The Ground Rules

The Ground Rules are the foundational principles established by Warren Buffett to manage expectations and define the relationship between himself (the General Partner) and his investors (the Limited Partners).

📍 Origin

While expectations were discussed since 1957, they were formally codified in a special letter on January 18, 1962.

"I will not be able to promise you results... but I can and do promise that: (a) Our investments will be chosen on the basis of value, not popularity; (b) Our risk of permanent capital loss will be minimized by a significant margin of safety."

📅 Chronological Evolution

• 1957 Letter: Informal Expectations.

  • Context: Even in his second annual letter, Buffett establishes the key behavioral norms: measure against the Dow, expect better performance in bear markets than bull markets, and accept that luck plays a role in any single year's results.
  • Significance: The Ground Rules existed as an ethos before they became a document.

• 1960 Letter: Pre-codification.

  • Context: Buffett introduces the idea of the "Yardstick"—comparing partnership results to the Dow Jones Industrial Average.
  • Quote: "A 'good year' should be defined as a year where we outperform the Dow, even if our absolute return is negative."

• 1962 Letter: Formalization.

  • Rules: Buffett outlines 7 rules, including the 3-to-5-year time horizon, the non-guarantee of results, and the benchmark of beating the Dow by 10 percentage points per annum.
  • Logic: This was necessary as the partnership grew in size and diversity of partners.

• 1964 Letter: Tax Philosophy Codified.

  • Addition: Buffett adds a definitive statement on taxes as part of the operating philosophy: "We will do our level best to create the maximum revenue for the Treasury — at the lowest rates the rules will allow."
  • Significance: This established that tax avoidance would never override investment judgment — a principle that persists at Berkshire to this day.

• 1980 Letter: The Legacy.

  • Evolution: When moving to the public company format of Berkshire Hathaway, Buffett adapted these into the "Owner-Related Business Principles" published in the annual report.
  • Shift: The focus shifted from beating an index (the Dow) to long-term growth in per-share intrinsic value.

📜 Key Principles

• Yardstick: Beats the market by 10% annually.
• Time Horizon: Judge performance over 3 to 5 years.
• Independence: Invest based on value, not popularity.
• Skin in the Game: The manager's wealth is invested alongside the owners.

🔗 Connections

• Parent: Warren Buffett
• Concept: Return on Equity (ROE)
• Concept: Intrinsic Value
• Source: 1960 Letter, 1962 Letter, 1980 Letter