All these institutions have these really high fee assets that are underperforming, as opposed to doing what they were doing previously, which was actually looking good.

I think it really is analogous to what we're talking about with Buffett. You find something that works. You shovel too much money into it and it stops working. As recently as 2020, Buffett confirmed that that is still the case. In the 2016 letter to shareholders, Buffett does acknowledge as he's done several times that there will be some successful managers. He says that there are, of course, some skilled individuals who are highly likely to outperform the S&P over long stretches. Now this part's crazy, though. Buffett says, this is a 94-year-old man who lives and breathes investing. In his lifetime, he's identified early on, so before the fact, only 10 or so professionals that he expected would be able to accomplish this feat. Keeping in mind that the two that he actually picked for Berkshire have not been able to do it so far. Maybe they will be able to eventually, but so far, they have not. 10 or so in his lifetime of this 94-year-old investment oracle, as he's called that. I mean, that's something to think about. When I hear people say like, “I'm a student of Buffett,” like okay.

Mark McGrath: All he had to do was just hop over to Twitter. There's thousands of them that he could have picked from there, obviously, the next great Warren Buffett. It's like, he didn't even know that.

Ben Felix: Didn't know. He's always been a little bit averse to technology. Just had to look on Twitter.

Mark McGrath: Fair enough. That's an incredible stat, is it not? The greatest investor of our lifetime, at least, says that he has met 10 people that he thinks could perform that way and vet 10.

Dan Bortolotti: Try to think about a skill that you could say, only 10 people in the world can do this. That's a pretty elite company there.

Mark McGrath: Well, and just the overconfidence for most people who think it's them, because they watched 17 hours of YouTube videos and read The Intelligent Investor. He's talking about me, guys. Yeah. Okay. James from wherever.

Ben Felix: I'm one of the 10. I'm one of the 10 Buffett’s talking about. I know it. Buffett concludes that section of the 2016 shareholder letter with this quote, “The bottom line when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.” Which I think also speaks to what we were just talking about with alternative investments, where those asset classes, I don't know about you, Dan, but we get pitched all the time from private credit funds, or private equity funds, or whatever that want to shovel our clients’ money into these things that charge 5% or 6% in total fees. Yeah. Of course, you want to put the clients’ money in there, but it's not obvious that it's beneficial.

Dan Bortolotti: These don't matter, Ben. It's after-fee performance that matters, of course.

Ben Felix: That is the talking point. Performance fees are good.

Mark McGrath: Not only that, though, but the barrier to access to all of these products has just dropped. Now there's robo-advisors. As long as your account is $50,000, you can access these exclusive asset classes. With all due respect, if you're an alternative manager and you're willing to accept accounts of that small – you're probably not the top decile fund manager looking for a $50,000 accounts amongst retail Canadians.

Dan Bortolotti: That's exactly it.

Ben Felix: Yeah. Adverse selection in that space is enormous. We see it. We have some clients who, because of what they did professionally, do get access to the best, for example, venture capital funds. Venture capital is a one place where the academic evidence on persistence is actually pretty strong. If you take the best venture capital funds from the last, whatever, 10-year period, they do tend to be the best venture capital managers in the future. That's interesting. There's also massive skewness in venture capital, where those best ones drive most of the performance of the asset class and most other funds, like the median fund, does not perform very well.

There's also massive dispersion, where the difference between the best and worst fund performance is enormous. The problem is, and we see this, because some of our clients are able to access the best funds. Even if you have the right connections, you can't get a very meaningful allocation, because there's only so much to go around. Most people are not the type of person that I'm talking about. You don't have the connections to get the access, even the limited access that they can get. If you don't have those connections, you can't even get access at all, which means you're investing in, say, the median fund, which doesn't tend to do very well at all. That adverse selection problem, I think, is huge. To your point, Mark, if you're accessing it through a robo-advisor, I don't know.

Buffett's message over many years has been very consistent and very clear about index funds. Most people should not be trying to pick stocks. They should just be investing in the index. I love the fact that he even says that he's not super confident that Berkshire is going to beat the index going forward. He says, “We're going to be good stewards of Berkshire Hathaway.” He's very conscious of the fact that many of his investors have most of their net worth in his stock. He doesn't want to mess up, but he makes no promises about beating the market. He just says, “I'm going to manage this money the way that I would manage my own money.” Of course, most of his own money is actually in Berkshire, but he makes no promises about beating the market, which I think is something that would be surprising to some people to hear.

Dan Bortolotti: It's a real testament to him, getting back to what we talked about in the beginning about people listening to him selectively. It doesn't take a great leap to say, he's basically saying, you're probably better off just investing in an index fund than giving us more money. He's too respectful to say that, but people don't want to hear it. Even he is telling them that he probably will not outperform, and people say, “I don't care. I'm still going to give you my money.” It's a testament, I think, to his charisma and his phenomenal reputation. Again, that's not taking anything away from him, but even he's seemingly a little uncomfortable with it.

Mark McGrath: Isn't this one line of thinking from him alone the biggest gotcha in the face of the argument of what about Buffett? Buffett himself is telling you. We may disagree with his geographical allocations, he's saying 100% US equity, for example, but he's out here telling you himself just by index funds. Those who are anchoring to certain characteristics and qualities of Buffett as an excuse to manage their own money a certain way are not really listening to Warren Buffett's advice.

Ben Felix: I agree with that. Now, despite Buffett saying that most people should just invest in index funds, I know a lot of people still will want to look for an edge. I think it is interesting to point out, both from an academic perspective, but also, maybe from a practical perspective, if people want to try and do it, that academic research has been able to explain Buffett's success using multi-factor asset pricing models. In simple terms, that just means that Buffett may have systematically held more of certain types of assets that have higher expected returns, which allowed him to beat the market.

Now, it's interesting for two reasons, I guess. Academically, it's interesting because it shows that, hey, maybe markets are still efficient and Buffett doesn't disprove that. He just tilted toward riskier stocks. That's academically interesting. Practically, it's interesting because if that is true, that's a lot more repeatable systematically than a special ability to pick stocks, which is what people often attribute Buffett's success to. This is a 2018 paper in the Financial Analysts Journal titled 'Buffett's Alpha' the authors set out to explain Buffett's past returns in terms of exposure to no one return premiums. That's a group of stocks with shared characteristics that have systematically higher average returns, often referred to as a risk premium, but not always because not everyone agrees on what explains those differences in returns.

The authors of the paper find that accounting for Berkshire's exposure to market beta, size, value, momentum, betting against beta, which is a beta low volatility factor, and quality factors, plus the use of some leverage largely explains Buffett's past performance. In other words, Buffett's success is explained by his systematic preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns, while surviving the inevitable large absolute and relative drawdowns that this strategy entails.

Controlling for those factors, Buffett's alpha, his ability as a manager to produce returns in excess of the risk taken through his factor exposures is statistically insignificant. I know that statement's heretical to Buffett acolytes, but it's true. It is important to acknowledge, though, that explaining Buffett's past performance with the benefit of hindsight, of course, in 2018 does not diminish what Buffett has done as an investor. I mean, it took academic research more than 50 years to catch up.

We had the CAPM in what, 1964 that paper was published? We had no asset pricing models, basically, when Buffett started. Now, we have asset pricing models that are multi-factor that can maybe explain his performance after the fact, but Buffett was doing this before we had those models at all.

Dan Bortolotti: I think we do have to tip our hat to him for that. You definitely cannot say, “Oh, well, it's just explained by the fact that he picked this stock and that stock.” He basically split the atom before people understood physics. That's pretty much what he did. Then it was like, “All he did was split the atom.” Let's at least acknowledge that it took incredible skill. But to your point, I mean, I don't know how repeatable that is, unless you have a time machine and his brain to go back and do that again, there aren't going to be any more Buffets.

Ben Felix: That's right. I agree with what you just said, completely. I've said this multiple times in this episode, I don't want to take away from what Buffett has done. It's absolutely incredible. He did split the atom before physics even existed, which is amazing. But the reality for an investor today is that physics does exist. We know that these systematic factors exist. We know they explain Buffett's performance and we know they can be implemented in a more diversified and systematic way than what Buffett did. The authors of this paper actually do that. They build a systematic Buffett-style portfolio. They build a diversified portfolio that matches Berkshire's beta idiosyncratic volatility, total volatility, and relative active loadings. They find that that diversified systematic portfolio performs comparably to Berkshire Hathaway.

That suggests that this is a quote from the paper, “Buffett's genius is at least partly in recognizing early on implicitly or explicitly that these factors work, applying leverage without ever having to fire sale and sticking to his principles.” Another interesting thing the paper touches on is how Berkshire Hathaway's style has changed over time. Because they're looking at its factor exposures over time, they can see how that's changed. Early on, when the returns were exceptionally high, Buffett had more favour for smaller firms. Then, later on, as the company Berkshire has gotten larger, it's become increasingly biased toward larger firms later in the analysis period. That speaks to Buffett's point that we mentioned earlier in 1954, which is pre-Berkshire. But 1954 was his best year ever.

He could pick small stocks and he thought we're going to do something crazy and he was right a lot of the time. Now, they've got so much capital, even if you do that and you're right, it's not going to move the needle. When you're buying larger companies, they just don't tend to have those types of returns, unless you can predict Nvidia, which Buffett would probably shy away from anyway. He hasn't been crazy about tech. That point, just the shifting style from smaller companies to larger companies over time, I think that also speaks to the capacity constraints, or diminishing returns to scale that we talked about earlier, where a skilled manager, if they've been able to do something incredible early on, the more and more capital you have, the harder it gets to repeat whatever that thing was. I think that's probably one of the things we've seen happen with Berkshire.

Before we finish this topic, I need to touch on Berkshire Hathaway's increasingly large cash holdings. This always comes up. It's often referenced as a sign that investors should also be going to cash, or at least they should be concerned about a potential market crash, because Buffett seems to be, because of his cash holdings. He was asked about this at the 2019 shareholder meeting. An attendee asked, “Warren, you are a big advocate of index investing,” as we've been talking about, “and of not trying to time the market. But by having Berkshire hold such a large amount of cash in T-bills, it seems to me you don't practice what you preach.” Pretty good question.

I cut it off, but the question also talked about how, if they had done that over whatever last period of time, then Berkshire's stock would have performed much better. There was a ton of cash drag. But the question was saying, if you had just invested in this and the S&P 500, like you tell everybody else to do, Berkshire would have had much better returns. Buffett has a great answer, of course.

He acknowledges that it's a perfectly decent question, and he said something like, “I wouldn't quibble with the numbers. You're probably right that we would have performed better.” He suggests that investing in index funds rather than cash may be a strategy that his successors at Berkshire should employ, because Buffett says, on balance, he would rather own an index fund than carry treasury bills. He does say that owning index funds in 2007 or 2008 when the market was tanking might have affected Berkshire's ability to make their opportunistic moves late in 2008 or 2009. They made some pretty famous big moves during the financial crisis because they had so much cash. Buffett said that that type of execution problem matters more with hundreds of billions of dollars than it does with a billion or two. A billion or two is still a lot to me. I don't know.

He agrees overall that it's a perfectly rational observation and Buffett acknowledges that looking back on the bull market that the opportunity cost does really jump out at you, the opportunity cost of holding cash. The premise is they're holding cash waiting for the right investment opportunities, and those opportunities have now presented themselves, so they continue holding cash. Meanwhile, the market's gone up a lot. Buffett goes on to say, and I think this is the key for most people watching and listening. Maybe there are some multibillionaires, I don't know. He would argue that if you're working with smaller numbers, keeping in mind that he was talking about billions as being smaller numbers, single-digit billions, it would make a lot of sense to invest in index funds, rather than holding cash while waiting for investment opportunities.

While Buffett wants to hold cash and Charlie Munger, who is unfortunately passed away now, he chipped in in that answer too and said, “We've been pretty conservative about holding cash. Maybe not right for everybody, but it's worked for us, so whatever.” I thought Buffett's comments on just, “Yeah, we probably would have done better and most people probably should just keep the money invested, rather than sitting in cash.”

Mark McGrath: They're not coming out and saying, “We're doing this because we expect the market to crash and we can deploy this at cheaper valuations.” That's not at all what they're doing when they're holding cash. People will take that as a sign of an impending market correction.

Ben Felix: No, I agree with that.

Dan Bortolotti: I wonder why he wouldn't just pay a dividend to shareholders. That's often what companies will do when they have excess cash and no reason to expect that they can deploy it productively. Let's say, well, pay it out to shareholders and they can deploy it however they would like.

Ben Felix: I think he thinks that they can still deploy it productively. In his 2012 shareholder letter, he goes through this big speech, not a speech, because it’s written, but this big dialogue about dividends and about why Berkshire has not paid a dividend and he walks through the difference in value creation with them having paid dividends versus not based on what they've been able to reinvest in inside the company. He basically says they're not going to pay a dividend because he thinks they can do better, but he thinks other companies that Berkshire invest in probably should pay dividends once they run out of good investment opportunities. In 2012, he does walk through super detailed reasoning about why they have not paid a dividend.

Warren Buffett is hands down one of the greatest investors in history with an insanely long track record of beating the market. If you can find the next Warren Buffett, if you can't before the fact, you should absolutely invest with him. But I don't know how you'd find them. I don't know how you decide that you have found them. As the existing Warren Buffett himself will tell you, he is no longer the obvious answer to beating the market and he hasn't been for quite a while now, because everyone knows how good he is, so they've allocated capital to him, which is made it harder for him to beat the market.

Now, that generalizes, that illustrates one of the biggest challenges of active management and it's consistent with theory and empirical observations on diminishing returns to scale in active fund management. Trying to find the next Warren Buffett before the fact is likely to be extremely difficult as Buffett himself has learned with the performance so far of his successors. Finding them at the fact is likely too late to benefit from their skill. I think if people actually listen to Buffett, his advice in no uncertain terms is that most investors should simply minimize their costs and invest in low-cost index funds. I tend to agree with him as listeners know.

The one place I depart from Buffett on is international diversification. He's a big advocate of investing in S&P 500 index funds. He's a big advocate betting on America. I would and as we do at PWL add more stocks outside the US. But generally, I think what Buffett says makes a lot of sense. For investors who must try to beat the market, I think the good news is that diversified systematic strategies that tilt toward factors with higher expected returns, like in Buffett's case and in that paper, safe, high-quality cheap stocks with a bit of leverage, can actually explain the historic results of Berkshire Hathaway. Implementing a systematic strategy in that fashion is more likely to be successful than reading financial statements and picking individual stocks.

Mark McGrath: Buffett was the original factor bro.

Ben Felix: A 100% he was.

Mark McGrath: Sweet. I feel validated. We're largely factor investors. If you were to bring that up with his accolades, they don't think about it in factor terms. They think it about it in security selection terms.

Ben Felix: That's the crazy thing about that paper is they basically show that it wasn't security selection. It was exposure to no one now risk premiums, and that you could have done the same thing more diversified. It wasn't about the individual securities he selected. It was about the risk factors that he was exposed to.

Mark McGrath: I think the other thing people fail to realize is due to his scale, he can customize a lot of deals. There’s a few examples of this, the one that I think is really interesting for us as Canadians is he stepped into effectively save Home Trust back in 2017. Home Trust is a Canadian financial institution. They’re, I think, mostly a mortgage lender, but they take deposits as well. There was essentially a run on the bank. Their deposit levels got so low that they were at risk of total collapse and failure. Buffett stepped in in a big way with a deal that I think only Buffett could have made and effectively bought, I think it was 400 million of stock, but I think it was done in two transactions, but in an effective price that was half the value of the market price of the stock.

He effectively bought it at something like a 40% to 50% discount to the actual market price of the stock, while also extending a 2-billion-dollar line of credit at below-market rates. Only Buffett can get that type of deal. You and I can't step in with our $150 monthly contribution to our TFSA and go save Home Trust Capital. But then, he also lends his name to that deal. That alone restores investor confidence. The stock soared nearly 30% on the news, which was enough to stave off the run on the bank and they started seeing deposits flow in again. I think he's done similar, maybe not to that degree, but similar stuff, even with Coca-Cola. He's been known to structure his own call options, or convertible securities in ways that are beneficial to him that the general market just wouldn't normally be able to get their hands on.

Dan Bortolotti: This is why it is mischaracterized to call him a stock picker. That sounds so quaint, like he's sitting at his desk picking stocks in his brokerage account or something. He's buying entire businesses with a phone call, probably. It's just not something that anybody can hope to say, “Well, I'm just going to learn his style and mimic it myself.” You can't do it.

Mark McGrath: I think with the home trust deal, it was something insane, like three days from the first phone call until the deal was signed. He saw what was going on, him and his team analyzed that overnight. Went, yeah, we're stepping in 400 million, done. In three days, the deal was struck, which is just insane. The speed at which he was able to pull this off. Most people didn't even know what was going on with Home Trust and he's already structured the deal. That's how fast markets move.

Ben Felix: I remember that happening. It was crazy. The other crazy thing, though, is does that move the needle for Berkshire Hathaway? Great deal. Incredible.

Dan Bortolotti: 400 million dollars. That's a big number for most of us. It's not a big number for Berkshire Hathaway.

Ben Felix: That's right. It's a crazy thing about so many different angles. That is a great deal objectively. But if you're a shareholder in the company, yeah, sure, you're happy that deal happened. But, I mean, how happy?

Mark McGrath: I want to go back because you mentioned dividends, and I think this is a big point of contention that I face with talking to people who are students as you put it, but people will use Warren Buffett's “love of dividends” as an excuse for investing in dividends stocks themselves. You already mentioned this, Ben, but it's not clear to me that he loves dividends. What he has said is that a company should pay dividends when they don't have better use for the capital, as you said. He did say this in, I think, it was a 2008 shareholder meeting. He said, “I do believe in dividends in a great many situations, including many of the companies in which we own stock. The test about whether to pay dividends is whether you can continue to create more than one dollar of value for every dollar you retain.” This is why he doesn't pay a dividend. Then asked that question, because he believes that he can create more value for shareholders by retaining that capital and investing in themselves than shareholders could create on their own where he'd pay out that dividend.

I'd say, he's probably agnostic to dividend policy and he's more interested in the business's ability to use that capital in productive ways. I wouldn't call him a dividend investor per se. No. I haven't read all of his shareholder letters. I'm sure he's expounded on dividends much more than that single quote I've given him, but I think it's important to understand how he thinks about dividends in isolation.

The other thing I'll mention is yield on cost, which drives me crazy. This is perhaps the most meaningless metric in all of personal finance. There's maybe some psychological benefits to this. I believe this is popular because he said it with respect to his Coca-Cola shares at some point. I couldn't find the quote. I was looking for yesterday in preparation for recording today, but I believe he talked about this at one point. The yield on cost is a metric where you effectively take the current yield of a stock and you divide it by your original purchase price to determine the yield on the cost of your investment. If you put $1,000 into a stock and it pays a 4% yield, and that compounds for decades, or however long, and now the stock is worth $10,000 and it's still paying a 4% yield, that's a $400 annual dividend.

Today, on a purchase that you made, let's call it decades ago, for $1,000, your yield on your cost is 40%. That sounds amazing. It sounds like, you're getting this unbelievable yield on this investment. This is compounding. It's got nothing to do with yield itself. If you did the exact same thing with a stock that did not pay a dividend, and that stock went up 4%, I could say my growth on cost and that exact same example is also 40%. It doesn't tell you anything about your actual investment experience, the returns you've earned, your ending wealth, the growth of wealth, it tells you absolutely nothing. But people will use dividend, or Buffett's yield on cost as a way to justify their continued use of a particular stock in their portfolio.

The hilarious thing is anybody with $10,000 could just go and replicate that exact portfolio today with the exact future investment experience. Their yield on cost would be 4%, not 40%, but their total returns are going to be the same. It drives me mental when people use it and I needed to get that out of my system.

Ben Felix: I could see the psychological argument though, where if your yield on cost is 40%, you're less likely to worry about volatility in the underlying share price. That's not a good reason to use this metric.

Mark McGrath: But that might also prevent you from selling about an investment. Well, I don't want to destroy my yield on cost, because if I were to sell that and literally buy it back tomorrow, I've reset my yield on cost.

Ben Felix: True. It could have an endowment effect.

Dan Bortolotti: I think it's classic. We've talked so much about dividend investing as a strategy and it has a lot of psychological benefits, but it also has pitfalls. If you are a dividend enthusiast and you hold on to a stock during a market crash, because you say, “Well, at least it's paying me yield every month.” I think that's doing the right thing for the wrong reason. But to your point about the endowment effect, in a tax-sheltered account, for example, you could sell a stock that you bought 10 years ago, repurchase it immediately, your return is exactly the same. It just feels way different. Now you're doing the wrong thing for the wrong reasons.

Mark McGrath: It goes back to your opening comments on reframing questions. Anybody with clients has probably framed this decision for clients where it's like, should I sell a stock? It’s like, well, if you didn't own it, but you had the cash, would you go and buy it today? Well, of course not. Well, then you should sell it. Simple reframing like that, I think, it catches people off guard in their decision-making.

Diversification concentration. People will use Buffett as an excuse to run concentrated portfolios because Buffett once said something along the lines of diversification is for people who don't know what they're doing. I would just like to reiterate that Buffett said that he found 10 people in his lifetime that he could identify as they know what they're doing in advance. When you're running a seven-stock Canadian equity portfolio, because you've watched a bunch of YouTube videos and you've watched Ben's videos and you've watched some dividend growth videos, he's not talking about you as the person that knows what they're doing. Buffett does smartly qualify, most investors should be buying index funds.

It's a shame he doesn't go deeper on that. You shouldn't be speaking in absolutes. When he's saying most, I would guess, he's talking about 99.9% of people. He's not talking about 62% of people.

Ben Felix: Yeah. Definitely.

Dan Bortolotti: I wanted to raise an issue with you guys and see what you think. Buffett's real superpower is not so much his ability. Well, of course, it is his ability to pick stocks and companies and make investment decisions, but it's really his long-term discipline and focus that has made him as successful as he is in many ways. You talked a little bit about Berkshire changing its strategy over time. I mean, that's inevitable. Buffett's not a trend follower, for example, and he's not a type who buys flash in the paying investments, and that's one of the reasons why he's been so successful.

I almost wonder if there's a darker side to that or not a darker side, but a downside in the sense that a lot of people will look at Buffett and Berkshire in the 90s and they didn't get caught up in the dot com hype, and they were rewarded for it, and that's all true. A lot of it, in retrospect, you look back and it just sounds like almost Luddite behaviour. I don't understand what this Internet thing is. In addition to not buying into the hype and buying the garbage stocks with zero earnings, my understanding is Berkshire also did not buy some of the stocks that went on to be the most successful companies in human history. You can call it discipline, but at some point, it's maybe closed-minded and stubborn as well. I don't know. Again, this is not any knock against Buffett personally.

Maybe I'm feeling a little bit like this with crypto. So many of us have been saying for years, it's not a real asset, it's unsustainable, and I feel like, there's going to be a point where we look back and go, “You know what? Totally wrong.” I don't think I'm there yet, but I'm just trying to be humble and say, we might be looking back in 10 or 20 years and say, “Yup, I completely got that wrong.”

Mark McGrath: That's a good point. Discipline is perhaps his greatest virtue. His returns are exceptional, but 19.8% doesn't sound like a big number. Again, I'm talking to people on Twitter all the time where like, “I got 140% last year. It's easy to beat the market. What are you talking about?” The greatest investor in history, his long-term track record is 19.8% annualized over decades and decades and decades. For the average investor, their investment time horizon is decades and decades and decades. Your five-year performance isn't that interesting. I'm 40. In my own personal financial plans, I go to age 95. I have 55 years of investing runway in which that I need to earn returns. The probability of beating the market over that 55 years is incredibly low.

So, 19.8%, it's not that number. It's the time over which he did it, and that takes unbelievable discipline. The same people who are earning 100% returns in a year, like this year are also through that same behaviour going to blow themselves up in the next market correction.

Dan Bortolotti: Yeah. I'm just trying to look at the other side of that though. I guess, my point was that when he resisted the hype of the dotcom bubble, that was the period where he outperformed the S&P 500, or at least in that lost decade after the dotcom crash, he did extremely well. In the period since then, a lot of companies that seemed like hype at the time have actually proven themselves to be extremely valuable companies. Maybe he was a bit late to the game on them. That helps explain the underperformance after that period.

It's hard to be right all the time. When you have a disciplined consistent strategy, it's going to appear to not work over some periods. As he's shown, if you get it right early on, you can be a little bit wrong later and still have the momentum, but you don't want to be moving in and out of different strategies, because then you're chasing yesterday's returns and fighting the previous war, or whatever other mixed metaphor you want to use. The fact that he stayed consistent has meant that he has looked foolish sometimes. But he has stood the test of time by sticking to those principles.

Ben Felix: I think it's very possible. We're having this conversation in December 2024, and US equity evaluations are edging up to dotcom bubble levels. It's very possible. I'm not predicting a market crash. We talk about US expected stock returns, maybe being a little bit lower than the past because of where evaluations are. I think that's probably true, but I'm not predicting a crash tomorrow, or anything like that. But market valuations look a whole lot like the last time people were saying, “Well, Buffett's lost his touch, or whatever.” We're saying now, well, hey, Buffett's underperformed the US market, but in a year, things could change. Valuations come back down. All of a sudden, Buffett looks pretty smart again.

Dan Bortolotti: Give him another 10 years.

Ben Felix: I don't know if he has 10 more years.

Dan Bortolotti: Give the company another 10.

Ben Felix: If that happens, if that outcome happens, that would be pretty incredible, and to the whole story. Even if it's his successors, though, I think it would still be pretty incredible to see Berkshire outperform again. But that's not the reality today. I think your point about discipline and potentially missing out on stuff is really important, Dan. We know stock returns are very skewed. We know a huge portion of the market's return comes from a relatively small number of stocks. Buffett gets this to an extent. He talks about it. This is why you should just index. If you don't own everything, there's a good chance you miss out on those best performers. They may be in an industry you don't like if you're an active investor. It may be in an industry you don't understand. But it doesn't mean you should miss it.

Mark McGrath: I might be making this up. But didn't you say one of his greatest investing regrets was not buying Apple sooner, or something like that?

Ben Felix: I think he has said something like that. Yeah. And he eventually did buy it.

Mark McGrath: Well, and it became a massive component of Berkshire, like nearly 50% at one point, I believe. I think he's trimmed it recently.

Ben Felix: I pulled up the overall gain instead of the annualized gain because you were talking about that, how important the time horizon is. That 19.8% versus 10.2% annualized. This is from the 2023 shareholder letter. Over the period 1964 to 2023, in cumulative terms, that's 31,223% for the S&P 500, 4,384,748% for Berkshire Hathaway.

Mark McGrath: It's insane. We have this exponential growth bias or hyperbolic discounting. We have a tough time visualizing what compounding and discount rates do over long periods of time. When you said 31,000 for the S&P, I was expecting 250,000 for Berkshire, 4 million, that's unbelievable.

Ben Felix: I know. It's crazy. The point about discipline is huge. Buffett's done this forever, before there was any academic research, or whatever else somebody else could lean on to say, this is the right way to do this, Buffett didn't have that. He was doing his own thing. In the first tech run-up, people were saying, “You're wrong. You're missing out.” He was doing his thing. It worked for a long time. As I mentioned a minute ago, I wouldn't be surprised if US equity valuations of the type of stocks Buffett doesn't own come down and Berkshire ends up looking pretty smart again. I'm not predicting that, but I wouldn't be surprised if it does happen. Then we'd have to go back and redo this whole episode and say that it is possible to beat the market.

Mark McGrath: Well, and it’s true. One market event can largely change that 22, or then 23-year history. You'd have to cherry-pick different dates, but exactly.

Ben Felix: 100%.

Dan Bortolotti: Change the start date. I'm guessing that a lot of the underperformance has come in the last 10 of those 22 years.

Ben Felix: Looking to the chart, that looks about right.

Dan Bortolotti: I don't know, but I'm just assuming that probably 2000 to 2008 or so, he probably did quite well.

Mark McGrath: Buffett's Alpha was published in 2018. If he really is still tilted to certain factors, especially in the US markets, it's largely been large-cap growth over the past 10 or 15 years. If he is actually tilted away from that, then you would expect him to have underperformed just from the factor exposure alone.

Ben Felix: Totally. As every value investor has experienced.

Mark McGrath: We'll have our day. Don't worry. Patience. You need Buffett-like discipline.

Ben Felix: Well, I mean, the nice thing about the Dimensional approach, if you can call that value investing, which it is to an extent, but you still own the market and you're not concentrated in a small handful of value stocks. It's pretty close to index investing, just with a little bit of spice.

***

Ben Felix: All right, let's go into the after-show. I did want to mention that I was on The Wealthy Barber Podcast, Dave Chilton's podcast. Not that I'm competitive at all. I swear I'm not, but that episode of their podcast episodes they've released has had by far the most downloads after two days, even relative to episodes that have had it for months. I'm not going to lie. I'm pretty happy about that. That was fun. I mean, Dave Chilton's a legend. I've watched him on TV when he was on Dragon's Den, and so doing a podcast with him was pretty cool.

Mark McGrath: He's a full-on legend. He's the OG Canadian personal finance content creator. When was the first edition of his book released?

Ben Felix: 1989.

Mark McGrath: Incredible.

Ben Felix: Yeah. He's been around for a long time.

Dan Bortolotti: There was definitely nothing like it at the time. That was back in the day where you could say, “You should just invest in mutual funds and expect 10% a year.” It wasn't crazy in 1989.

Ben Felix: Yeah. You can check that podcast out anywhere. It's on YouTube and on all the podcast platforms, but I thought that was cool. I did also want to mention our Mike Green and Randy Cohen episode, which was not a debate, but a discussion. There was no winner in my eyes. I think it was just a discussion between two pretty well-informed smart people. That episode has been generally very well-received. I've heard from lots of people that it was their favourite episode ever of all our podcast episodes that they've listened to.

Interestingly, I have also heard less favourable reviews where, well, most people seem to have loved it. There seems to be some people who couldn't finish the episode and found either Mike or Randy to be hard to listen to. I didn't get that at all. I thought that they're both really respectful and had a great well-informed discussion. I just find it interesting that most people seem to really like it. Some people either didn't like Randy or didn't like Mike, which leads me to believe that those people may just have a bias toward one way of thinking over the other and had trouble listening to both sides. I don't know if you guys listened to that episode.

Dan Bortolotti: I think it's confirmation bias. If you go into that discussion already heavily biased towards one side, you might find the other person a little bit hard to take. Obviously, we all have our own biases. I personally found that episode to be really refreshing, because let's agree that most of what passes for discussion and debate these days is people yelling at each other and refusing to budge. It was amazing how many times they checked in with each other and effectively said, “Okay, I think we can get to some consensus on this point. I will give you that and I agree with you, but,” and then they would go on to discuss where they differed. But there wasn't this idea of I'm on one ideological and you're on the other. We’re just going to smash foreheads against each other for two hours and refuse to give an inch.

It was a very, very civilized discussion and well-moderated by you guys. I quite enjoyed it. It was very long, but I got through it without any problem at all. Which isn't always the case for some long podcasts. I don't need this one specifically, of course, but there's a lot of two-hour podcasts out there that I can't get through. But that one I thought was excellent. I think you guys did a great job.

Ben Felix: Mostly, Mike and Randy, honestly, we didn't say much in that episode, we all agreed beforehand what we wanted to cover. We didn't get through all of it, but we got through most of it. They knew where to go, and I agree with you. They had really good dialogue together. They listened to each other, and it was just an overall good discussion. It left us and the other listeners with what are the questions that they didn't agree on, and that's what we should care about. That's what we should go and try and figure out next.

Dan Bortolotti: I think they would agree with you on that. I don't think either of them said, “I'm 100% correct on this with virtual certainty. Anybody who disagrees with me is dead wrong. It's just this concerns me. I think it's an unresolved issue. We should pay attention to it.” That's what a good debate is.

Ben Felix: I've got some specific things that I'll take away and talk to some of the other people we've had on our podcast about just on those related topics. I'll try and sort some of the remaining questions I have out, and then hopefully, we can report back on that in a future episode.

We've got two new reviews here. Pretty positive review. I don't know. Maybe as positive as it could possibly get. “Literally changed my life.” All right. That's pretty good. “The quality of financial advice offered in this podcast is amazing. I've since gone back and listened to every episode.” I always find it incredible when people say they've done that, and also it makes me a little nervous. I don't know. Was I good at podcasting seven years ago? Probably not.

Mark McGrath: Probably not. I went back and watched some of your earlier YouTube videos, Ben.

Ben Felix: Stop. Stop it. Stop it.

Mark McGrath: That's how you get better, man. You got to get the reps in. I was an original listener of the RR when it first came out. I haven't gone back now and listened to the earlier episodes, but maybe I shouldn't.

Ben Felix: I can't watch my old videos. I'm so ridiculous. Some people leave comments every now and then. “Wow, you've gotten so much better over time.” Thanks. I appreciate it.

Mark McGrath: Well, it's like anything you do though. Any creative work, you're going to get better. It's like drawing. If you're not improving, something is critically wrong. But you've been doing it for a long time, so it's progress.

Ben Felix: This person says, “I've since gone back and listened to every episode, and it's given me the confidence I need to better manage my financial future.” Very nice. That’s from Asset Caribou in Canada.

Mark McGrath: Very nice. “Randy and Michael's debate, awesome. Michael might be the only individual on Earth that sees it all, which scares me more than anything because Einstein was pretty much the only individual on Earth that saw the light. There has to be math involved in this equation. It's large numbers, but absolutely a fascinating discussion. Thank you.” That's from Andrew40001 from Apple Podcasts, and he is in the USA.

Ben Felix: Tons of comments on that episode. If you want to go into the Rational Reminder community and see what everybody thought, I think there's 190 or so comments from people in there.

Mark McGrath: Are you planning to host more debates like that? Has that been talked about?

Ben Felix: I don't know. Those two guys are really well-suited for that format. Mike is a very good speaker. He's very calm. He's very composed. Randy was suggested to us by people listening to Mike Green's episode, and they contacted me. People who are practitioners, or academics in finance, or a combination. They listened to Mike Green episode and they said, “That was a really interesting discussion, but I think that there's another perspective that needs to be heard.” I was like, “Cool. I'm not going to debate Mike Green, because he's really, really good at speaking and thinking quickly.” Sorry, I said debate. We intentionally didn't make that a debate, because that's not what I wanted it to be. It was a discussion. There was no winner.

I told some of the people who contacted me like, “Listen, I would host that kind of discussion if you have someone that can speak on Mike's level and has the quick thinking ability that Mike has, then I think that'd be great.” That took a few weeks of people asking around and poking around to find someone that was one, knowledgeable enough to have that discussion, two, willing to engage in a public format, and three, able to speak at Mike's pace, or think at Mike's pace. That's how we found Randy Cohen.

If there's a topic that's as divisive and that we can find two people on who can speak as respectfully and intelligently as those guys, then for sure, I would do it again. I think that was a relatively rare – a bunch of things came together that made that work, and it's not obvious to me that we could recreate it. I would if the opportunity arises for sure. I thought that was cool.

Not a review, but I did want to mention, Michael Mauboussin, who is someone that I followed for a very long time, he's written a ton of really interesting stuff. He's written about the paradox of scale that we talked about earlier. His writing's incredible. He tweeted the Rational Reminder Podcast, “Is wonderful for anyone who wants to learn about financial economics and investing. Benjamin Felix and Cameron Passmore.” He didn't know you guys yet. He's not caught up on episodes, I guess. “Do a great job with excellent guests on important topics, including the rise of indexing.” I guess, he listened to the Mike Green, Randy Cohen episode. “Listening to finance professors is almost always easier than reading them. Their main points are often clearer. They discuss nuances and identify what work has left to be done.”

That was pretty cool, because like I said, I followed Michael Mauboussin for a very long time. I think he's an incredible thinker and writer to see that he, one, listens to the audience and two, want to tell other people about it. I thought it was pretty cool.

Dan Bortolotti: Very nice endorsement from a big name, for sure. His work is great.

Ben Felix: Yeah, it is. Okay, last thing. Our year-end episode, we're switching up the format this year. Historically, we have done this work-intensive, time-intensive process where Cameron goes through all the episodes of the year and picks out snippets, and then we clip them together in an episode that we then add additional commentary onto each clip. Very time-intensive for Cameron, for our production team, and for Cameron and I to record it together. We're going to try something different. We submitted, or we sent out a form that we asked people on Twitter and LinkedIn and in the Rational Reminder community. We said, submit your AMA questions. We're going to do an AMA.

We received 158 questions, which I don't think we were quite expecting that many. Over the course of eight days, people spent on average 18 minutes with the form open thinking about what they were going to ask.

Mark McGrath: That's incredible. 18 minutes.

Ben Felix: It's a lot of thinking. A lot of time went into that. I guess, we outsourced the time to our listeners for this.

Dan Bortolotti: Eighteen minutes times 158. That's a lot of time.

Ben Felix: Still time-intensive. Just we diversified it a little bit. Spread it around. Our plan is to go through as many as we can. I tried using ChatGPT to see if there were redundant questions that could be grouped together, and it said, no. I was chatting to somebody who has enterprise access to Claude and Perplexity, and they suggested that those might come up with a different answer. So, we're going to try that and see if we can group some of these together to get the number of questions down without sacrificing anybody's question.

Dan Bortolotti: Are you going to get that software to give us the answers as well?

Ben Felix: Maybe I should.

Dan Bortolotti: It's much less time-consuming.

Ben Felix: Feed it all the past episodes and get it to give us the answers. Yeah, so hopefully, we can get that down from 158 to some smaller number, but we'll try and go through as many as we can within reason. There are lots of really good questions, so I think it's going to be an interesting episode to finish the year off.

Mark McGrath: Are we going to prepare answers to those questions? Or is it going to be live?

Ben Felix: We're recording that episode on December 9th, Mark.

Dan Bortolotti: Get moving.

Ben Felix: I'm not going to have very much time to prepare.

Mark McGrath: I haven't looked at the questions at all. Not a single one.

Ben Felix: I can send them to you. I think most of them, we can probably go off the cuff. If there's one that we can't answer off the cuff, we can say whatever thoughts we have and maybe come back to it later. I don't know.

Mark McGrath: Like a true AMA.

Ben Felix: I think it's probably more fun if we don't prepare.

Mark McGrath: That's what I'm thinking. I think the genesis of AMAs were largely Reddit. Maybe I'm wrong, but AMAs were very, very popular in Reddit. I'm sure they still are, right? Where somebody's there, and the audience is asking them questions and responding live. I think that's true to the spirit of the original format of an AMA. I don't want to be over-prepared. It depends on the depth of the questions here. I'll just pitch all the technical stuff over to you guys and I'll answer the ones that require very little thinking and preparation.

Dan Bortolotti: I'm just laughing, because I think we've rarely been over-prepared.

Ben Felix: Yeah.

Dan Bortolotti: I'm only speaking for myself.

Mark McGrath: Yeah, likewise.

Ben Felix: I'm usually over-prepared.

Dan Bortolotti: Ben is usually over-prepared.

Ben Felix: For Dave Chilton’s podcast, I had zero preparation. He didn’t even send me the questions ahead of time. I was like, “What topics are we going to cover?”

Dan Bortolotti: He didn’t know the questions ahead of time.

Ben Felix: Yeah. That may be true. All right, anything else?

Dan Bortolotti: I think we're good.

Ben Felix: All right. Thanks everyone for listening. We'll see you next time.

Dan Bortolotti: Thanks.

Is there an error in the transcript? Let us know! Email us at info@rationalreminder.ca.

Be sure to add the episode number for reference.

Participate in our Community Discussion about this Episode:

https://community.rationalreminder.ca/t/episode-335-what-about-warren-buffett-discussion-thread/33610

Papers From Today’s Episode:

'Buffett’s Alpha' — https://doi.org/10.2469/faj.v74.n4.3

'Mutual Fund Flows and Performance in Rational Markets'— https://journals.uchicago.edu/doi/abs/10.1086/424739

Books From Today’s Episode:

The Intelligent Investor — https://amazon.com/dp/B0CBQ18KDB/

Links From Today’s Episode:

CPP by the Fire — https://pages.pwlcapital.com/webinar_cpp_by_the_fire

Meet with PWL Capital: https://calendly.com/d/3vm-t2j-h3p

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.

Rational Reminder Website — https://rationalreminder.ca/ 

Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/

Rational Reminder on X — https://x.com/RationalRemind

Rational Reminder on TikTok — www.tiktok.com/@rationalreminder

Rational Reminder on YouTube — https://www.youtube.com/channel/

Rational Reminder Email — info@rationalreminder.ca

Benjamin Felix — https://pwlcapital.com/our-team/

Benjamin on X — https://x.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/

Mark McGrath on LinkedIn — https://www.linkedin.com/in/markmcgrathcfp/

Mark McGrath on X — https://x.com/MarkMcGrathCFP

Dan Bortolotti on LinkedIn — https://www.linkedin.com/in/dan-bortolotti-8a482310/

Braden Warwick on LinkedIn — https://linkedin.com/in/braden-warwick-a40b48a3/

PWL Capital CPP Tool — https://research-tools.pwlcapital.com/research/cpp

Ben on The Wealthy Barber Podcast — https://thewealthybarber.com/podcast/ben-felix-a-deep-dive-into-the-world-of-investing-twb-podcast-5/