25th August 2020
Successful investing anyone? This week we share a short piece from the Oracle of Omaha, Warren Buffett. We learn about ‘Gotrocks Family’, how they had it all, and how they managed to throw it away, or more accurately, to have had it taken away from them! I consider if this ‘informed turkey’ is actually voting for Christmas?! Importantly, we share our view on how Irish investors might avoid such disasters, and to keep more of the returns they deserve.
You may already be a big fan of Buffett. If so, please excuse this repetition from 15 years ago. For those that may be aware of him, but who do not read much of his thinking – I hope this short piece will shine a light on how he thinks about investing, and how we might all benefit from him sharing his views so richly.
‘Successful investing’ is of course a subjective term – what would be a success to one investor may be a disaster to another. In our view, successful investing is one which enables you to achieve your most cherished financial goals and of course the lifestyle you most hope to have for you and your loved-ones.
We have campaigned for years now about the need to know what you are invested in, why you are invested, what YOU actually want to achieve from doing so, and the need to know exactly what you are paying and why you are paying it to the parties involved.
Some of our core beliefs when it comes to successful investing:
Simple but certainly not easy!
The Annual Berkshire Hathaway (BRK) Shareholder Letter:
Every year since 1965, Warren Buffett has written and published a letter to shareholders of BRK. They are typically lengthy letters outlining some of his thinking about the company’s investments and often lots of great nuggets of his thinking of broader matters. The BRK letter of 2005 was no different – it contained a humdinger of a section titled ‘How to Minimize Investment Returns‘. Here is a couple of minutes of a short story that I think sums up a lot about how to be a good long term investor – or more accurately, how to avoid being turned into a bad one!
The Gotrocks – A Tale about Successful Investing:
“….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.
To understand how this toll has ballooned, imagine for a moment that all American corporations are, and always will be, owned by a single family. We’ll call them the Gotrocks. After paying taxes on dividends, this family – generation after generation – becomes richer by the aggregate amount earned by its companies. Today that amount is about $700 billion annually. Naturally, the family spends some of these dollars. But the portion it saves steadily compounds for its benefit. In the Gotrocks household everyone grows wealthier at the same pace, and all is harmonious. But let’s now assume that a few fast-talking Helpers approach the family and persuade each of its members to try to outsmart his relatives by buying certain of their holdings and selling them certain others.
The Helpers – for a fee, of course – obligingly agree to handle these transactions. The Gotrocks still own all of corporate America; the trades just rearrange who owns what. So the family’s annual gain in wealth diminishes, equaling the earnings of American business minus commissions paid. The more that family members trade, the smaller their share of the pie and the larger the slice received by the Helpers. This fact is not lost upon these broker-Helpers: Activity is their friend and, in a wide variety of ways, they urge it on.
After a while, most of the family members realize that they are not doing so well at this new “beatmy-brother” game. Enter another set of Helpers.
These newcomers explain to each member of the Gotrocks clan that by himself he’ll never outsmart the rest of the family. The suggested cure: “Hire a manager – yes, us – and get the job done professionally.” These manager-Helpers continue to use the broker-Helpers to execute trades; the managers may even increase their activity so as to permit the brokers to prosper still more. Overall, a bigger slice of the pie now goes to the two classes of Helpers.
The family’s disappointment grows. Each of its members is now employing professionals. Yet overall, the group’s finances have taken a turn for the worse. The solution? More help, of course. It arrives in the form of financial planners and institutional consultants, who weigh in to advise the Gotrocks on selecting manager-Helpers. The befuddled family welcomes this assistance. By now its members know they can pick neither the right stocks nor the right stock-pickers. Why, one might ask, should they expect success in picking the right consultant? But this question does not occur to the
Gotrocks, and the consultant-Helpers certainly don’t suggest it to them.
The Gotrocks, now supporting three classes of expensive Helpers, find that their results get worse, and they sink into despair. But just as hope seems lost, a fourth group – we’ll call them the hyper-Helpers – appears. These friendly folk explain to the Gotrocks that their unsatisfactory results are occurring because the existing Helpers – brokers, managers, consultants – are not sufficiently motivated and are simply going through the motions. “What,” the new Helpers ask, “can you expect from such a bunch of
zombies?” The new arrivals offer a breathtakingly simple solution: Pay more money. Brimming with self-confidence, the hyper-Helpers assert that huge contingent payments – in addition to stiff fixed fees – are what each family member must fork over in order to really outmaneuver his relatives.
The more observant members of the family see that some of the hyper- helpers are really just manager-Helpers wearing new uniforms, bearing sewn-on sexy names like HEDGE FUND or PRIVATE EQUITY.
The new Helpers, however, assure the Gotrocks that this change of clothing is all-important, bestowing on its wearers magical powers similar to those acquired by mild-mannered Clark Kent when he changed into his Superman costume. Calmed by this explanation, the family decides to pay up.
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).
A sufficient number of arrangements like this – heads, the Helper takes much of the winnings; tails, the Gotrocks lose and pay dearly for the privilege of doing so – may make it more accurate to call the family the Hadrocks.
Today, in fact, the family’s frictional costs of all sorts may well amount to 20% of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of what they would earn if they just sat still and listened to
no one. Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can
calculate the movement of the stars, but not the madness of men.”
If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”
What Might We Take From Buffetts’s Gotrocks Story- Keys to Successful Investing
Turkey Voting For Christmas in Successful Investing?
It may seem unusual for someone like me, a Financial Planner, to suggest and indeed endorse the fact that you should have as few advisors/partners as possible!? Truth is that our financial lives are composed of far more than simply investing in an asset class such as equities.
If the success of your financial life boiled down purely to the returns you got from an asset class then the world would not need Financial Planners. The fact that your financial life success is dependant on far more than that; the structures you use or could use, the decisions you make, the tax opportunities and pitfalls, the nuances of our complex investing and pension regulations, the investor behaviour, the changing of habits. All of this means that client-focused Financial Planners are becoming more and more necessary.
Indeed, one of our principle roles is helping people to pursue successful investing, to develop a simplified client-focused strategy, and using only simplified client-focused structures. All of this ultimately should be designed to help you reduce friction; both monetary and emotional, to ensure the Gotrocks remain the Gotrocks!
Simple but certainly not easy!
The value of your investments will rise and fall, and of course you could get back less than you invest. This is not advice – always seek advice before taking any actions with your investments or financial decisions. Just make sure that it is the right advice and not just another ‘Helper’!