In a letter to his Berkshire Hathaway shareholders entitled “How to Minimize Investment Returns,” Warren Buffett points out that between December 31, 1899 and December 31, 1999, the Dow rose from 66 to 11,497. That’s a 17,400% gain! Thus, a hundred dollars invested into a Dow portfolio during the 20th century would have grown to $17,500!
Yet, that’s an annual compound return over 100 years of only 5.3%, said Buffet while adding that, if only 1% per year is paid in management fees, nearly 20% of the profits would go to the money manager.
Building on Mr. Buffets warning: If a $100 investment was made the last day of 1899 and managed for 1%, it would COMPOUND at a net rate of only 4.3%. Thus, the portfolio would have grown to only $6,736 during the century that followed. The fee would have cost great-gramps over $10,000, leaving him with a little over one-third what he would have without “professional help”.
So what does all this mean in real dollars? Although a dollar in 2000 was worth only 5.4 cents compared to 1900, Great-grandfather’s $100 would have increased by 2000 to nearly $945 in real value compared to 1900, almost 10 times what he started with. Yet, his investment would only be worth $363 after a money manager took an annual 1% bite.
For Warren Buffet, a frictional cost of 1% is very damaging, but what about smaller investors – realizing virtually everyone is a smaller investor than Mr. Buffett. Many are charged fees of 2% or more, either through higher fees or with annuity charges added.
An investor charged 2% in management fees per year on a hundred dollar “Dow” investment held during the 20th Century would end up with only $2,570, instead of $17,500 without management costs! In real dollars of the 1900 variety, that investor would have $139 – a real value profit of $39 rather over $800. Thus, professional help at 2% would have cost the investor 94% of his gains. Value added”? I think not!
In his letter, Mr. Buffet quotes Sir Isaac Newton, a scientific genius who nevertheless lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” It seems that even a genius can be fooled when it comes to investments.
By: William S Shepherd
William Shepherd is the founder of the law firm of Shepherd Smith and Edwards a securities law firm that represents investors seeking recovery of losses in their accounts at investment firms. If you or someone you know has suffered investment losses, contact Shepherd Smith and Edwards today.