Actually, it was the title of a section of Warren Buffet’s Berkshire Hathaway’s just released annual report. I figure, if it’s good enough for the world’s greatest investor, it’s good enough for me.
In this report, Buffet tells a fable about a wealthy American family prospering as the family business grows.
One day, a few fast-talking professionals approach some of the family members and offer, for a fee, to help outsmart other family members by buying certain assets and selling others.
What were those other family members to do? Why hire their own professionals, naturally. Pretty soon this family finds itself with multiple professionals, of all types, taking a big chunk of the family earnings, which haven’t increased one iota.
In reality, this fable is a metaphor for the increasing expense burden put on the American investor through the “my professional is better than yours” fallacy. The inevitable outcome has to be that the investor will earn the market return less the ever-increasing costs imposed by our professionals.
Buffet’s cautionary tale was definitely preaching to the choir for yours truly, but it stopped short in the specifics department. So, I thought I would expound a bit and offer you this simple two-step approach to minimizing your investment returns.
Step One: Family first – buy funds from an expensive mutual fund family.
You’ve heard that it’s not about what you pay, it’s about increasing your net return. Of course, in the world of investing, what you pay will ultimately result in a lower return.
Since we’re trying to minimize returns, put the family first and pick funds from an expensive mutual fund family. You can see from the chart that domestic mutual fund performance is inversely proportional to its costs. Morningstar rates mutual fund performance against their peers, and nearly 60 percent of the Morningstar Family ranking is predicted just by knowing their costs.
Should you be worried that buying a five star fund from an expensive family may maximize your return? Not at all. Even a poorly rated family has some hot funds, but those funds are likely to regress to the family’s dismal performance.
If you’re unsure of which fund family has low overall performance, go to www.Morningstar.com. Even without researching, it’s a pretty safe bet that if you pick a fund family from a Wall Street brokerage firm, you have an expensive, low performing family.
It may be that they are following the advice of their Wall Street analysts who have consistently underperformed the market.
Now if you want to increase your odds of minimizing returns, pick a “fund of funds” in the expensive mutual fund family. That way you get an added layer of costs and are virtually guaranteed to be throwing your money away.
If the costs of expensive mutual funds aren’t minimizing enough, Buffet notes the option of paying even higher fees to hedge fund managers in this zero-sum game.
Step Two: Follow your instincts.
To minimize investment returns, I always suggest we listen to our emotions. We are emotionally programmed to buy high and sell low, so let’s go with that.
Today you might notice that all of the hype is about gold, energy and real estate investment trusts. First, let’s way overweight those sectors that have already done well. Then, once they’ve established a nice track record of underperforming, let’s have our fear take over and sell them faster than traffic on Interstate 25.
Then let’s do it all over again when greed lures us into buying the next hot sectors. Nothing like constant turnover to suck your returns down the drain.
Finally, I can’t stress enough the importance of believing every word-of-mouth tip you receive during your daily life. That neighbor of yours spilling beer on his shoes at the block party is actually a brilliant investor, or has a professional who is one. By all means, listen to their brilliance and buy what they say. This strategy worked quite well to minimize returns during the Internet bubble and always stands the test of time.
I can’t guarantee that expensive investments and following your instincts will underperform every year, but it will in the long run. Buffet notes that had Sir Isaac Newton not been so traumatized by his South Sea Bubble investment loss, he may have discovered the fourth law of motion: For investors as a whole, returns decrease as motion increases. That motion increases costs and taxes and will achieve the long-term goal of minimizing investment returns.
Now, for those who would rather maximize investment returns, just do the opposite of this two-step approach. Keep costs and taxes low, then let the power of inertia take over and do nothing. Buffet noted last year, “Investors should remember that excitement and expenses are their enemies.”
Allan Roth is a CPA and a certified financial planner. He is the founder of Wealth Logic LLC, an hourly based financial planning and licensed investment advisory firm, and is an adjunct finance faculty member at the University of Colorado at Colorado Springs. He can be reached at 955-1001 or at ar@DareToBeDull.com.