Warren Buffett - How to minimize investment returns

Key takeaways at the end

""

It’s been an easy matter for Berkshire and other owners of American equities to prosper over the years. Between December 31, 1899 and December 31, 1999, to give a really long-term example, the Dow rose from 66 to 11,497. (Guess what annual growth rate is required to produce this result; the surprising answer is at the end of this section.) 

This huge rise came about for a simple reason: Over the century American businesses did extraordinarily well and investors rode the wave of their prosperity. Businesses continue to do well. But now shareholders, through a series of self-inflicted wounds, are in a major way cutting the returns they will realize from their investments.

The explanation of how this is happening begins with a fundamental truth: With unimportant exceptions [...] , the most that owners in aggregate can earn between now and Judgment Day is what their businesses in aggregate earn. 

True, by buying and selling that is clever or lucky, investor A may take more than his / her share of the pie at the expense of investor B. And, yes, all investors feel richer when stocks soar. But an owner can exit only by having someone take his / her place. If one investor sells high, another must buy high. For owners as a whole, there is simply no magic [...] that will enable them to extract wealth from their companies beyond that created by the companies themselves. 

Owners earn less than their businesses earn because of “frictional” costs. And that’s my point: These costs are now being incurred in amounts that will cause shareholders to earn far less than they historically have. [...]

That’s where we are today: A record portion of the earnings that would go in their entirety to owners [...] is now going to a swelling army of Helpers. 

[Buffett goes on in length explaining how this army of ”Helpers” established themselves over time. In short, Buffett wants you to think of the following: (in ascending order of fee levels and perceived sophistication) brokers; managers; financial planners / consultants; and then come the hyper-helpers with sexy names: private equity; hedge funds. Key takeaways explain the conflicts of interest.]

[...] Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases. 

Here’s the answer to the question posed at the beginning: [...] a gain of 5.3% compounded annually. (Investors would also have received dividends, of course.) To achieve an equal rate of gain in the 21st century, the Dow will have to rise by December 31, 2099 to – brace yourself – precisely 2,011,011.23. 

2005 Shareholder Letter

* Bold emphasis added

""

Key concepts and takeaways:

• Returns decrease as motion increases: Over a long period, the amount of friction costs has a tremendous impact on your returns. 

• Conflicts of interest: There are several groups of “Helpers” that live off volumes and have limited skin in the game. Although execution services are necessary and stock analysts provide potentially valuable insights, you must never forget the following inherent conflicts of interest. 

  • Brokers and research / stock analysts: This group is trying to persuade you to act (buy or sell). Their compensation is driven by trading volumes.

  • (Fund) managers: This group is trying to persuade you that your money is better managed and safeguarded with them. Yes, not everyone has time and capabilities to manage their own portfolio, however, one must not fall into a trap of expensive and seemingly sophisticated products that are no better than a simple and cheaper exposure to a market index.

  • Media / macro forecasters: Their job is done the second you click on that catchy headline.