This article is an excerpt from the Shortform book guide to "The Snowball" by Alice Schroeder. Shortform has the world's best summaries and analyses of books you should be reading.
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What was Warren Buffett’s first partnership? How did that business boost his revenue?
In The Snowball, Alice Schroeder highlights the early days of Warren Buffett’s success. When he was only 25, Buffett founded an investment partnership that made him what he is today.
Let’s take a closer look at Warren Buffett’s partnership and how he ran his firm.
Partners in Business
Instead of selling stocks, Warren Buffett’s partnership was created, Buffett Associates Ltd., in which he’d manage his own money and that of friends and family. The point of the business was to let money compound—his partners put up the seed money, and Buffett’s share would come from his nominal management fee, which he’d reinvest using the techniques he’d learned under Graham. Schroeder writes that by the end of 1956, Buffett’s partners’ earnings had beaten the market by 4%, and more investors were eager to join.
Buffett was transparent about his partnership’s terms but not about how he invested the money. He only ever revealed where his partners’ money was in an annual summary report—otherwise, the investments were a matter of trust that Buffett knew what he was doing, and his partners wouldn’t interfere or invest without him. To be fair, Schroeder explains, the terms of the deal incentivized Buffett to make as much money as he could, while also making him liable for losses. As his network grew, he formed more partnerships under these terms, and by 1958 he was managing over $1 million in assets. (Shortform note: $1 million in 1958 dollars is equivalent to roughly $10 million today.)
The market shot upward in the early 1960s and Buffett’s hunt for new investments went into overdrive. He kept his focus on undervalued stocks, and Schroeder says that when the market finally dropped, Buffett had built up enough cash to scoop up cheap stocks by the bushel. One was American Express—it had taken a blow in a financial scandal, driving down its stock price, but the public’s perception of the company hadn’t wavered. Another was Berkshire Hathaway, a failing textile company that would one day become the center of Buffett’s entire operation.
(Shortform note: American Express’s financial troubles in 1963 were of a nature that damaged its reputation in the financial world while being too obscure for the layman to fathom. At the same time, American Express had what Buffett would characterize as an economic moat. In 7 Secrets to Investing Like Warren Buffett, Mary Buffett and Sean Seah define an economic moat as a product or service that customers will buy no matter what is going on in the economy. In the case of American Express, their “moat” was their popular Travelers Cheques, which were ubiquitous before the rise of ATMs.)
Buffett had well exceeded his goal of becoming a millionaire by the age of 35. By 1966, he was starting to have trouble finding undervalued stocks to buy with all the money he had, to the point that he decided not to take on any more partners. Schroeder writes that any further growth would have proved problematic. In 1969, Buffett announced that he’d dissolve his partnerships entirely. He would no longer be responsible for anyone’s money but his own.
(Shortform note: While Buffett was always reluctant to predict the ups and downs of the market, he was certainly aware that the end of the 1960s marked a sea change in the financial world. Throughout the ’60s, the government initiated projects to spread the nation’s wealth to the poor, such as Medicare and food stamp programs, while ramping up military spending on the Cold War. The government’s reluctance to raise taxes for funding, coupled with a flood of money from the Federal Reserve, led to a decade of recession and inflation that would not level out until the end of the 1970s.)
Beating the Market
For an investor, “beating the market” means that the sum of your investments produced a higher return than that of an established baseline, such as the Dow or S&P 500. However, beating the market doesn’t necessarily mean turning a profit. For example, if the Dow were to drop 10% over a year while your own investments lost only 5%, you would still have beaten the market despite the fact that your investments went down in overall value.
In I Will Teach You To Be Rich, Ramit Sethi points out that, unlike Buffett, most so-called financial experts rarely beat the market, and when they do, it’s because of luck more than skill. Sethi suggests that the poor track record of financial advisers and the mutual funds they manage is hidden behind a cloud of survivorship bias—companies such as Morningstar that rate the performance of mutual funds focus mainly on the few that succeed and not the many that fail.
Ignoring the Market
By not disclosing his day-to-day trades, Buffett in effect forced his partners to abide by one of his basic principles—that of disregarding the ups and downs of the market. In The Warren Buffett Way, Roberg G. Hagstrom explains that in the short term, the value of the market is fueled by cycles of optimism and fear that cancel each other out in the long run.
By keeping his trades private, Buffett acted as a buffer between his partners and the market’s volatility, allowing him to invest without emotion as a factor while banking on his partners’ economic goodwill, which Hagstrom defines as the good feelings people have toward a business (in this case, their partnership with Buffett) based on Buffett’s economic performance. The only emotion Buffett wanted guiding his partners’ investments was their confidence in him.
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Like what you just read? Read the rest of the world's best book summary and analysis of Alice Schroeder's "The Snowball" at Shortform.
Here's what you'll find in our full The Snowball summary:
- A biography of one of the wealthiest people in the world, Warren Buffett
- Why Buffett is known for his honesty and wisdom, just as much as his wealth
- How Buffett's life was shaped by his family, his teachers, and the era into which he was born
