How to Minimize Investment Returns – By Warren Buffett

I just watched the Will Smith movie The Pursuit of Happyness this weekend. I found it ironic that he really didn’t change job types when he joined Dean Witter. Mr. Gardner started out a salesman, and ended up a salesman. But by managing to change his product to financial services, he turned his tenacity and people skills into millions of dollars.

Why is financial services such a lucrative field? This reminded of an excerpt that I had saved from Warren Buffett’s 2005 Letter to the shareholders of Berkshire Hathaway. Although a tad on the long side, I think it provides an excellent “big picture” view of investing the the stock market.

It’s been an easy matter for Berkshire and other owners of American equities to prosper over the years.

Between Dec. 31, 1899, and Dec. 31, 1999, to give a really long-term example, the Dow rose from 66 to 11,497. (Guess what annual growth rate is required to produce this result; the surprising answer is at the end of this piece.)

This huge rise came about for a simple reason: Over the century, American businesses did extraordinarily well and investors rode the wave of their prosperity. Businesses continue to do well. But now shareholders, through a series of self-inflicted wounds, are in a major way cutting the returns they will realize from their investments.

The explanation of how this is happening begins with a fundamental truth: With unimportant exceptions, such as bankruptcies in which some of a company’s losses are borne by creditors, the most that owners in aggregate can earn between now and Judgment Day is what their businesses in aggregate earn. True, by buying and selling that is clever or lucky, investor A may take more than his share of the pie at the expense of investor B.

And, yes, all investors feel richer when stocks soar. But an owner can exit only by having someone take his place. If one investor sells high, another must buy high. For owners as a whole, there is simply no magic — no shower of money from outer space — that will enable them to extract wealth from their companies beyond that created by the companies themselves.

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.

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 “beat my 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 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 percent of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80 percent 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.

Here’s the answer to the question posed at the beginning of this piece: To get very specific, the Dow increased from 65.73 to 11,497.12 in the 20th century, and that amounts to a gain of 5.3 percent compounded annually. (Investors would also have received dividends, of course.) To achieve an equal rate of gain in the 21st century, the Dow will have to rise by Dec. 31, 2099, to — brace yourself — precisely 2,011,011.23. But I’m willing to settle for 2,000,000; six years into this century, the Dow has gained not at all.

Again, why is financial services such a lucrative field? I believe it is because you can take a huge amount of money “off the top” and most people won’t be able to tell the difference. The power of compounding works so well that as long as the client looks at their financial statement and they see a big number, they’re happy. Many don’t have a clue if they could have gotten a lot more.

Same thing happens with 401(k)s:

Friend: Man, I love my 401(k). I just checked and I have $15,000 in it now!

Me: Nice, what were your returns this year?

Friend: I don’t know, but it must have been pretty good!

Comments

  1. Cheng-Jih Chen says:

    Hmpf. The problem with the Gotrocks parable is that it assumes that intra-family communications are costless, and that all family members have equal appetites for risk.

    Suppose Johnny Gotrocks owns a widget factory in a small Midwest town. He’s older now, and just wants to retire and play golf, so he needs to sell off his ownership. How does he find buyers to his stake?

    Going further, Johnny has found that buyer, and now he has a buttload of cash. He still needs to fund his retirement, but he doesn’t want to lose a lot of his money in some stock market hiccup when he’s out on the 9th tee. He has a low appetite for risk. Is there anyway he can work with Bobby Gotrocks, who needs funding for a startup widget2 venture?

  2. I know the following may be somewhat off-topic, but the financial services community takes makes the Gotrocks worse off, collectively, in similar fashion to how the health insurers collectively worsens the Gotrocks’ health.

    Think of how much money collected from individuals goes to insurance companies versus to the amounts that end up in the hands of the persons/businesses who actually provide the health services. You have hundreds of insurers each with their own executives, managers, actuaries, salespersons, administrative staff, etc. Then, of course they insurance companies have to take in enough money to maximize their earnings after paying all those executives, managers, actuaries, salespersons, admin staff, etc. On top of that, they pile the costs of occupying lavish office buildings (i haven’t seen any studies done regarding their rents but i would bet the insurance sector pays on average more per square foot for office rent than any other industry — including financial sector). Add IT costs to the mix and it’s not hard to figure out why our “health care” costs are soaring while our health diminishes (i know we’re living longer…but are we living healthier? I doubt it).

    Now if only we modeled our healthcare system like any of the 20+ nations with superior overall health care (all of which are, dare i say…NATIONALIZED), then we wouldn’t have to live like the Hardrocks — who end up paying more to get less.

  3. @Phoenix:

    You are completely right! I think it’s a very good parallel.

    And don’t forget the cost of physicians having to spend a substantial fraction of their work time arguing with insurance companies to get things covered. Friends that are residents these days are full of stories of “…and then I called back for the 4th time and said `you know what, you’re just making this hard because you think I’m going to give up. But you know what? I’m NOT! So you should just give in and cover the procedure now, because Mrs. Jones just isn’t going to live without it!’ But of course they still denied it, so then I had to write a letter to the supervisor of __ documenting __…”. It’s enough to make you scream.

    We went through 9 years of post-graduate training to make repeated phone calls where we haggle and ask to speak to the manager and send complaint letters in order to get routine medical care for our patients?

    And don’t forget, every minute we spend on the phone, the insurance companies are also paying someone in a nice office building to sit and talk back to us….

  4. Steve Austin says:

    Financial services, at least the big money (management fees), are a winner-take-all arrangement. People are willing to pay up for (what they believe to be) the best, and so the best take almost all of the money for such services provided to the people who are willing to pay. Why walk down the street to find a good money manager (like you would a good electrician), when you can just send your money across the country to the (supposedly) best of the best and have her/him run your portfolio?

    I once asked a very close friend of mine a question, and I always recall his answer. He’s an attorney now, but he wasn’t then. I asked him “Why do doctors and lawyers get paid so much more than others?” His answer, “Because there is a strong market for them.” Those are the kind of services that you don’t truly respect until you need them, e.g. a surgeon to save your life, an attorney to argue your a$$ out of jail. How much will people pay for those services? That’s why those fields are so lucrative.

    As for financial services, I think it’s a similar story, but not the same. Most financial service providers are mediocre, and get paid on the coattails of the %-assets-under-management model that hardly anyone challenges. “It’s just the way it is” appears to be the common, defeatist response to these fees. What bothers me the most about this pricing model: whether you fork over $1M or $10M, the manager will deploy those funds in largely the same fashion at largely the same effort on her/his part, and yet will get paid 10x (!) more just for being “the best”. It would be a different story (complaint) if the money manager assumed the risk of losing money as she/he lost money under management, but that isn’t the case. The only incentives are 1) to not look bad relative to one’s peers, so that money under management does not go elsewhere, and 2) if possible, outperform your peers so that you attract their managed money to you. I submit that 1) is the more powerful of the two, in that someone riding the gravy train would much rather continue to ride that same train than to risk the loss of the train in exchange for a shot at a larger train. The money is just too easy to risk.

    But it still all boils down to the market for financial services. It’s so lucrative only because people blindly fork over their money for said services. It’s no mystery. If you want to change this, the only thing you can do is stop paying for financial services and do it yourself. (Since it’s your money and no one cares about it more than you, I propose that you can manage it better than anyone else.) Make your own personal mutual fund with stocks that you pick. Divest yourself of all mutual funds, which is hard to do with a 401(k) plan. Instead, yell at your company to get your plan provider to offer rock bottom fund expense ratios. Next time you look for a job, make 401(k) fees a prominent part of what you say you are looking for in the way of acceptable benefits. If you *must* be in some funds, never, ever pay more than 20-30 basis points in total fund expenses, and always look to reduce those fees via fund exchanges (e.g. exchange out of Janus, et. al. and into Vanguard, TIAA-CREF, et. al.)

  5. Great article Jon. What options are there? Is there a way to make sure the Helpers don’t get such a big portion of the pie? It appears that these Helpers and Managers are an institutional in this game.

    I also agree with what Phoenix has to say. Be careful though, the Helpers might brand you as a socialist, and down goes your reputation. In the health care scheme, the Helpers long ago conned the Gotrock into thinking they could have better helath care compared to brothers / relatives only if they went private.

    My opinion, the health care issue should be 2,000,000 times more important then the current financial scheme. Without a healthy nation we are just fooling ourselves into thinking we are a financial super power.

  6. a great and accurate comment on our current health insurance problem.the problem is educating the public that our current govt medical programs{medicare,medicaid and the va} work relatively well and are SOCIALIST in some measure.once that fear mongering bugaboo is overcome we might get on the road to improve our health care system

  7. having the government decide your healthcare is the worst idea ever. its bankrupting most nations, name me something the government has run well, and do you want the government telling you what care/treatment you can and can not get? also, socialized healthcare results in less people in the medical field which increases service times (hello, canada? or the nurse strike in australia).

  8. I know, I know, he’s a genius and this is heresy but I have to disagree with the old man. Question 1: Hedge funds and Hired Management Co have been around for centuries, haven’t they? Is this something new? Question 2: Aren’t the owners of Hedge Fund and Hired Management Co the Gotrocks family and investors like you and I?

    My point is that HedgeCo and ManageCo are part of the market, not outside of it. His letter attempts to say that they are outside of the market and extracting an ever larger piece of the market pie.

    -Wes

  9. Growing Wallet says:

    I love this allegory by Buffet. He is so graceful and logical in explaining something we are all familiar with statistically. I just wish I would have bought some PetroChina back when he did!

    On a seperate note Jonathon,

    You recently spoke about how you would not own Berkshire or similiar stocks that act as mutual funds. What is the logic behind neglecting Berkshire? Over the long period, or even just this past year, its performance would have enhanced anyone’s overall portfolio’s return.

  10. To Squeezer:

    If you changed the word “government” to “private insurers” in your post ,you would describe exactly the current shameful state of our health care system. The USA is indisputably the largest economy in the world, yet millions of its citizens can not afford health insurance or are undercovered by private health care schemes. The US, with its private system, is bankrupting its citizens. There is always enough money to fund wars though, even if it means going way over budget.

    - Medical bills make up half of bankruptcies: http://www.msnbc.msn.com/id/6895896

    “Having the government decide your healthcare is the worst idea ever.” — In fact, it is the private insurers that decide what they will (as an operating loss) and will not cover.

    No system is perfect, but one that can cover all of its citizens better reflects a country with democratic values.

  11. Hey Squeezer, let’s not be too hard on the Canadian system. It does have some gross inefficiencies, but at the end of the day, the people who most need the care are getting that care in a timely fashion. The Canadian government has made “wait time” into the fundamental metric for improvement, but it really isn’t. It’s just that quality of healthcare here is so good that lowering “wait times” is kind of the next rung up the ladder.

    I know a few young doctors and the truth is that they’re really quite amazed that our system works with all of the inefficiencies in the system, however, they’re not complaining about the quality of patient care, and we don’t have people dying in the emergency waiting room while we try to contact the HMO.

    It’s nice to think that healthcare is bankrupting the Canadian economy, but clearly it’s not, we’re still running a surplus. In fact, overall, the overall healthcare costs/person are cheaper here. All other things equal, we’re paying like 15% more taxes (for added healthcare), but the cost of healthcare in the States is greater than 15% of annual salary (though you may not see it all). The money your boss is spending on your healthcare is money he can’t give you.

    But all money aside, here’s my problem with non-public healthcare: healthcare is not ruled by supply-demand, it’s not an elastic industry. If I suffer some frost on my crop and have to double the price of oranges, then people will just have to eat less oranges and supplement with different fruits or pay twice as much. Healthcare doesn’t work this way.

    If I double the price to put a cast on a broken leg, the number of broken legs doesn’t magically drop by half. People can’t “go elsewhere” unless some hospital is charging less, but with the HMO model, this may not be relevant.

    The fact is, private healthcare costs are also eating into the profits of the “Gotrocks” family. If they just got together, they could offer healthcare for way less money as a group than they can by each running their own institutions. That’s what public healthcare is about, it’s not an attempt to be “socialist”, we’re actually just saving money b/c “competition” isn’t actually healthy in non-elastic markets.

    As to Buffet’s services model, how many people are now just following Malkiel’s buy & hold Index funds model? Wasn’t it like 40%? Sounds like we may be getting the idea, we just take a while to get there :)

  12. Personally, I believe that you will do best if you take personal responsibility for your health (just as you should take personal responsibility for your investments).

    My motto is: read, learn for yourself, take action. My mom used to say, if you don’t help yourself, nobody will.

    I personally don’t think that any doctor, no matter how good he is has the time and the real interest to solve my issues, no matter what healthcare systems is. And even if he does, by the time I reach him, I might be beyond any help!

    That’s how I feel. You, however, might have the smartest and the most compassionate doctor by your side and 100% medical coverage and it is great. I am happy for you. But most people I know don’t.

    I try to do little things every day to make sure that I wouldn’t need any healhcare for as long as possible, except for routine check ups, preventive medicine, childbirth, pediatrics and things like that.

  13. Great post! I think a lot of people would be better off learning about investing and trying it without so many middlemen. I think though that many people are intimidated by the stock market, they know so little about it and don’t find the time to learn, so they find it easier to get someone else to do it for them.

    Squeezer, the U.K. and Canada are not the only examples of nationalized health care. I lived in Holland for a number of years and their system is fantastic. There have also been studies done that compare the systems in the U.K. and the U.S. and not only do people in the U.S. spend a lot more on healthcare than they do in the U.K. (including the taxes per capita that go towards the national system) but people in the U.S. on average are no where near as healthy as they are in the U.K. I don’t recall all the numbers off the top of my head but it was significant.

  14. Buildandsucceed says:

    The post was good but I don’t see the next generations using financial services as much as in the passed. With the internet and all the other tools and resources that we have now it’s so easy and cheap to do it yourself. Of course there are still fees…

  15. Cristobal Colon says:

    Thanks for posting this gem.

  16. So is Mr. Buffett really talking about the hidden super class in America?

  17. Swim Upstream to Wealth says:

    This letter from Buffett is a classic. Everyone should spend a few hours learning about portfolio building…it isn’t hard.

    1. Understand what return you need to meet your goals and how much volatility you can handle.
    2. Find several non-correlated assets in the lowest cost vehicle possible (think ETFs or index funds)
    3. Understand how this portfolio has performed over serveral periods in the past to understand what MIGHT happen in the future
    4. Rebalance annually

    You can spend 15 minutes a year on your portfolio and top most of the money managers out there since you are diversifying and containing costs as much as possible.

    Now I am a fee-only financial planner. I am in this field not to generate enormous management fees, but to actually reduce and help people. While it only takes a few hours to educate yourself, I have found that most people don’t want to do it. They need help unfortunately. I needed help and got whacked by a broker (and his egregious fees). This is what prompted me to manage my own money. I just took it to the next step cause I found so many folks getting hammered by the middlemen.

    But, I encourage folks to learn as much as possible so they can do it themselves and really build their wealth.

  18. It’s intriguing how different people read this story and view the story differently.

    Another view is that this is against mutual fund managers. If you think of the big picture, they are really just trading with each other. In order for one manager to buy a huge chunk (millions of dollars worth at a time), another has to sell it. If both are charging 1% of returns, that’s a pretty big hurdle for either one to overcome. Add in tax consequences, and you’re even farther behind.

    The alternative is owning a passively-managed low-cost mutual fund that owns the entire market. Therefore, you already own everything. You are the Gotrocks, pre-Helper.

  19. Conspiracy theories aside, I don’t think that he’s actually trying to display the investing game as a “Zero-sum game” (Jonathan, feel free to comment) where fundamental growth is driven by actual growth in resource production.

    At a base level if we produced 1 million bananas last years and we produced 1.1 million bananas this year, then we’ve grown by 10%. If the production of bananas was divided amongst 8 companies (the Gotrocks family) and that’s all that they did (no side investing, no other business just bananas in and out), then the average growth of the companies is 10%.

    It doesn’t matter how you divide it, overall, they grew an average of 10%. Now when you bring in the advisers, as the example does, these advisers don’t actually produce more bananas. In fact they do the exact opposite, they cost me bananas in the hopes that I can steal a bigger share of the banana market.

    Again, we’re producing a flat number of bananas. These advisers are not producing bananas, they’re stealing them for my competitive advantage. Of course, once everyone has advisers stealing bananas from each other, we’re back to where we started. In Buffet’s example, the Gotrocks keep spending bananas in an attempt to steal more bananas from the opposition. So it becomes this game of escalating theft.

    But the Gotrocks are not making any more bananas, the advisers have now just become an extra overhead rather than a competitive advantage. The advisers are actually stifling growth. Instead of buying more workers and more land so that they can grow more bananas, the Gotrocks (we the investor) are paying advisers to steal bananas that are just getting stolen back.

    This is where you get guys like Burton Malkiel (Random Walk Down Wall Street) suggesting that you just buy index funds (ETFs) and leave the rest alone. Paying mutual fund fees is equivalent to paying needless overhead on services.

    It’s the fallacy of management all over again. Management is just overhead and so are these advisers. At some point you have to stop paying the overhead, but the financial services industry has gone the other way, they’ve added deeper levels of overhead (instead of less) in an attempt to suck people in deeper. The point is that we can’t grow faster than we “make more stuff” and advisers don’t make stuff, they take stuff, so we should be aware.

  20. Steve Austin says:

    Best approach for pers finance, health care (a la Irina, above) and everything else one can manage is: do it oneself. No one cares more about one’s affairs. Doctors and mutual fund managers (even passive ones) as a last resort!

  21. Gates VP: Aren’t managers providing a valuable “service”? Isn’t this new economy a “service economy”? How many people that read this blog actually make widgets? I would bet very few. Most of us are involved in shuffling other peoples money around.

    One of Buffet’s big money babies is insurance! Now there’s a business that, in effect, takes a lot of peoples money, pools it, and then pays it out, reluctanly, upon demand. Is that so different than a mutual fund manager? The two just have a different software system.

    Finally, what is Mr Buffet himself besides a mutual fund manager, albeit a successful one? (20% annualized since 1965)

    -Wes

  22. As a side note, I absolutely love that movie. Will and his son both do a terrific acting job in that movie. Good article and a nice finish that proves your point well.

  23. I make widgets. Also, a lot of “services” entail more than shifting money around, though I grant it often seems that way.

    As for health care, it’s true that it is an inelastic product that doesn’t work according to ideal market principles, for the reasons outlined above. The endless redundancies of bureaucracy and countless lawsuits between insurance companies and medical providers (and other insurance companies and other medical providers) drastically reduce the efficiency.

    A nationalized system can certainly work ok, as we’ve seen in some other countries. There are, of course, yet other countries where it’s a nightmare, though these are usually poorer/more corrupt locations. Of course, there’s often not as much motivation in even the better socialized systems for real and expensive innovation, which is why many of the heroic leaps and the best “rich-guy” healthcare tends to initially show up in the US, and then eventually get adopted elsewhere when the technologies and techniques are mature and cheaper.

    Whether it’s socialized or private, I personally think that was really drives the price of healthcare up is that it is not really fungible like we want to think it is, and that we refuse to admit to any possibility of compromise or discussion/analysis of cost/benefit. People with private insurance or government coverage ALWAYS expect THE VERY BEST treatment available for any given condition. This is understandable, but the 95% best treatment is typically 1% of the cost of the 98% best treatment. But since we’re paying in a “socialized” model — whether it’s a gov. or private system (ie, I pay the same no matter what) — we don’t ever consider whether what we’re getting is “worth it” (and truly, in many cases don’t have time to decide, on the spot — but we could make many admittedly hard decisions ahead of time).

    And then ultimately, “health care” is battling death, and I recall seeing numbers showing what an obscene percentage of all costs are spent in the last very small time period of people on an inevitable downward decline, typically in their very old age, which personally seems like it has more the effect of prolonging suffering than anything else, in many cases… but of course people want to keep living, and that stat is easily skewed. However, I really do think that we fail to make any evaluation of services, instead treating “health care” like a boolean value that is either on or off, and that is a major reason why the costs keep going up: because we all think that any option that exists, that has even a marginal chance of success, is our due without even any consideration otherwise.

    The biggest advantage of gov. health care is that it’s more easily restrained, probably. Simpler to keep one system under scrutiny. I favor letting the market free in most cases, but certain insurance systems are tricky institutions…

  24. Large Talons says:

    Great post, and great comments. As a whole, people are willing to pay for things that they don’t want to do, or don’t know how to do themselves. I pay a plumber because I don’t feel comfortable messing around with possible causing thousands of dollars in water damage. On the other hand, I would never pay someone to create a website for me. Managing investments may not be that difficult for me, or obviously the vast majority of people who read this blog to do, but most people simply don’t want to be bothered with it. Of course Buffet is going to rail against money managers, because he would never need one. Now, I would agree that with a little bit of education (as little as reading a book, or even a couple of blogs), most people would find that they could do quite well managing their own investments. That seems to be the real issue. That compared to the amount of knowledge and skill it takes to manage investments with a decent return, the amount of pay managers receive is unbelievable. Still though, it is only an elite few that ever reach movie star money. A think the more interesting point that Buffet is making here is that with all this added overhead, there is no way that the market can continue to return that 5.3% over the next century. Unless our rate of productivity is accelerated that is, which is possible I suppose with automation and computer intelligence in the future.

    As for the comparison to health care, Phoenix I believe you are right on. There is one major factor that is being missed here though. Insurance companies make their money by investing the unused premiums. That is where the real profit is. A government run system does not do this. I would consider myself mostly a libertarian, except that I do believe that the government should provide a basic level of social insurance. We should offer catastrophic crop loss insurance instead of farm subsidies, unemployment and disability insurance instead of social security, and a high deducible medical insurance instead of Medicare and Medicaid. There would still be room for private insurance if people wanted it for the deducible part of the government insurance. I believe this would provide people with a basic level of health care and protect them from catastrophic loss while at the same time protect the tax payer from abuse in the system (people going to the doctor all the time when they don’t need to, or walking into the ER with a small cut.) It would also cut down on the amazing amount of overhead used just to conform to the different billing standards of each insurer. (There is an entire industry dedicated to medical billing!) Coupled with a tax advantaged savings plan, I think that could go a long way in controlling health care costs.

  25. Hey James;

    To clear up a little bit here, in Canada we do actually have limitations on expenses for various procedures. We get “the standard” procedure, delivered at a certain level. If you want the 98% solution, that’s coming out of your pocket or out of a private health insurance plan (which also exists).

    The issue of “value for money” is a dicey one. Paying money into terminal patients is one case, but what about supporting hospitals for “vegetables” or even what to do with certain classes of premature babies (that cost the system, literally, a billion dollars and will never be “productive”)? The cost of supporting one of these babies is the same as the cost of supporting dozens of other people, so which do we take?

    At least in a public healthcare scenario, these decisions effectively become “public forum”. Even if nobody really seems to care right now, at least they can in the future. They can be election issues or human rights issues. Private healthcare just makes this a cost-benefit analysis (revenue lost vs cost of supporting obscure problem) and removes this engine for “public compassion” (or worse yet just offloads it to the government in a more costly manner).

    Obviously, we have a book’s worth of material here, but I think that it’s pretty clear that the public system has the potential to operate for significantly less + the potential for more coordinated public support.

  26. It?s really an interesting allegory. I myself started with my own analysis of stocks for purchase and created an optimal portfolio. By the way, there are many programs for optimal portfolio creating but they are for those who have made up their minds regarding what to invest in. As a result, I had an eligible investment. Why don?t I teach others and get money for that? There are people who are really good in investing, and there are people who want to invest but don?t know how or don?t have time to dig in. This is their choice to pay for such services.
    I just want to say that I do not save on professional services neither in health care nor in investing. Knowledge and experience do cost money.

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