Buffett 2013 — The index-fund will and six moves that explain it
From Warren Buffett's 2013 Berkshire Hathaway shareholder letter: the widest single-year underperformance in Berkshire's history (−14.2 pts vs. S&P) framed as a structural design feature; the Heinz/3G partnership template as a repeatable acquisition architecture; the "Powerhouse Five" delivering record $10.8B pre-tax earnings with minimal dilution over nine years; eleven consecutive underwriting-profit years and the float-as-revolving-fund reframe; a two-case investment philosophy primer (Nebraska farm + NYU building) that cuts against daily price-watching; the EFH bond loss and a one-line admission; and the will clause directing 90% of his wife's trust into a Vanguard index fund — explained not as modesty but as precision about who can actually beat the market.
Published: February 28, 2014 — Warren Buffett, Berkshire Hathaway 2013 Annual Report
The 2013 letter contains a passage that every Buffett reader eventually has to sit with: he reveals the investment instruction in his own will. For his wife's trust, he directs the trustee to put 10% in short-term government bonds and 90% in a very low-cost S&P 500 index fund — specifically, Vanguard's. 1
The man who has compounded Berkshire's book value at 19.7% annually since 1965 — versus 9.4% for the S&P 500 — is telling his wife's trustee to buy the index. 1 The juxtaposition is not a contradiction. It is the most compressed statement of Buffett's investment philosophy in the letter: the exceptional returns he has produced are genuinely exceptional, and the right lesson for the non-professional investor is precisely not to try to replicate them.
That tension — between what Buffett does and what he recommends everyone else do — runs through every section of the 2013 letter. The year saw Berkshire trail the S&P 500 by the widest margin in the firm's 49-year history. It also saw Berkshire name its five largest non-insurance businesses the "Powerhouse Five" and report their combined pre-tax earnings at a record $10.8 billion. 1 Both facts are in the same letter because they tell the same story: excellence over long cycles, structural underperformance in the strongest bull-market years, and a clear-eyed accounting of both.
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The underperformance that was designed to happen
In 2013, Berkshire's per-share book value grew 18.2% — an $34.2 billion absolute gain in net worth — while the S&P 500 returned 32.4% including dividends, leaving a gap of 14.2 percentage points. 1 Over 49 years, that kind of underperformance had happened only ten times.
Buffett's response in the letter's opening pages was neither defensive nor apologetic. He had long stated the structural prediction: "Charlie Munger, Berkshire's vice chairman and my partner, and I believe both Berkshire's book value and intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall short, though, in years when the market is strong — as we did in 2013." 1 Nine of the ten underperformance years in Berkshire's history occurred when the S&P gained more than 15%.
The accountability he offered was characteristically framed in terms of full cycles rather than single years: "Over the stock market cycle between yearends 2007 and 2013, we overperformed the S&P. Through full cycles in future years, we expect to do that again. If we fail to do so, we will not have earned our pay." 1
For the investor: a manager who specifies in advance the conditions under which they will underperform — and then underperforms exactly those conditions — is demonstrating something rarer than alpha. Most managers quietly retire or revise benchmarks when results turn unflattering. The willingness to keep the same yardstick when it makes you look bad is itself a signal about how incentives are structured.
The Heinz partnership template
In June 2013, the Berkshire–3G Capital acquisition of H. J. Heinz closed. The structure was two-part: $8 billion in Heinz preferred stock paying a 9% coupon (with additional features pushing effective returns to roughly 12%), plus $4.25 billion in common equity representing half of Heinz's common shares, with 3G Capital matching Berkshire's common equity stake. 1
3G Capital, led by Buffett's long-time friend Jorge Paulo Lemann, provides the operational discipline — systematic cost management, zero-based budgeting — while Berkshire provides permanent capital with no exit mandate. Buffett identified the structural distinction directly: "Though the Heinz acquisition has some similarities to a 'private equity' transaction, there is a crucial difference: Berkshire never intends to sell a share of the company. What we would like, rather, is to buy more." 1
He called it "a partnership template that may be used by Berkshire in future acquisitions of size." 1 Heinz contributed only modest earnings in 2013 — the year absorbed $1.3 billion in one-time restructuring charges — but Buffett projected "substantial" 2014 earnings, and the preferred alone was yielding compounding returns regardless of operational results. Heinz also made Berkshire the owner of its 8½th Fortune 500-level company, prompting his characteristic aside: "Only 491½ to go."
For the investor: the preferred-plus-equity structure extracts multiple return layers from one capital commitment — dividend yield, redemption premium, and equity upside. When Berkshire uses this template, reading the deal requires evaluating all three terms together, not the headline equity percentage alone. The permanent-capital distinction is equally important: the absence of an exit mandate removes the return-timing pressure that private equity's fund structure imposes, which is what allows a management team to optimize for decade-horizon value rather than near-term realizations.
The Powerhouse Five and the dilution scorecard
The 2013 letter introduced formal nomenclature for Berkshire's five largest non-insurance businesses: BNSF (railroad), Iscar (metal cutting tools), Lubrizol (specialty chemicals), Marmon (industrial conglomerate), and MidAmerican Energy (regulated utilities and renewables). Buffett named them the "Powerhouse Five" and reported their combined pre-tax earnings at a record $10.8 billion, up $758 million from 2012. 1
The relevant context is the nine-year acquisition history: in 2004, only MidAmerican was Berkshire-owned, earning $393 million pre-tax. The other four were acquired over the following years, three entirely for cash, BNSF for roughly 70% cash and 30% stock — the latter representing a dilution of only 6.1%. The nine-year earnings gain from these five businesses was $10.4 billion annually, delivered with "only minor dilution." 1
Buffett framed the goal explicitly: "not simply growing, but rather increasing per-share results." 1 BNSF's 2013 capital expenditure of $4 billion — a record for any railroad in a single year, approximately double its depreciation — illustrated the forward investment posture. Buffett quoted his own 2009 characterization of the BNSF purchase: "an all-in wager on the economic future of the United States," and renewed it: "Charlie and I believe that 'betting' on the continued prosperity of America will be very nearly as good a wager in the future as it has been in the past." 1
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For the investor: the dilution scorecard matters as much as the earnings growth headline. A company that doubles operating earnings while doubling its share count has accomplished nothing on a per-share basis. Buffett's insistence on measuring per-share results — and on acquiring businesses for cash wherever possible — is the mechanism that turns operating growth into shareholder value. Any acquisition that requires significant stock issuance warrants scrutiny on this dimension.
Insurance float: eleven years and a revolving-fund reframe
By yearend 2013, Berkshire's insurance float reached $77 billion, up from $41 billion eleven years earlier — and the insurance operations had produced a pre-tax underwriting profit for eleven consecutive years, with 2013's contribution at $3.1 billion. Cumulative pre-tax underwriting profit over the eleven-year streak: $22 billion. 1
Berkshire's $8.6 million acquisition of National Indemnity in 1967 was the seed. Ajit Jain's BH Reinsurance operation — started from zero in 1985 — carried $37 billion of that float alone. Buffett characterized Ajit's output simply: "Ajit's mind is an idea factory that is always looking for more lines of business he can add to his current assortment." 1 In June 2013, Ajit also launched Berkshire Hathaway Specialty Insurance (BHSI), entering commercial insurance under Peter Eastwood — a business Buffett projected would generate "several billion dollars of premium volume within a few years." 1
The accounting reframe Buffett offered in the letter is worth internalizing. GAAP records float as a full liability — as if every policy would be paid out tomorrow and no new premiums would ever arrive. Buffett's counterargument: "If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this liability is dramatically less than the accounting liability." 1 This gap between GAAP treatment and economic reality is one of the two structural explanations for why Berkshire's intrinsic value substantially exceeds its book value.
For the investor: when analyzing an insurance holding company, the central question is not "how large is the float?" but "at what cost is the float being held?" Eleven consecutive years of underwriting profit means the cost was negative — Berkshire was paid to hold capital it then invested freely. A combined ratio above 100 means the float is expensive debt. The distinction between these two conditions is the entire difference between a float-as-asset and a float-as-liability.
The farm and the NYU building: five investment principles in twelve pages
The longest section of the 2013 letter — running roughly twelve pages under the heading "Some Thoughts on Investing" — is also the most direct expression of Buffett's investment philosophy. He frames it through two small, non-stock investments.
In 1986, Buffett bought a 400-acre Nebraska farm from the FDIC for $280,000 — far below the loan value the failed bank had carried against it. He knew nothing about farming but his son was a farmer. He calculated the normalized return on corn and soybean yields against operating costs, estimated roughly 10% on his purchase price, and bought. Twenty-eight years later: earnings had tripled, the farm's value had increased more than fivefold. He had visited it twice. 1
In 1993, he purchased a commercial property near New York University from the Resolution Trust Corporation (the government vehicle created to liquidate assets from the savings-and-loan crisis). Unleveraged current yield was approximately 10%. The anchor tenant paid roughly $5 per square foot; other tenants were paying an average of $70. When those leases rolled off in nine years, the building's economics would transform. Current annual distributions now exceed 35% of his original equity investment. He has never visited the building. 1
From these two cases he drew five principles. The most important was the treatment of price volatility: "Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays." 1 His explicit analogy: if you held a farm or apartment building and couldn't get a daily quote on it, you wouldn't sell in a panic because a neighbor offered you a low price. The daily stock quote is a feature of markets, not a requirement to transact.
On macroeconomic forecasting, he was direct: "Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important." 1 In 2008 and 2009, amid extreme financial panic, he had never considered selling either the farm or the New York building. "Corn would be grown in Nebraska" and "students would flock to NYU." The business fundamentals hadn't changed because credit markets had.
For the investor: the farm analogy resolves a question that trips up many equity investors — why isn't the daily price quote useful information? Buffett's answer is that it is useful precisely when price dislocates from productive capacity, and useless (or harmful) when it substitutes for productive-capacity analysis. His statement that "a climate of fear is your friend when investing; a euphoric world is your enemy" 1 is not contrarianism for its own sake. It is a structural consequence of buying productive assets at depressed prices.
The will clause: what the index fund recommendation actually means
The last analytical move in the letter is also the most frequently misread. Buffett's instruction to his wife's trustee — 90% S&P 500 index fund, 10% short-term government bonds — appears immediately after his extended argument that non-professional investors cannot reliably pick winning stocks or winning managers. 1
The recommendation is not modesty. It is precision. His stated logic: "The goal of the non-professional should not be to pick winners — neither he nor his 'helpers' can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well." 1 The helpers comment carries weight: he is describing not just the average retail investor but pension funds, institutions, and individual investors who pay active managers. Most of them underperform a passive benchmark after fees.
He added a behavioral qualifier about the word "when": the main danger for the non-professional investor is not bad stock selection but mistimed market entry and panic-driven exit. "The primary danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur." 1 His prescription: accumulate equities over time, never sell on bad news, and minimize costs.
Barton Biggs — the veteran Morgan Stanley strategist who died in 2012 — supplied the epigraph: "A bull market is like sex. It feels best just before it ends." 1 The practical guidance that follows it is Buffett's own: buy the index, hold it through bad news, keep costs close to zero.
For the investor: Berkshire in 2013 was, in a sense, proving both things simultaneously. For the professional with genuine analytical advantages, a concentrated portfolio of wonderful businesses held for decades will outperform an index over a full cycle. For everyone else — and this includes most professionals — the index is not a consolation prize but the rational choice. The will clause is Buffett acknowledging, without embarrassment, exactly which category most investors occupy. The harder question is which category you actually belong to, not which one you believe you belong to.
One honest mistake
The 2013 letter also contains one of the rarest things in the Berkshire corpus: a straightforward admission of an investment error with a named culprit.
Energy Future Holdings (EFH) was created in 2007 to execute a leveraged buyout of Texas electric utility assets — $8 billion in equity, heavy debt layered on top. Berkshire purchased approximately $2 billion of EFH bonds. Buffett sold them in 2013 for $259 million, having collected $837 million in cash interest along the way. Net pre-tax loss: $873 million. 1 He expected EFH to file for bankruptcy in 2014 unless natural gas prices spiked significantly.
The accountability was simple and unadorned: "About $2 billion of the debt was purchased by Berkshire, pursuant to a decision I made without consulting with Charlie. That was a big mistake. Next time I'll call Charlie." 1
He opened the EFH discussion with a line that functions as both self-deprecation and reader advisory: "Most of you have never heard of Energy Future Holdings. Consider yourselves lucky; I certainly wish I hadn't." 1
For the investor: the EFH loss was roughly 1.7% of Berkshire's 2013 book value — significant but not existential. The structural lesson Buffett draws is not about leveraged buyouts or utility regulation. It is about process. He made the decision alone, outside the normal check that Munger provides. His prescription for himself is identical to what he would prescribe for any organization: design the process so that the bypass condition is harder to trigger, not merely resolved to avoid next time.
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The 2013 letter ends, quietly, with Berkshire at an inflection. The firm had grown to a scale where finding businesses large enough to affect results required either full acquisitions at the Heinz level or continuing to hold concentrated equity positions in American Express (14.2%), Wells Fargo (9.2%), Coca-Cola (9.1%), and IBM (6.3%) — the "Big Four" whose $4.4 billion in combined earnings attributable to Berkshire were two-thirds invisible in GAAP income because only the $1.4 billion in dividends was reported. 1 The will clause, read against that backdrop, is consistent: the man building a structure that compounds unreported earnings invisibly for decades recommends the rest of us stop watching the scoreboard, buy the index, and go outside on Saturdays.
Cover image: AI-generated illustration
References
- 1Berkshire Hathaway 2013 Annual Shareholder Letter
berkshirehathaway.com
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