Some Reasons Buffett Thinks about Poor Investment Returns

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In his 2004 shareholder letter (the part in italics in this article), Buffett listed some of the main reasons for poor investment returns.

The reward of listed companies and investors is opposite

Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.

Three primary cause

There have been three primary causes:

first, high costs, usually because investors traded excessively or spent far too much on investment management;

Second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and

Third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline).

Frictional costs

Excitement and expenses are enemies

Investors should remember that excitement and expenses are their enemies. And
if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.

Frictional costs eat up investors’ rewards

In the 2005 shareholder letter, Buffett wrote a very long story to explain how frictional costs eat up investors’ returns; I will not repeat the story in the letter here. After telling this story, Buffett gave the following three paragraphs (in italics) of conclusions about frictional costs.

Indeed, owners must earn less than their businesses earn because of “frictional” costs. And that’s my point: These costs are now being incurred in amounts that will cause shareholders to earn far less than they historically have.

And that’s where we are today: A record portion of the earnings that would go in their entirety to owners – if they all just stayed in their rocking chairs – is now going to a swelling army of Helpers. Particularly expensive is the recent pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or lucky, and leave family members with all of the losses – and large fixed fees to boot – when the Helpers are dumb or unlucky (or occasionally crooked).

Reward is inversely proportional to activity level

For investors as a whole, returns decrease as motion increases.

Poor Investment Returns — credit: fool.com

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