Active investment managers will argue that skilled fund managers (such as themselves) CAN exploit inefficient pricing in the market and deliver above-average returns. And they then invariably point to Warren Buffett, to prove that it is indeed possible to outperform the market over the long-term, and achieve astonishing results.
Warren Buffett is one of the richest people on the planet, and the world’s most successful investor. To wit, $100 invested in the S&P500 index would have grown to $9,841 by the end of 2013 (dividends re-invested), the same amount invested in Berkshire (Mr. Buffett’s investment company) would have grown to $693,518 (based on book value). That is 70 times more than the S&P500!
Notably, Berkshire’s annualised growth rate (19.8% pa) is ‘only’ double the annualised return of the S&P500 (9.7%). But when it comes to compounding, even small differences make a huge impact on the long-term outcome. This is why 10X places so much emphasis on low fees, because long-term fee savings compound into dramatically higher pensions at retirement.
But back to Warren Buffet. No doubt he is highly regarded by just about all active managers, and many try to emulate his style and success. Unfortunately, this admiration is not mutual, as becomes evident in his 2014 Annual Letter to Shareholders.
In his letter, he discusses some of his “key fundamentals of investing”. Although his comments refer to individual stock purchases, they apply equally to retirement fund members.
“You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick ‘no’.”
Notice the term ‘satisfactory’. Serious investors do not strive for the exceptional return, but rather the return that satisfies their requirements. Historically, the market has delivered a ‘satisfactory’ return for retirement investors; choosing a low-cost index funds that tracks is thus “certain to work reasonably well”. Yes, some actively managed funds have delivered satisfactory, even stand-out results, but the majority deliver unsatisfactory results: below- average returns compounded by high fees. That is the problem with selecting an active manager: you cannot be certain that your choice will “work reasonably well”.
Mr. Buffett also cautions against listening to investment ‘experts’ because they encourage you to react and deviate from your long-term strategy: “Because there is so much chatter about markets, the economy, interest rates, price behaviour of stocks, etc., some investors believe it is important to listen to pundits – and, worse yet, important to consider acting upon their comments. [But] 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.”
Share market volatility is a fact of life. Investors who react to daily market moves risk losing sight of their long- term goal.
Owners of stocks, however, too often let the capricious and often irrational behaviour of their fellow owners cause them to behave irrationally as well. Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard.”
He underlines the importance of proper diversification. Most lay investors do not have the skill to predict the future earning power of individual companies (or the performance of fund managers), but that should not be a problem:
“The typical investor doesn’t need this skill. 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. A low-cost S&P 500 index fund will achieve this goal.”
What about beginning investor, who fear they will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur?
“The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long term results than the knowledgeable professional who is blind to even a single weakness.”
Mr. Buffett puts his money where his mouth is: In his will, one bequest provides that cash will be delivered to a trustee for his wife’s benefit. His advice to the trustee: “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. 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.”