It is important to know who is providing investment commentary. What experience do they have? Are they educated? Have they been successful? Do they have any vested interests?
Each year Warren Buffet writes a letter to all Berkshire Hathaway shareholders. It is available on the company website at http://www.berkshirehathaway.com/ . As is each year's letter starting from 1977. They all make outstanding reading. They incorporate interesting and thoughtful financial observations with some enjoyable humour.
In his latest letter Warren Buffet provided interesting commentary on the financial services industry.
But before looking at what Warren Buffett has to say, let's answer the four questions posed in the first paragraph of this article.
What Experience Do They Have?
Warran Buffett has run successful investment businesses since the 1950's. The first was a private partnership. Since 1965 it has been the publicly listed company Berkshire Hathaway. As well as running Berkshire Hathaway, Warren Buffett has served on the boards of publicly listed companies that he has held investments in.
Are They Educated?
Warren Buffet has a tertiary education in finance - learning under Ben Graham, the famous author of the books 'Intelligent Investment' and 'Security Analysis'.
Have They Been Successful?
In the last 41 years the per-share value of Berkshire Hathaway has grown at 21.5% a year. The US S&P 500 index has grown at a rate of 10.3% a year over this same period. In 1965 the book value per-share of Berkshire Hathaway was $19 a share. Today it is $59,377.
Warren Buffett's investment partnership prior to 1965 was also extremely successful.
It is possible to make the case that Warren Buffett is the most successful modern investor. His results are extraordinary over a long period of time.
Do They Have Any Vested Interests?
No doubt Warren Buffett likes investors to purchase his shares. That said, he rarely raises additional capital through issuing additional shares, he is not looking for more investors and he has well and truly built his own personal wealth. There does not seem to be a strong reason for him to ?push' any specific financial product, service or way of thinking.
Warren Buffett's Comments on the Financial Services Industry (From his 2005 Letter to Investors)
Warren Buffett starts by building the argument that any person who simply owns a share of the overall investment market will, over the long term, have done extremely well. They will have earned the market return less some ownership costs. To just invest in a portion of the overall market is reasonably cheap, so the costs would not have diminished the returns by much.
He then moves to say that these costs are now 'being incurred in amounts that will cause shareholders to earn far less than they historically have' (emphasis from original quote).
He lists a number of Helpers who take the focus away from simply owning a share of the long term market returns to a more expensive pursuit of higher returns.
The first are the broker-Helpers, who offer, for a fee, to try and outsmart other investors by buying and selling holdings. These broker-Helpers charge a fee each time that people trade - which encourages the broker-Helpers to encourage trading. So now the increase in wealth of people is the increase in the overall market, less the broker-Helper fees.
Warren Buffet proposes that after a while most of the investors do not do so well under this arrangement, so they recruit a new set of Helpers, the fund-manager-Helpers. The fund-manager-Helpers still use the broker-Helpers to trade the underlying investment assets. So now the increase in wealth of people is the increase in the overall market, less the broker-Helper fees and the fund-manager-Helper fees.
At this point in time Warren Buffett suggest that people's finances have taken a turn for the worse, so they look to employ more professionals in the form of financial planners and institutional consultants to help them select the fund-manager-Helper. And again the fees increase, which decreases overall returns.
With three classes of helpers and overall results getting worse, Warren Buffett suggests that people are despairing, and turn to what he calls hyper-Helpers. These hyper-Helpers are surprisingly similar to the fund-manager-Helpers, although with labels like hedge fund managers and private equity managers. They are expensive - their solution to the increasing reduction in returns is to charge high fees.
Warren Buffett concludes by observing that investment costs 'may well amount to 20% of the earnings of American businesses'. (I can assure you that the situation in Australia is similar to the situation in America)
He suggests the development of a Fourth Law of Motion (after Sir Isaac Newtons laws of motion): 'For investors as a whole, returns decrease as motion increases.'
So what is my response to his broad criticism of the financial services industry? I could not agree more. It is absolutely crucial to keep investment costs down. As a financial planner my job is not to pick expensive fund managers who are going to provide above average returns - I simply cannot do that. I could sound like I was able do do that by selecting for clients a bunch of fund managers who have outperformed over a previous period. However, we know that outperformance over a period is not an indication of future performance, and that the majority of fund managers will underperform the market in the long term. So I cannot expect to find outperforming fund managers. My job is to provide cost effective investment solutions with a focus on getting the correct financial strategy, encouraging people to save regularly and ensuring that they have a well diversified portfolio with appropriate asset class exposure.
Warren Buffett talked about fees. He could also have included taxes as something that diminishes wealth through high levels of trading. As the broker-Helpers, fund-manager-Helpers and hyper-Helpers trade underlying investments, it is likely that more and more tax has to be paid on realised capital gains, which further reduces an investors returns.
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