The Real Cost of Management Fee
As explained by Warren Buffett.
In today’s short article, we look at Warren Buffett in his letter to Berkshire Hathaway’s shareholders. It is a fascinating story of how Warren Buffett bought 3 shares of Cities Service in 1942. He then underscores the growth of the American economy dubbed as the American Tailwind that made Berkshire prosperous from their investments.
He writes:
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.
What might be surprising though, given the same setup but only a tiny change: introduction of management fee could affect the overall returns significantly.
To wit, Warren Buffett further writes:
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.
Yes, from a 5,288 gains to a 2,644 gains because of the helpers.
So investment “helpers” are not at all needed then?
In our view, not needing investment “helpers” is akin to not needing restaurants. Everyone can theoretically cook their own meals themselves, most probably in a much more affordable manner. In practice, however, food from restaurants are often enjoyed and still craved (needed).
This is similar to investments. We believe that theoretically everyone can invest themselves. But in practice it is naive to believe that that is the case. So how much should investment helpers charge to their patrons?
There are expensive restaurants and more affordable restaurants. There are also expensive investment helpers and affordable investment helpers. What we believe is that investment helpers should be affordable.
As what Warren Buffett suggests, an introduction of management fee 1% annually could cut overall gains in half over a long period of time.