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Warren Buffett: More Myth Than Legend

Reprinted courtesy of

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As much as I respect and admire Warren Buffett, I would not hire him to manage my money — and I don’t think you should either.

Buffett is widely considered to be the most successful investor of the 20th century — and still going strong in the 21st. He’s a successful businessman, author, philanthropist and inspiration to many people — and one of the wealthiest people on the planet.

More than 50 books have been written by or about Buffett, and he has a great long-term track record. In 1965, he took control of Berkshire HathawayBRK.A -0.35% , an insurance company in Omaha, which he is now the primary shareholder, chairman and chief executive.

A $10,000 investment in Berkshire Hathaway stock in 1965 would have grown to be worth nearly $30 million 40 years later, in 2005. That’s about 60 times as much as you would have made if you’d invested $10,000 in the Standard & Poor’s 500 Index and held it for those same 40 years. He makes it sound easy.

So, what’s not to like about the way Buffett invests? Well, for starters, it doesn’t always work.

Buffett’s specialty is value investing . That means buying stocks with long-term prospects that are believed (by the value investor) to be undervalued. The unloved underdog, for instance, that has been unfairly ditched by Wall Street and that will be rediscovered in the future.

He articulated this approach succinctly in his 2008 letter to shareholders:

“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

When this works (and it often does), it makes the value investor look like a genius. Buffett is a famous case in point.

You can jump on his bandwagon by buying Berkshire Hathaway stock. But should you?

Fifteen years ago, investors knew the stock had compounded at more than 34% since 1978. A $100 investment had grown to $36,200. I’m sure that many investors thought: “If I can earn half of that, I’ll be happy.”

Those who confidently bought the stock may be excused if they feel chagrined at having made a compound return of only 5.3% a year since then, according to Morningstar.

Those investors might understandably wish they had taken his advice instead of his portfolio. Buffett has repeatedly said that investors should use index funds instead of buying individual stocks.

When I looked back at the U.S. and international value funds offered by Vanguard and Dimensional Fund Advisors (DFA) that were in existence 15 years ago, I found that buying five DFA value funds would have earned an average return of 9.3%. Three similar funds at Vanguard compounded at 6.1% in that same period. (That’s a 12% increase in return at much less risk.)

Returns in the 15 years ended June 30, 2013:

Vanguard Value Funds %
U.S. Small Cap Value (VISVX) 9.9
U.S. Value (large cap) (VIVAX) 4.8
International Value (VTRIX) 5.4
DFA Value Funds %
U.S. Small Cap Value (DFSVX) 9.9
U.S. Large Cap Value (DFLVX) 6.6
Intl. Small Cap Value (DISVX) 9.7
Intl. Large Cap Value (DFIVX) 5.9
Emerging Mkt, Value (DFEVX) 14.2

In those 15 years, an investment of $10,000 would have grown to $21,698 in Berkshire Hathaway stock. The same money would have grown to $24,307 in the three Vanguard value funds or $37,958 in five DFA value funds.

Warren Buffett does recommend index funds, but he usually specifies only the Standard & Poor’s 500 Index SPX -0.95% , which compounded at only 4.2% over the past 15 years. I don’t know why he doesn’t recommend value index funds.

The financial media relentlessly revere Buffett as if he’s some sort of god. Here are some typical headlines I found:

“18 Brilliant Quotes From the Greatest Investor of All Time.”

“Warren Buffett: What is he Buying Right Now?”

“Why There Will Never be Another Warren Buffett”

A Wall Street Journal article credited Buffett’s success to the notion “that he plays a different game than the rest of us. He gets the first call on deals and he gets attractive terms on his investments. We can’t replicate those advantages.”

Actually, I disagree. As the numbers I cited above show, we can probably do better by diversifying into low-cost value indexes and passively managed funds.

The real fruits of Warren Buffett’s success have gone to his very-long-term stockholders, those who bought in when he and Berkshire Hathaway were relatively unknown. And to advertisers on his television appearances as well as authors and publishers who have found a way to tell others how to emulate his success.

In fact, a small industry has emerged to teach investors how to emulate him.

For my money, I have to wonder whether Warren Buffett is as good as he is made out to be. If his management really “adds value” to value investing, why don’t his results at least equal the performance of passive value index funds?

And if he can’t do that, what makes individual investors (who have far fewer hours and resources than he does) think they can?

Warren Buffett once said, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”

I don’t think you have to have “even” a 130 to beat Buffett. All you have to do, at least over the past 15 years, is invest in value index funds. What’s so hard about that?

I’m all in favor of being smart. But being disciplined is more valuable in the long run. And Index funds have discipline in spades.

In a way, this choice comes down to the question of where you place your trust. You can trust Wall Street, with its tempting tales of trying to beat the market. Or you can trust the academic community (University Street, as I like to think of it), which has found through decades of rigorous study that achieving the returns of the market almost always wins in the end.

Warren Buffett walks with Wall Street. I’ll take University Street.

Richard Buck contributed to this report.

DISCLOSURE: Paul Merriman owns shares in each of the five Dimensional funds mentioned in the article.