By the time I compose this post (the afternoon of February 25, 2018) I have already read his letter three times; I will undoubtedly read it several more times to ensure I do not overlook any ‘pearls of wisdom’. The beauty of Buffett’s annual letters is that he has a knack for distilling what can be complex into something that is easily understandable.
The entire letter contains valuable information but it is the “The Bet” is Over and Has Delivered an Unforeseen Investment Lesson section which really grabbed my attention. One of the reasons Buffett entered in a bet on December 19, 2007 was to demonstrate that a virtually cost-free investment in an unmanaged S&P 500 index fund would, over time, deliver better results than those achieved by most investment professionals. Buffett goes on to explain how fees associated with actively management investments can have a huge drag on returns even though actively managed investments are most likely to underperform.
I also touched upon the very issue regarding actively managed accounts and their fees in my ‘Using Financial Advisors: A Cautionary Tale’. Subsequent to that article, the investors for whom the investments were being actively managed learned that the investments were not being managed specifically for them. Their investments fell under an ‘actively’ managed program in which investment decisions were being made at a very high level for all investors with a similar investor profile. In other words, investment decisions were being made for hundreds, if not thousands, of investors who met similar metrics.
The manner in which the investments were being managed now explains why there are multiple holdings of insignificance in several companies. Here is just a sampling of some holdings in a multi-million dollar portfolio.
- Amazon (NASDAQ: AMZN) – 3 shares
- Apple (NASDAQ: AAPL ) – 25 shares
- MasterCard (NYSE: MA) – 22 shares
- McDonald’s (NYSE: MCD) – 23 shares
If another investor with a similar investor profile had 10 times the value in their investment account then the previously reflected volumes would have been tenfold those reflected above.
In addition, the Wealth Management firm managing the investments confirmed that the annual management fee applied to the total value of the portfolio. This meant that if, for example, a 5 year Guaranteed Investment Certificate (GICs) was purchased there would be an annual 1% fee levied on the GIC since it was part of the portfolio. Not a bad deal for the Wealth Management firm….make one decision in year 1 and you get compensated for the next 5 years! One seriously has to question in whose best interest an investment portfolio is being managed if the weighted average interest rate on a pool of GICs is ~2.425% and a ~1% fee is being charged.
While the management fee might be tax deductible, the after tax return is still negligible and is not far off from the annual rate of inflation. In addition, some of these 5 year GICs were purchased in a low interest rate environment. This certainly is not going to help the investor as we are now in a rising interest rate environment.
Fortunately, I started reading about Buffett’s and Munger’s investment philosophy years ago. I also learned my lesson pretty quickly in the early 1990s when I parked a very small amount in a mutual fund. While the mutual fund underperformed the benchmark in each of the 5 years in which I was invested in the fund, the firm still took its pound of flesh from me.
I certainly do not have access to a pool of capital that comes remotely close to what Buffett and his team manage. In addition, I do not possess Buffett’s and Munger’s business acumen. My passively managed investments, however, have done reasonably well over time; I have recently uploaded Information on My Historical Investment Performance in an effort to provide some color on our historical investment performance.
I am not an active trader and anyone watching our portfolio would very likely come away with the impression that it is akin to watching paint dry. My investment approach is to analyze a company, the industry in which it operates, the growth potential, and to look at how the company has performed during different economic cycles. If I come away with a good feeling after having performed my analysis then I will initiate an investment with the view of holding it for the long-term. In addition, I will periodically add to my position as appropriate.
This does not necessarily mean our investments are totally ‘hands free’. I will still read quarterly and annual reports and I will listen to investor and analyst presentations.
On the rare occasion where I have sold an investment, it has been because:
- the company no longer satisfied the underlying reasons for my initial investment. An example is when I sold General Electric in 2017 (NYSE: GE) before they announced a cut in the quarterly dividend;
- I need money to cover expenses.
Going forward, the likelihood for a sale is most likely to be because we need money to cover expenses or because we are trying to reduce the value of our retirement accounts. Unless we start withdrawing funds from our Registered Retirement Savings Plans (RRSPs) over the next 13 – 16 years before the mandatory conversion to Registered Retirement Income Funds (RRIFs) at age 71, we will be faced with a huge tax burden because of the mandatory minimum annual RRIF withdrawal requirements.
Frankly, how I manage our investments is not ‘rocket science’. I:
- Don’t chase yield;
- Don’t speculate;
I also take into consideration that my investments need to be made on the basis that my wife doesn’t have to worry whether any of the investments are going to ‘blow up’ in the event something happens to me.
Fortunately, following the teachings of Buffett and Munger over the past ~25 years has paid off. If you are unfamiliar with their investment philosophy, please take the time to read Buffett’s Letters to Shareholders for which I have provided links at the beginning of this post.
I hope you enjoyed this post and I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected]
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long CNR, MA, MCD.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.