Warren Buffett's most important investment advice

Warren Buffett (Image credit: forbes.com)
At his recent annual general meeting in Omaha, the billionaire chairman of Berkshire Hathaway Inc. Warren Buffett once again reiterated that investors need to question the fees that are charged by expensive money managers and consultants who consistently fail to better the returns of index funds.

At the AGM, Buffett explained to shareholders that probably the most important investment lesson in the world is that Wall Street salesmanship has masked poor returns for years. “Consultants have steered pension funds and others to high-fee managers who, as a group, underperform what you could get ‘sitting on your rear end’ in index funds. The arrangements eat up capital like crazy,” said Buffett.

His views are echoed by Steven Nathan, CEO of 10X Investments, who agrees with Buffett’s criticism of the traditional investment system that mainly results in an enormous wealth transfer away from savers to the industry. “This system promotes hundreds of different, often complex, investment products, managed by mostly underperforming fund managers and hedge funds with high fees that are endorsed under the guise of independent advice by investment consultants.”

“The net result is that most investors unknowingly underperform the index, pay high fees and retire poor while the industry prospers,” Nathan adds.

Nathan also concurs with Buffett’s comments that consultants who provide investment advice are not incentivised to recommend low cost index funds, or to advise their clients to hold these for the next 50 years.

Nathan says that while there has been a significant rise in index funds over the past forty years and some funds have moved partially or exclusively to passive investing, many others still follow the active management approach in the hope of market-beating returns – despite the low odds of success.

This growing preference for indexing is evident in numbers released by Thomson Reuters, which show that in the United States passively managed equity funds attracted over $1.824 trillion in flows since 2009, while active funds only attracted around $150 billion over the same period. If nothing else, the Global Financial Crises had brought home the message that active managers could not protect investors from a market down-turn. 

Nathan points out that whereas active fund managers believe that their skills enable them to beat the market return, passive managers know that it is simply not possible for most funds to do so.

According to Nathan, two things still hold index funds back, despite their increased popularity. One is distribution: the brokers who sell funds to investors have little incentive to sell cheap ones, as lower fund fees usually translate into a lower commission. “In addition, many investors still believe that they can beat the market by picking a hot fund. Some funds will indeed beat the index, whether by luck or skill, but is hard to identify those funds in advance.”

He points out that the vast majority of South African retirement funds are unfortunately still invested in actively managed funds with the expectation - or hope - of earning a market-beating return. “This higher or excess return is called “alpha” and South African retirement investors pay at least 1% per annum in extra investment fees for alpha.”

Nathan explains that private sector retirement fund assets equal around R1.5 trillion (R1 500 billion), so the quest for alpha costs retirement savers around R15 billion every year. “Investors and trustees seem willing to pay the extra R15 billion, yet few understand what alpha actually represents, and that the total value of alpha in the market - available for all investors to share - is zero.  This misconception is common in the SA industry.”

“At 10X, we are proud to say that our investment model is fully aligned with Buffett’s views. However, as Buffett points out, most investors are seduced by slick sales pitches and marketing promises that are seldom delivered. Hopefully more people will heed his advice and create their own wealth by investing in low cost index funds for long time periods and avoid the traditional system’s salesmanship and empty marketing promises,” concludes Nathan.