When somebody grows their personal fortune to more than seventy billion dollars, questions are naturally asked. How did this person make his money? Was it earned or inherited? For Warren Buffett, many people think his money came from Berkshire Hathaway, however, that misses a lot of his early life. Instead, when you study how Warren Buffett made his money, you have to look to his original partnerships.
When Warren was in his mid 20s he started the first of seven partnerships. Since Buffett came from a well-connected family, his father was a congressman, the original investors were wealthy friends and family members. The folks who invested with Warren put up a few thousand to tens of thousands of dollars to compound. According to The Snowball, by Alice Schroeder, the compensation was structured so that the partnership would pay Warren’s investors four percent interest. If Warren exceeded that return, he got fifty percent of the excess with his partners getting the rest.
The Buffett Partnership’s Compensation is key to how Warren Buffett Made his Money
When Warren Buffett was first starting the investing game, he applied the lessons he learned from Ben Graham. For many people, that is all they think about with Warren. His massive outperformance of the stock market was how he got wealthy. While a large part of the story, it actually gets more interesting. With his partnerships, Warren only invested $100 of his own money. Part of the genius of how Warren Buffett made his money is how he structured his compensation. A large part of his fortune today has its roots there. By massively outperforming the market, Buffett was able to make astronomical returns on the $100 he invested with his partners.
Going through Buffett’s partnership, it is clear just how different a game Warren was playing compared to a run of the mill mutual fund manager. Whereas most managers can’t outperform the market, Warren Buffett was demolishing it. Since most mutual funds only charge around 1% of assets, sure the money earned is fine. Warren, though, was compounding at 20% plus. His much higher fees based on his hard work and talent allowed him to amass millions of dollars on only a few hundred dollars invested. The terms that Buffett set up as his compensation allowed him to reap vastly outsized rewards compared to other compensation arrangements. The ability to reap half of his partnership’s gains while investing such small amounts is related to one of the most important lessons young people can apply to today’s economy.
Applying this Principle in your Life
With a lot of people I know talking about how little income they have after paying expenses, the ability to achieve high rates of return on little invested capital are going to be key to making money. Look at your life. Are you staying at a hotel or renting an apartment or house? Chances are good that the people managing the place are not the same as the people who own it. The folks managing the property receive a percentage on the rent paid for managing the property so the owners don’t have to focus their energies on that. Many people know about how hedge fund managers get twenty percent of their funds profits in compensation over the course of the year. Same thing. Do you like to write ebooks for Amazon? Then you are familiar that since Amazon provides the base, they take a cut of your profits when somebody downloads your work.
One of my ideas was that back when I worked as, I guess you would say secretary, for a medical company that dealt with patients medical records was writing code to scan and sort the records rather than having to manually input and sort them. Unfortunately, I didn’t have the computer or code writing skills to follow through. ‘Lo and behold, a few years after I had left, the company apparently brought in a system to do just that. These things exist out there, but you have to have the skills to follow through with it.
The ability to find high return ideas with low capital investment is, and is going to be, the determinant of financial independence. The hard part is finding opportunities that don’t require a lot of money on your part. The first bit of advice I can give is to look at the world around you. The second is to learn as much as possible. I know that falls under that annoying generic advice column that I absolutely hate receiving, and I know I am being hypocritical here. My only defense is that I don’t know what your skills and talents are. Some people reading this would excel at writing code and developing software. Others would do great at investing other people’s money The point is that none of these folks would have to put up massive amounts of money to get their ideas off the ground. When going through your life keep your eyes open because with this, you only have to do it once or twice, you can achieve financial independence when you hit the home run.