The disastrous effect of a 1% management fee

[RenoJay]

Warren Buffett's (Berkshire Hathaway's) annual letter came out today. This passage about the effect of a 1% management fee strikes me as incredible. A big nod to St. Jack Bogle who invented index funds and brought down investment fees for all of us:

"Let’s put numbers to that claim: If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019 (the
latest data available before the printing of this letter). That is a gain of 5,288 for 1. Meanwhile, a $1 million investment by a tax-free institution of that time – say, a pension fund or college endowment – would have grown to about $5.3
billion.

Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have
been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate."

 

[medved]

This assumes that the investor (institutional or individual) would make the same (or better) investment decisions, and achieve the same investment returns, without professional advice as with professional advice. In other words, it assumes that the guy who takes the one percent (or whatever) fee adds no value. That seems to be a commonly held belief among people who post frequently on this board. But I am a dissenter. I believe that investment management professionals — at least good ones — and value. (I do not dispute that there are bad investment management professionals and advisors who take a fee but do not add value, just like there are bad lawyers and doctors and chefs and plumbers).

 

[NYEXPAT]

^+1
Many pro's have outperformed the S&P over their careers including the 1% fee.
I saw my Fathers performance over the years From the 1960's-2000 and he probably averaged 4% better after fee's. Also, these #'s do not account for inflation or that the SPY did not come into existence until the early 1990's. Little known fact: Before buying BH, his career was less than stellar!

 

[6miths]

'The plural of anecdote is not data.' The evidence strongly suggests that the 1% fee is not worth it versus the index as the outperforming advisor cannot be predicted in advance and one is simply left with the drag of the fee. The argument for paying the fee is that the 'average' DIY 'investor' does not in fact stick with a reasonable AA and the indexes but rather lets their emotions get the better of them and does worse than both the indexes and the advisor. If one takes the dispassionate AA/index approach one optimizes the outcome.

 

[audreyh1]

The only argument for an advisor that I can see is that otherwise the individual investor will not stick to a reasonable investment plan, i.e. needs handholding. But the advisor would do the investor a favor by putting them in low cost index funds and rebalancing occasionally rather than managing securities directly for the investor and trying to mimic much lower costing mutual funds.

I don’t need handholding and investing is generally easy, so I prefer not to pay large AUM fees to an advisor.

When you finally figure out that the advisor you got is not one of the “good ones”, well it’s too late.

 

[GrayHare]

The "Rule of 72" strikes again.

 

[Bir48die]

The only argument for an advisor that I can see is that otherwise the individual investor will not stick to a reasonable investment plan, i.e. needs handholding. But the advisor would do the investor a favor by putting them in low cost index funds and rebalancing occasionally rather than managing securities directly for the investor and trying to mimic much lower costing mutual funds.

I don’t need handholding and investing is generally easy, so I prefer not to pay large AUM fees to an advisor.

When you finally figure out that the advisor you got is not one of the “good ones”, well it’s too late.

Well, I guess I’m just an idiot to pay someone managing part of my portfolio for the last 20 years. Some day I’ll be as smart as you.

 

[pb4uski]

.... Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have
been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate."

I was shocked and initially didn't think it was true, but it is:

1*(1+11.8%)^77 = $5,371
1*(1+10.8%)^77 = $2,689

 

[pb4uski]

.... Little known fact: Before buying BH, his career was less than stellar!

Yup... real slacker.

https://www.oldschoolvalue.com/blog...e/warren-buffett-career-timeline-investments/

1949 to 1954 – Age 19 to 24
Buffett’s savings reaches $9800.

He joins Columbia University and learns from Benjamin Graham. He was willing to work for Benjamin Graham, even for free, but was not offered a job.

Buffett returned to Omaha, purchased a Texaco station, but did not go well. He was also working as an investment salesman for Buffett-Falk & Company, at his father’s brokerage firm.

In 1954, Benjamin Graham called him again and offered him a job for $12,000 a year. During this period, Buffett was able to also work closely with Walter Schloss.

1956 – Age 26
Graham decides to retire and fold his business. Buffett’s savings have grown from $9,800 to $140,000.

Buffett returned to Omaha and on May 1, created Buffett Associates Ltd. Seven family members and friends invest a total of $105k. Buffett invested only $100k.

1957 – Age 27
Buffett created more partnerships and was managing a total of 5 partnerships, all from his home.

1958 – Age 28
After 3 years, Buffett doubled the partner’s money.

1959 – Age 29
Buffett and Munger
Buffett and Munger Best Friends Forever

Buffett was introduced to Charlie Munger by his friend Edwin Davis at a dinner. Charlie Munger later becomes the Vice Chairman of Berkshire Hathaway.

1961 – Age 31
Buffett is running seven partnerships by 1961; Buffett Associates, Buffett Fund, Dacee, Emdee, Glenoff, Mo-Buff, and Underwood.

The partnerships are worth a few million and Buffett made his first million dollar investment in Dempster – a windmill manufacturing company.

Sanborn Map Company accounted for 35% of the partnerships’ assets. He explained to the partners that in 1958 Sanborn was selling at $45 per share when the value of its investment portfolio itself was at $65 per share which meant that it was undervalued by $20 per share with a map business coming in for nothing.

Buffett reveals that he earned a spot on the board of Sanborn.

1962 – Age 32
Buffett goes to New York to meet his old acquaintances to include more partners and raise capital. He collects a few hundreds of thousand dollars. Buffett partnerships is worth $7.2 million. Buffett then merges all partnerships into one and rename it as Buffett Partnerships Ltd.

Munger introduces Buffett to Harry Bottle, CEO of Dempster, who cut costs, laid off workers, and turned around Dempster to generate cash. At this time, Buffett notices Berkshire Hathaway selling for $8 a share and starts buying aggressively.

1963 – Age 33
Buffett sells Dempster for a $2.3 million gain, 3x times the invested amount.

Buffett aggressively purchases Berkshire paying $14.86 per share while the company had working capital of $19 per share. This did not include the value of fixed assets. Buffett partnership becomes a single largest shareholder of Berkshire Hathaway.

1964 – Age 34
American Express is victim to the salad oil scandal and shares fall to $35. Buffett saw the value and bought 5% of the company.

1965 – Age 35
Buffett invests $4 million in Walt Disney after a meeting with Walt Disney himself which is almost 5% of the company. Buffett takes full control of Berkshire Hathaway and names Ken Chase to be the CEO.

 

[Jerry1]

I was shocked and initially didn't think it was true, but it is:

1*(1+11.8%)^77 = $5,371
1*(1+10.8%)^77 = $2,689

The thing about compounding is the time frame. 77 years is a very long timeframe. Using the same formula for shorter time frames, you see a less drastic result.

For 40 years
$86.63
$60.48

For 30 years
$28.40
$21.69

This is more what one would expect and it makes more sense if you assume that you don’t use an advisor until after you retire. Not saying that time changes the result, just the magnitude.

 

[6miths]

Yup... real slacker.

https://www.oldschoolvalue.com/blog...e/warren-buffett-career-timeline-investments/

Yes he really got off to a slow start. If only he had really applied himself.

 

[Midpack]

I believe that investment management professionals — at least good ones — and value. (I do not dispute that there are bad investment management professionals and advisors who take a fee but do not add value, just like there are bad lawyers and doctors and chefs and plumbers).

When you finally figure out that the advisor you got is not one of the “good ones”, well it’s too late.

Or stated another way, ‘by the time you know enough to pick a great/value added advisor, you don’t need one.’

Many pro's have outperformed the S&P over their careers including the 1% fee.

Many/some pros may outperform short term (some just at random), but do you have some evidence to support that “many pro’s” can over the long term - more than 2-3 years? Everything I’ve read is about 80% don’t, and it’s not obvious who the good 20% are in advance (see adage above). If it was, the underperformers would have washed out long ago.

Two acquaintances of mine are EJ advisors, neither of them had any background in finance and all they really do is whatever the back office tells them. When I ask questions, it’s all basically scripted. Both of them had about 7-8 weeks training before being turned loose on clients...and last I heard EJ takes about 1.25% of AUM annually.

 

[Jerry1]

I know I will not convince someone who feels an advisor is a drain on the portfolio, but do realize that they add more to the equation than investment advice. A good CFP will provide other advice around taxes, insurance, estate planning, etc. So, picking a three fund portfolio and an AA may be good investment advice, there’s a lot more to manage.

My hope in choosing a CFP is that the package of advice he’s providing will do better than what I could have done on my own. Investment performance is a big piece of that, but not the only consideration.

 

[audreyh1]

I know I will not convince someone who feels an advisor is a drain on the portfolio, but do realize that they add more to the equation than investment advice. A good CFP will provide other advice around taxes, insurance, estate planning, etc. So, picking a three fund portfolio and an AA may be good investment advice, there’s a lot more to manage.

My hope in choosing a CFP is that the package of advice he’s providing will do better than what I could have done on my own. Investment performance is a big piece of that, but not the only consideration.

I have no problem paying for tax or insurance and estate advice, etc. I’m just not going to pay them an ongoing percentage of my assets for that type of advice.

 

[NYEXPAT]

Or stated another way, ‘by the time you know enough to pick a great/value added advisor, you don’t need one.’


Many/some pros may outperform short term (some just at random), but do you have some evidence to support that “many pro’s” can over the long term - more than 2-3 years? Everything I’ve read is about 80% don’t, and it’s not obvious who the good 20% are in advance (see adage above). If it was, the underperformers would have washed out long ago.

Two acquaintances of mine are EJ advisors, neither of them had any background in finance and all they really do is whatever the back office tells them. When I ask questions, it’s all basically scripted. Both of them had about 7-8 weeks training before being turned loose on clients...and last I heard EJ takes about 1.25% of AUM annually.

Your referencing sell side people. I was talking about buy side portfolio managers. look up Walter Schloss (47 years beating the S&P by 600 bp) David Tepper has averaged 30% returns over most of his career. Warren Buffet/Charlie Munger, That woman at T Rowe Price (Holcomb ?) many others that run their own private investment management firms that you will never know about if you don't travel in WS circles.

 

[pb4uski]

The thing about compounding is the time frame. 77 years is a very long timeframe. ...

Agreed, the extremely long time horizon accentuates the 1% difference in return.

 

[traineeinvestor]

While I'm happy to manage my own money, I do have part of my portfolio in professional hands - I've seen too many examples of people making really bad financial decisions and want to ensure there is a reasonable amount for DW and our daughters if I lose the plot and put it all in lottery tickets. The management fee is a form of insurance against my declining mental capabilities.

 

[DrRoy]

I had a FA for several years, and briefly had 2. They both underperformed my own results (which was mostly indexing) so I fired them.

 

[Midpack]

Your referencing sell side people. I was talking about buy side portfolio managers. look up Walter Schloss (47 years beating the S&P by 600 bp) David Tepper has averaged 30% returns over most of his career. Warren Buffet/Charlie Munger, That woman at T Rowe Price (Holcomb ?) many others that run their own private investment management firms that you will never know about if you don't travel in WS circles.

I thought this thread was about the merits of paying an advisor to this community? It can be value added for some (e.g. panic sellers and market timers), but it’s simply a significant and unnecessary drag on returns for many here. No right answer. And again, investors have about a 1 in 5 chance of picking a value added advisor.

 

[Perryinva]

In order to get the big performers you have to be practically institutional in size, or be an institution. No pension fund (remotely well managed) pays 1%. They pay far less. For peons like us, from what I have seen, an FA picking mutual funds, including managed funds, is a total crap shoot. Many people need hand holding, but for the totally generic advice they get, 1% is outrageous, IMHO. It takes exactly the same amount of effort and script to invest $100k as $1M , and even if $1M is “discounted” to 0.75%, they are charged $7500 vs $1000! But then, I feel the same way about Real Estate agents, and they at least can bring some definitive benefits. Its the old fox running the henhouse scenario.

Anecdotal, I know, but I’ve had 4 different work friends/aquantances ask me if I felt they were geting their monies worth from FA’s, from 2015 through 2017, and all I did was show them index fund returns which clobbered their personal returns. 2 of them confided in me (against my advice) that they had over $1M with these advisors, and they couldn’t understand how everyone was talking about the Dow/S&P’s great preformance during those times and they were looking at 4% returns. At LEAST if those FA’s had invested them in index funds, it would have appeared to be good advice but they were obviously churning them for their own profit. When they “fired” them, the advisors did absolutely nothing to try to retain their business and could care less. So apparently there are plenty of fish in those client barrels. Those same 2 bought me restaurant gift cards just because I pointed them at articles about simple portfolios and index funds. And don’t get me started on an ex neighbor of mine that was starting out at EJ and tried to get me as a client. A more clueless dolt I never met in this arena. And I am by no means any great shakes at investmenting. My own 10year performance lags the S&P by 1-2%, but a lot if that is because our 401k has only 2 index funds, which they only added 5 or so years ago.

Our savings plan also offers Financial Engines, and according to HR, there is a better than 25% participation rate. They give you 3 months “free” to try them out, then charge 1%/yr after that. A few of us took the free trial and they gave everyone EXACTLY the same generic advice. We all opted out and I tracked their hypothetical performance over the last 5 years, and it was pretty sorry.

 

[EarlyBirdly]

In this Age of Information and the Internet, all one needs to do is educate themselves and do their homework.

eg: https://www.buyupside.com/calculators/feesdec07.htm is a very simple and easy to use calculator to show effects of fees on returns over given time periods.

30 years ago an advisor was pretty much a necessity. Not so much anymore.

As well , as one poster alluded to, many "advisors" are just quickly trained salesman these days.

Robo-Advisors are also available now, and at greatly reduced fees (Schwab=0.28%) if one finds it necessary or it gives them a better comfort level.

To each his/her own I guess...

 

[Badger]

I have no training and little understanding of the financial world but with the help/advice of a few folks here I made what I feel were the best decisions to make at the time given the circumstances. Never used a financial advisor except for one time. It was a free consultation from a Dave Ramsey FA recommendation to review my investments and investment plan about 15 years ago. I was told that he couldn't do any better. (Thank you early-retirement folks) Never pursued hiring anyone to handle our investments and relied on a common sense approach and some of the examples given on this website. Other than a few stocks the bulk of our investments are in Wellesley and Wellington for a 50/50 AA. Dividends are swept into MM accounts and living and play expenses are taken from there. Once I got past the initial few years of investment ignorance, considered the advice from a few members here, and rearranged investments it has been a no-brainer. Understand that I was not out to beat the market but instead have a conservative plan that would allow me to reach my goal of retirement with enough to live comfortably and never out live my retirement money.



After a little help to understand the simple concepts that Buffett and members (my unaware advisors) suggest then I am not sure why investing needs to be difficult, convoluted or technical. I do understand that for some here all the higher math and statistics are fun and would probably join the mental exercise if I was wired that way but as long as my investments are as stable as possible in the investment market I will use my time for other pursuits and be thankful for all your help.



Cheers!

 

[Bir48die]

So I'm going to give a scenario that many of you can shoot down as part of the discussion:

Investor #1 - $1mm to invest in various funds. Management costs 25 basis points or .25%.

Investor #2 - $1.0mm to invest with a money manager. Cost to manage portfolio 1%. Portfolio consists of 50% high quality individual stocks paying nice dividends and 50% in MLP (let's just say midstream and downstream only).

Assume both portfolio values rise and fall at the same rates.

Investor #1 averages 3.25% on dividends so net of fees makes $30k in income at a net 3% return.

Investor #2 averages 4% on dividends at a 1% fee so nets $15,000 on his equities. Then portfolio of MLP averages 7.5% to 8% income (this was the average this year). So let's be conservative and say 7.5%. Income net of 1% fee is $32,500. Total returns are $47,500 net of fees.

So, in this example which is real world does it make sense sometimes to have someone else manage some part of your portfolio when you've netted 1.75% return higher than a self managed portfolio?

Just curious. I could be all wrong here.

 

[Rianne]

Yup... real slacker.

https://www.oldschoolvalue.com/blog...e/warren-buffett-career-timeline-investments/

I find Buffets experiences ages 6 yr old - 19 yr old much more interesting. What kid thinks that way? And that's why finance should be taught from 1st grade. I've always thought that.

 

[Dtail]

So I'm going to give a scenario that many of you can shoot down as part of the discussion:

Investor #1 - $1mm to invest in various funds. Management costs 25 basis points or .25%.

Investor #2 - $1.0mm to invest with a money manager. Cost to manage portfolio 1%. Portfolio consists of 50% high quality individual stocks paying nice dividends and 50% in MLP (let's just say midstream and downstream only).

Assume both portfolio values rise and fall at the same rates.

Investor #1 averages 3.25% on dividends so net of fees makes $30k in income at a net 3% return.

Investor #2 averages 4% on dividends at a 1% fee so nets $15,000 on his equities. Then portfolio of MLP averages 7.5% to 8% income (this was the average this year). So let's be conservative and say 7.5%. Income net of 1% fee is $32,500. Total returns are $47,500 net of fees.

So, in this example which is real world does it make sense sometimes to have someone else manage some part of your portfolio when you've netted 1.75% return higher than a self managed portfolio?

Just curious. I could be all wrong here.

Not sure this is a true apples to apples comparison, as typical buy and hold portfolios don't contain MLP's. Additionally, typical B&H portfolios ER fees are lower now than 25 bps. My fees are 4 bps.