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Ethan Olson
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As a full-time auditor with a Big Four accounting firm, investing is my part-time hobby. I received my Bachelors and Masters Degree in Accounting from the University of Alabama with an additional emphasis in Finance. I have five years of investing experience and a philosophy based on strong... More
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  • Becoming A Berkshire Millionaire

    As an investor that knows just how disastrously wrong things can go with individual stocks, I would never advocate somebody putting all of their investing eggs into one stock basket when it comes to saving for retirement or building wealth. However, if you did decide to do just that, Berkshire Hathaway (BRK.A, BRK.B) may just be the best place to do it. Because of its portfolio spanning roughly a dozen different sectors, containing the stock of 43 different publicly traded companies at last count, and claiming a few wholly-owned subsidiaries, Berkshire looks a lot more like a highly diversified mutual fund than a stock.

    So, I had an intriguing thought: how long would it take to become a millionaire by investing in only Berkshire Hathaway stock? (See my article on why I don't think Berkshire should be paying dividends here.)

    Now, past performance of the stock is not a perfect indicator of future performance. Even though Berkshire has added an average of 19.7% to its book value every year since 1965, it would be unreasonable to think that that streak will continue over the next 50 years. As the company grows, there will be diminishing returns associated with the difficulties of uncovering investments large enough to be worthwhile for Berkshire. And as much as anyone hates to admit it, myself certainly included, there will be a time that Berkshire will have to do without its current chairman, president, and CEO, Warren Buffett. However, Buffett's investing philosophies focused on value, sustainability, and long-term growth will continue on even after he's gone and I have little doubt that Berkshire will continue to outperform the S&P 500 because of it.

    Having said all of this, I wanted to see just how wealthy an investor would become if they had started investing in Berkshire fairly recently.

    Model Assumptions

    To start out, I used the following assumptions:

    1) An investor purchases $3,000 in BRK-B stock on the first day (or the next day the market is open) of every month. This would be an aggressive contribution for the average investor, but it's definitely doable somebody living frugally.

    2) Brokerage commission fees are $5 per transaction. I used OptionsHouse to provide this quote.

    3) Since fractional shares cannot be purchased, any part of the $3,000 left over from a prior month will roll over into the next month and be applied toward those purchases.

    4) Since BRK.B has only been available to the public in recent years (since 1996) and went through a 50:1 stock split in 2010 after its initial 30:1 ownership ratio compared to BRK.A, I simply used the adjusted closing price of BRK.A and divided it by 1,500 to come up with a projected closing price for BRK.B.

    Before I get hounded in the comments section over assumption 4, let me just say that the purpose of this article is to see what an investor could reasonably expect their investments to grow into from investing in Berkshire moving forward. Even though BRK.B was not always available to the public in the past, it will be moving forward and this model will just go to show how powerful Berkshire's compounding can be when it comes to building wealth.

    Results

    The results I've found are summarized in the table below.

    (click to enlarge)

    From looking at this, you can see that if an investor started these contributions in just 1998, they'd be a millionaire today.

    The most important places to look in this table, though, are the Monthly IRR and Annual IRR (internal rate of return) columns on the right. Using this rate, you can calculate the portfolio's value for any contribution amount using the following formula:

    The IRR is important because it is the rate at which the contributions compound during every period throughout the life of the investment.

    You can tell that the maximum IRR was obtained from the 1990 and 2010 start dates and this is pretty indicative of the overall markets at those times. Having invested in 1990, an investor would have ridden the bull market throughout the majority of the 90s. The 2010 start date investor would have bought in near the bottom of the market and ridden the post-recession rallies we've seen in recent years. If I ran this model again in 10 years, I would expect the 2010 Annual IRR to normalize to around 12%-13%.

    For comparison purposes, here's how an investor would've fared investing in just an S&P 500 Index Fund over the same period.

    (click to enlarge)

    The difference in the Annual IRRs between these two tables is staggering. The dollar value effect can really put this difference into perspective. Based on an investing start date of 1990, a Berkshire investor would have nearly tripled (2.66x) the portfolio value of an S&P 500 investor with the same contributions. Tripled!

    And as you can see, this difference is consistent across 5 of the 6 periods observed. In fact, the Annual IRR of Berkshire is more than double that of the S&P 500 for 3 out of the 6 years observed (1990, 1994, and 1998) and the only year that Berkshire trails the S&P in (2010) has the shortest time horizon, which causes more volatility in the IRR calculation, and the difference is less than 1%.

    Concluding Thoughts

    Like I said before, this article is no more than an informational look in the rearview mirror. If anything, it's a testament to just how consistent and high-performing Berkshire's investments have been over the past three decades. From this analysis, it's clear that Berkshire has not just outperformed the S&P 500 over the last 24 years. They've obliterated it.

    You would be hard-pressed to argue that Berkshire doesn't merit serious consideration in every investor's portfolio, even if Berkshire's returns aren't expected to be as impressive in the future. As far as the equity investments section of one's portfolio goes, I would encourage a long, hard look at taking a serious stake Berkshire stock.

    However, this exercise highlights a second point that's just as important to investors: consistency in contributions to investments is the most powerful tool you have. No matter how the market behaves in the short-term, the value of your portfolio will grow exponentially higher if you can find a way to invest a set amount every period.

    The model used here is based on contributions of $3,000 per month. For some, this may be feasible. For others though, this might not be enough. Tailor your investing strategy to fit the greatest amount of contributions you can afford to make. Maximizing your contributions at the start of your investing career will generate the greatest portfolio value in the long run.

    Demonstrating this, 19.3% of the total portfolio value for the Berkshire investing strategy starting in 1990 (shown in the first table above) came from contributions in 1990 alone. Those contributions added up to just 4.1% of the total contributions made! The power of compounding caused these contributions to be the most valuable though because they had the longest time horizon in front of them (24 years).

    One thing this model also assumes is that contributions will never increase throughout the entire 24 years observed, which is somewhat ridiculous. Do you want your portfolio to grow more? Let your investment contributions keep up with raises to your compensation. Can you afford to downsize your spending temporarily? Do it! There's nobody stopping you and the benefits of just a few sacrifices in the short-term will continue to amplify as time goes on.

    The only thing holding you back from creating wealth is yourself. Starting your investing early on will give you the freedom to not only live off of your wealth instead of your employer, but will allow you to do so earlier than those who wait to start investing.

    And if you're looking for a good place to start your investing, I hear that BRK.B is only trading at 1.3x Book Value...

    Thanks for reading my instablog! If you'd like me to send you my model, just leave your email in the comments section below and I'll be happy to get it to you.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Feb 20 2:07 PM | Link | Comment!
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