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Warren Buffett's Ground Rules: Words of Wisdom From the Partnership Letters of the World's Greatest Investor by Jeremy Miller

Great book on the partnership letters of Warren Buffett when he was managing money in his early years. The author read all of Buffett's partnership letters and summarized them in this book and added his own insight as well. Highly recommended if you're looking to set up your own hedge fund or investment partnership. Warren is very famous for being one of the best stock pickers and this book focuses on the first stage of his evolution as an investor. This book also looks in depth at how Warren set up the partnership and focuses on how fair Warren was in not robbing his partners with high fees.


My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe 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.

In the great majority of cases the lack of performance exceeding or even matching and unmanaged index in no way reflects lack of their intellectual capacity or integrity. I think it is much more the product of: (1) group decisions - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is "safe" and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) and adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.

Buffett’s lessons from the letters have revolved around six key ideas for all investors: Think of stocks (1) as fractional claims on entire businesses, (2) that swing somewhat erratically in the short-term but (3) behave more in line with their gains in intrinsic business value over the longer term, which, when (4) viewed through the lens of a long-term compounding program (5) tend to produce pretty good results, which, with (6) an index product, can be captured officially in a low-cost, easy-to-implement way.

It had a general partner, the GP (Buffett), who was responsible for the management and took a percentage of the profits. The limited partners, the LPS (like aunt Alice), contributed capital but had no saying how funds were deployed.

I had no plans to start a partnership, or even have a job. I had no worries so long as I could operate on my own. I certainly did not want to sell securities to other people again. But by pure accident, seven people, including a few of my relatives, said to me, "You used to sell stocks, and we want you to tell us what to do with our money." I replied, "I'm not going to do that again, but I'll form a partnership like Ben and Jerry had, and if you want to join me, you can." My father-in-law, my college roommate, his mother, my aunt Alice, my sister, my brother-in-law, and my lawyer all signed on. I also had my hundred dollars. That was the beginning - totally accidental.

Buffett set [his investment partnership] up so that additions and redemptions could be made only once a year, which forced investors to look at their performance from a long-term perspective. However, partners could borrow as much as 20% of their capital or pre-fund year-end additions for this privilege, before charged or paid 6% interest respectively, giving LP's access to funds in the event that they really needed them and more than fairly compensating those who wish to add to their existing investment.

In the event of losses, there will be no carry back against amounts previously credit to me as general partner. Although there will be a carry forward against future access earnings.

The right to borrow during the year, how to 20% of the value of your partnership interest, at 6%, such loans to be liquidated at year end or earlier.... I expect this to be a relatively unused provision, which is available when something unexpected turns up and they wait until your end to liquid a part or all of a partner's interest would cause hardship.

Pg 71-72 - The types of investments Buffett made in his partnership.

Buffett teaches investors to think of stocks as a conduit through which they can own their shares of the assets that make up a business. The value of that business will be determined by one of two methods: (1) what the assets are worth if sold, or (2) the level of profits in relation to the value of assets required in producing them.

Operationally, a business can be improved in only three ways: (1) increase the level of sales; (2) reduce costs as a percent of sales; (3) reduce assets as a percentage of sales. The other factors, (4) increase leverage or (5) lower the tax rate, are the financial drivers of business value. These are the only ways a business can make itself more valuable.

Several morals: 1. our business is one requiring patience. It has little in common with a portfolio of high flying glamour stocks and during periods of popularity for the ladder, we may appear quite stodgy. 2. it is to our advantage to have securities do nothing price-wise for months, or perhaps years, why we are buying them. This points up the need to measure our results over an adequate period of time. We suggest three years as a minimum. 3. We cannot talk about our current investment operations. Such an open mouth policy could never improve our results and in some situations could seriously hurt us. For this reason, should anyone, including partners, ask us whether we are interested in any security, we must plead the "Fifth Amendment."

Our business is that of ascertaining facts and then applying experience and reason to such facts to reach expectations. Imprecise and emotionally influenced as our attempts may be, that is what the business is all about.

There are only three ways to avoid ultimately paying the tax: 1 Die with the asset - and that's a little too ultimate for me - even the zealots would have to view this "cure" with mixed emotions; 2 give the asset away - you certainly don't pay any taxes this way, but of course you don't pay for any groceries, rent, etc., and 3. lose back the gain - if your mouth waters at this tax saver, I have to admire you - you certainly have the courage of your convictions.

One of my friends - a noted west coast philosopher - maintains that the majority of life's errors are caused by forgetting what one is really trying to do.

Means and end should not be confused, however, and the end is to come away with the largest after tax rate of compound.

I just don't see anything available that gives any reasonable hope of delivering such a good year and I have no desire to grow up around, hoping to "get lucky" with other people's money. I am not attune to this market environment and I don't want to spoil a decent record by trying to play a game I don't understand just so I can go out a hero.

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