Low cost is elementary, according to Buffett

When Warren Buffett offers to share his most important investment lesson it is not surprising that investors around the globe take notice.

Buffett can reasonably be described as the best known active investor in the world. So when his “investment secret” is to tell Berkshire Hathaway shareholders that “passive” investors can do better than “hyperactive” investors because of the impact of high fees, some commentators have reacted with surprise and a level of disdain.

This year, the Berkshire Hathaway annual shareholder meeting was streamed live for the first time – all seven hours of it – dramatically increasing the audience to hear directly from Buffett and his long-time business partner and the company’s vice-chairman, Charlie Munger, which means any of us with a decent internet connection can watch the replay at our leisure.

For Buffett followers – of which there are legions – his critique of investor “helpers” will have not been a surprise.

After all, he has a long-standing bet with hedge fund Protege Partners that a low-fee S&P index 500 fund will beat five fund-of-hedge funds picked by the hedge fund manager over 10 years. Buffett updated Berkshire Hathway shareholders at their recent annual meeting in Omaha on the progress of the decade-long bet for $1 million that will be paid to the winner’s chosen charity.

The bet began back in 2008 and at the end of 2015 the S&P 500 index fund had a cumulative return of 65.7 per cent – compared to the hedge fund’s 21.9 per cent.

Buffett’s “sermon”, as he described it, at the recent Berkshire Hathaway meeting is really calling out the corrosive, destructive impact of high fees on investment returns.

In many ways the argument for passive investing is counter intuitive.

Whether it is at school, university, in the workplace or on a sporting field we are exhorted to work hard and with that extra effort comes the expectation of higher rewards (not always monetary) in whatever is our chosen field of endeavour.

In everyday life – be it education, technology, cars, travel or restaurants – we can generally see a link between higher prices and higher services or value. We understand the maxim that you get what you pay for.

Which is where investing challenges our usual, rational decision-making processes.

Doing nothing can feel like a cop out. Accepting “average” returns may feel like a recipe for mediocrity.

The term “passive” investing is a misnomer. If you decide to invest using an index approach that is an “active” decision. Using index investment vehicles like funds or ETFs to build your asset allocation within your portfolio is both a result of active decision-making and one of the most important decisions you make as an investor.

Deciding to focus on what is within your control as an investor – like costs – is another critical, active decision.

The lesson for investors from Warren Buffett’s message is not about index versus active styles of investing. Both have a role to play particularly where fees for active management are kept as low as possible.

As Munger pointed out Berkshire Hathaway shareholders have been well-rewarded over the company’s investment journey. There will always be a small set of managers who will outperform market returns.

The challenge is finding them and as Munger told the annual meeting “that is like trying to find a needle in a haystack”.

Better then to buy the haystack – which is what investor’s following Buffett’s advice to buy broad-based, low cost index funds are doing.

This material has been reprinted with the permission of Vanguard Investments Australia Ltd

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