High investment industry fees do not result in superior returns

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Were past periodic stock market victories just plain good luck? What is the probability of being lucky again?

Warren Buffett thinks investment industry fees are too high. This was one of his messages in the 2017 annual letter to Berkshire Hathaway shareholders.

Excessively high fees are not a new topic for Warren Buffett, or this column.

“When trillions of dollars are managed by Wall Streeters charging high fees, it is usually the managers who reap outsize profits, not the clients,” Buffett wrote.

Taking into account the rarity of someone outperforming the stock market, Buffet continued, “The problem simply is that the great majority of managers who attempt to over perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well.”

We know from logic, as well as academic evidence, the higher the investment fee paid the less money remains for the investor. The arithmetic is simple, high fees equal low returns.

A consistent message from Buffett is to invest in low-cost diversified index funds. In a previous column, several years ago, I discussed his estate planning strategy for money he will leave his wife.

Upon his passing, Buffett has instructed his wife’s trustee to put 90 percent of her inheritance into a low-fee S&P 500 index fund and 10 percent into short-term government bonds.

Buffett didn’t say this split would be good for all investors, but the point made is it’s better to have a low-cost investment option than overpay for underperformance from a traditional manager.

My recommendation for investors is to have strong diversification, low cost, tax effective investments. It is that simple.

Unfortunately, simple doesn’t work for many “sophisticated” investors, including pension funds and charities.

Many of these strategies are still built around the obsolete notion that having a high-priced manager will somehow miraculously result in superior returns.

Not so.

Failure often leads to replacing one high priced, ineffective, manager with another.

And the cycle of inferior return continues.

In that sense, the less sophisticated retail investor has started to see the benefit of low cost and diversification.

Actively managed, and expensive, mutual funds in the United States lost $342 billion as a result of clients withdrawing their money.

That is an amazingly high amount of withdrawals.

Particularly because the stock market has had attractive returns during that period so you would think that many investors would be satisfied.

Guess where the money went? Over $500 billion of new money was invested in low-cost passive index and exchange traded funds.

The beginning of the end has started. Finally, we see that logic will prevail.

For some the transition will be hard.

They look back at past successful investment decisions and think they have the ability to maintain that winning streak.

The soul-searching question is whether past periodic stock market victories were just plain good luck.

What is the probability of being lucky again?

There are many things for investors to consider. After careful thought, decide how you invest your funds.

High priced managers, including those who manage your mutual funds, do not justify their high fees when you look at past performance. The more money they make the less money you make.

There are better investment alternatives with lower fees and the likelihood of better returns.

These are the types of investments you should own.

Speak with your investment advisor about adjusting your investment strategy towards lower cost investment solutions.