Warren Buffett’s Incredible Investing Insight That’s Applicable for Anyone

Can you really explain to a fish what it’s like to walk on land,” Warren Buffett once asked. He then added, “One day on land is worth a thousand years of talking about it, and one day running a business has exactly the same kind of value.”

For me, that describes everything regarding how I feel about the difference between attending Buffett’s Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) Annual Shareholders’ Meeting and reading descriptions and summaries about it. This year, I was fortunate enough to be able to make the trek down to Omaha, Nebraska in the U.S.A. to attend Berkshire’s AGM. Based on Singapore’s time zone, it had started on Saturday night and ended in the early hours of Sunday morning.

As promised, I would be bringing back coverage and insights I have about the meeting that concluded just hours earlier. So, here’s the first golden nugget of insight that I thought was incredibly important. And, it has to do with two numbers that were shown during the AGM: 43.8% and 12.5%.

Six years ago on 2008, Buffett had made a wager with asset manager Protégé Partners. The firm’s investment strategy is built on an exclusive focus “on investing in established smaller hedge funds and select emerging managers” – in other words, Protégé Partners helps build funds that invest in other funds.

Buffett had bet back then that a low-cost index fund that closely mirrors the S&P 500’s (a widely-followed American stock market index) returns would triumph over five different fund of funds that were hand-picked by Protégé Partners.

Six years on, and Buffett’s investment choice has now achieved cumulative returns of – this is where the two numbers come in – 43.8% while Protégé Partners’ five fund of funds had collectively gained only 12.5%.

The massive discrepancy in returns above contains a particularly noteworthy insight for every investor: Fees, matter.

Truth be told, it wouldn’t be tough at all to foresee how the S&P 500 would have crushed the five fund of funds – even when putting aside all questions about the efficacy of the funds’ investing methods. Hedge funds are in itself, extremely expensive investment vehicles for investors due to their high fees. But a fund of funds exacerbates the problem by charging a fee on top of a hedge fund’s fees. With that many layer of fees, the hurdle that needs to be overcome by the fund of funds in order to generate market-beating returns is immense.

For an idea of how big the hurdle can be, consider this. In Singapore, the two exchange-traded funds (ETFs) that track the Straits Times Index (SGX: ^STI) are namely the SPDR Straits Times Index ETF (SGX: ES3) and the Nikko AM Singapore STI ETF (SGX: G3B). These two carry total expense ratios (the total amount of annual fees the fund charges as a percentage of the amount invested) of 0.3% and 0.39% respectively.

Meanwhile, a 2013 report compiled by investment research outfit Morningstar had shown the average stock-based unit trust in Singapore to have annual expense ratios of some 1.94%. For the stock-based unit trust to just match a low cost ETF like the SPDR STI ETF, the former needs to beat the latter by almost 1.8% per year before fees are factored in. To place the difficulty in doing so into perspective, even a legend in the investing business like the American fund manager John Neff had managed to beat the S&P 500 by only 2.1% a year on average throughout his 31-year career spanning 1964 to 1995.

The next time you or anyone else would like to pass the baton to a manager when it comes to investing your money, please take note of fees. Protégé Partners, as smart and as talented the team there can be, couldn’t overcome the simple disadvantage of having very high fees (in all likelihoods) eat into its investors’ returns.

There’d be more from Berkshire Hathaway’s AGM here at Fool Singapore. So, keep your eyes peeled!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway.