Investors are so fixated on maximizing their investment returns that they often fail to consider one of most crucial considerations: investment expenses. Why do expenses matter? They matter because a little means a lot.
The 2% Difference
Take two investors who each have $20,000 in the same exact investments. One earns 10% a year and the other earns 8% a year. At the end of the 30 years, the 10% investor has investments worth $349,000 and the 8% investor is left with investments worth $201,000.
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This 2% difference was worth $148,000 over the 30 year period. And this difference is for investors who only invested $20,000. Imagine the significance when millions of dollars are invested.
Read Between the Lines
Before investors consider investment returns, they should first look at the expenses incurred. With many mutual funds charging up to 2% a year, you can see how much those fees can be worth.
More importantly for individual investors, pay attention to brokerage fees and commissions. And for most market participants, avoid rapid-fire trading unless you have a keen ability to spot price discrepancies, which despite what many of us may think, most are not qualified to do. A famous saying goes "when sitting at a poker table, if it takes you more than 10 minutes to figure out who the sucker at the table is, it's most likely you."
The Best for Free
Believe it or not, there exists an investment that over the past 40 years has returned over 20% a year. On top of that, its run by the most highly regarded money manager in the world. I'm referring to none other than Berkshire Hathaway (NYSE: BRK-A, BRK-B).
Most people look at Berkshire as simply another large publicly traded company when in fact the company holds a portfolio of securities hand picked by Buffett and GEICO chief Lou Simpson. Best of all they don't charge you a management fee to do so. So investing in Berkshire means you are getting Buffett's investment management skill for free.
And with Berkshire, you are getting excellent diversification. You get an insurance business, one of the largest utility businesses in the country, private businesses like Dairy Queen and Fruit of the Loom, and an equity portfolio with quality blue chips like Kraft (NYSE:KFT), Johnson and Johnson (NYSE:JNJ), and Berkshire's newest investment, medical supply company Becton Dickinson (NYSE:BDX). In addition, you get Berkshire's unparalleled access to some of the best deals in the world. One that comes to mind was Buffett's investment in Chinese electric car maker BYD, an investment that is up over 400% since Berkshire bought in. (For more, check out Warren Buffett: How He Does It and Think Like Warren Buffett.)
Berkshire's future returns will not even come close to replicating the past track record. The company was much smaller then. Nonetheless, Berkshire will most likely do very well relative to the overall market and investors will not have to incur frictional costs to do so.
There are some quality value-oriented mutual funds out there that charge very attractive fees considering the talent and brains you are getting. Two that come to mind are the Fairholme Funds run by longtime Buffett fan Bruce Berkowitz and the Longleaf Funds headed up by value investor Mason Hawkins.
No investor wants to lose money, but that's what can happen over time if you don't pay attention to investment expenses.