Investors are always looking for better returns but most forget that cost is also a crucial factor.
In Berkshire Hathaway’s 2005 letter to shareholders, Warren Buffett introduced the Gotrocks family example to illustrate this point.
The Gotrocks family owns 100 percent of corporate America. “They share the earnings growth and dividend returns from thousands of companies every year. The family wealth keeps growing year after year, and all family members are winners,” he wrote.
However, some family members listened to the advice of some so-called financial experts and started to buy and sell stocks frequently in the hope of magnifying the profit. Certainly, these transactions need to go through those “experts”, who would receive commissions.
The family wealth growth started to slow since part of the investment returns were taken away by these “experts”. Moreover, the family had to pay more trading fees.
Some family members quickly realized something had gone wrong. To rectify the situation they turned to another group of experts that specialize in stock picking.
One year later, the return declined further. The family kept changing financial consultants and planners and the return got even worse.
In the end, all family members gathered together to discuss the issue.
A wise, elderly member pointed out the reason. “All the commissions you paid to those experts, and those extra trading-related taxes are all coming out from the investment returns. Let’s get back to the starting point and get rid of all those experts.”
Equity investing is about owning a piece of a company and sharing in its earnings and growth.
Sometimes, share prices move ahead of fundamentals and sometimes the opposite, but in the long run, share prices always reflect the pace of company growth.
If you are invested in some good companies already, just hold on to your portfolio instead of engaging in trading or switching. Give the companies time to grow and you would be able to share the handsome long-term rewards.
Paying 3-4 percent to financial intermediaries may sound little. But if you are investing for decades, cost savings can make a huge difference.
Assume an investment period of 40 years, with a 10 percent annual compound return. A HK$100 principal will grow to HK$4,500. But if the annual compound return is reduced to 6 percent, the same principal will only increase to HK$1,000.
This article appeared in the Hong Kong Economic Journal on Feb. 1
Translation by Julie Zhu
[Chinese version 中文版]
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