Why Know-Nothing Investors Obtain Better Long-Term Results

A version of this article was first shared with members of my Quality Value Investing (QVI) subscription service in Seeking Alpha's Investing Groups on February 14, 2023.

Although unpopular with the crowd, the success of quality-driven value investing mirrors the wisdom of legendary investor Warren Buffett - founder and chairman of Berkshire Hathaway Inc. (BRK.A, BRK.B) - the premier investor of our time who happens to live and work in Omaha, Nebraska, instead of Manhattan, New York.

The "know-nothing" investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.[1] - Warren Buffett.

Buffett wrote the profound quote in his 2013 letter to Berkshire Hathaway shareholders. He proposes that inexperienced investors who are pragmatic about imperfections can obtain better long-term results than the informed, although shortsighted, professional. Successful investors on Main Street are aware of their inherent shortcomings that, in the eyes of the Wall Street elite, equate to unsophisticated, know-nothing amateurs.

As Buffett suggests, counter the noise by combining an alleged impaired vision of investment insight with common sense, low-cost, and risk-conscious asset allocation within a disciplined investment model. The return horizon is the slow, steady, long view in opposition to the get-rich-quick mentality of day traders, trend followers, and momentum investors.

The Juxtaposition of Wall Street

In movie-making jargon, juxtaposing is the art of presenting two opposing ideas or characters in contrast within a scene or storyline.

When performed as intended, the juxtaposition creates an illusion, pulling the viewer into the director's vision. Such is the value of entertainment. Whether it is worth the ten bucks per ticket and double that for popcorn, candy, and soft drinks depends on the movie. Nonetheless, many films fail to recoup budgets despite the high costs passed on to viewers. Movies are risky investments, indeed.

On Wall Street, the coupling of extraordinary investment return potential - or the recorded history of actual returns - and high fee structures justify elevating the costs for participating investors from projected or historical returns created by educated and credentialed professionals.

Unlike the movies, there are no scripted endings or guaranteed outcomes when investing. As talented film directors create persuasive art, the titans of Wall Street generate record-breaking revenue streams through enormous fees and commissions coupled with legal mirages of the potential for superb investment returns. Wall Street has crafted the art and nurtured the science of making investing a sophisticated institution, justifying overspending for results that underperform in many scenarios.

The Wall Street Way tempts a movie director's quest for an entertaining juxtaposition. Just ask Oliver Stone, co-writer and director of the classic drama Wall Street (Century City, CA, 20th Century Studios, 1987), featuring Michael Douglas as the antagonist Gordon Gekko, an unscrupulous corporate raider. Douglas won the best actor Academy Award for his archetypal portrayal of the 1980s excess.

Yet, almost four decades later, extravagance and greed in the financial services space remain rampant.

Outperforming Gordon Gekko

As reported widely in the financial media, only a minority of Wall Street traders and money managers beat the market consistently, such as the S&P 500 Index (SP500) or any asset class of the particular investment product benchmarks.

It is collecting fees and commissions and leveraging assets under management that finance the annual profit and bonus windfalls on Wall Street more than its investment returns. Nonetheless, most professional portfolio managers' picks underperform the broader market. So why does the collective of individual and institutional investors continue to pour trillions of dollars into the advisory fee-sucking coffers?

Perhaps it is all we know. The Wall Street Way induces customers to its mode of thinking via slick advertising campaigns, press release regurgitation from mainstream print and online media, and the proverbial talking heads on financial television stations. And well-intentioned human resource departments steer unwitting employees into high-priced one-size-fits-all retirement plans and risky company stock with an unknowing smile of loyalty to the status quo.

Then again, why argue with success in the era of the billionaire class and paparazzi-pervaded celebrities?

Who's Driving the Sports Car?

There is an adage that says never take advice from a salesperson, yet investors let Wall Street institutions sell them biased information all day long.

Imagine going to an upscale restaurant one weeknight to celebrate your significant other's birthday or a job promotion. At the end of the evening, as you wait for the valet to bring up your vehicle, you notice a $150,000 sports car in the queue awaiting its driver. It has vanity plates, so the next day your internet search of the name on the plate uncovers the owner of the luxury vehicle as a local independent financial planner affiliated with a national investment and insurance brokerage.

An online profile portrays the financial planner as a decent citizen, and the sponsoring investment advisory services company shows no apparent issues in a related internet search. However, the financial planner sells high-commission products such as annuities, whole life insurance, complex trusts, and sales-loaded mutual funds to a predominantly middle-class clientele.

Thus, the rhetorical question is, "How many of the advisor's clients drive six-figure European sports cars to a high-end restaurant on a weekday evening?"

Any client experiencing such luxury is a fabulous thing. Maybe a few of the sports car owner's clients are driving Toyotas or Chevys and aspiring to such material gain by investing hard-earned dollars with this money manager who presents an aura of wealth. Nevertheless, are the clients joining the financial bliss by allocating investable dollars to the high fees and commissions-generating products?

In the lopsided, 1-percent-owns-90-percent-of-the-wealth-economy, perhaps few indeed.

Build Your Vacation Home, Not Your Advisor's

It is customary for do-it-yourself investors to overweight their favorite stocks of publicly traded corporations in a portfolio. But how do they know which companies will do better in the long run?

Although bordering on speculation, we can make an educated guess based on research and due diligence. Nevertheless, keeping conjecture to a minimum is the best approach to successful investing over the long term.

My investing experiences and market observations shared in my Seeking Alpha articles throughout the years whittle down to:

Cultivating an equal-weighted basket of the common shares of quality companies purchased at reasonable, if not bargain, prices and held for an extended duration with the objective of most stocks outperforming the market over time.

But why don't more investors follow the low-cost, equal-weighted, buy-and-hold, quality-purchased-at-a-value-price approach to portfolio construction?

It's because the purveyors of the Wall Street fee machine cannot build beach houses or drive sports cars on the minimal fees and commissions generated from the long-tailed portfolios of retail-level value investors. Instead, Wall Street promotes or advocates bonus-generating advisory fee models.

As a result, institutional investors or professional advisors engage in or endorse options, short-selling, arbitrage, technical analysis, momentum investing, trend following, forward high-yield dividends, and other speculative, rampant turnover-driven trading platforms designed to underwrite pleasure drives to their weekend retreats.

The more profitable alternative for retail investors is to pursue the dream of building your beach or lake house by taking a thoughtful, disciplined, and patient approach to portfolio construction, capital allocation, and dividend reinvestment.

But Must We Ditch Our Money Manager?

The short answers are no and maybe.

This article is impartial to firing an investment advisor, financial planner, or broker, whether operating on Wall Street or Main Street. Many reputable, fee-only advisors or planners, as well as ethical discount brokers, exist and have the best interests of their clients at heart. Plus, laws and regulations hold registered investment advisors to a fiduciary responsibility of always acting in their client's best interests.

As implied with the sports car-driving financial planner, the advisory fees and brokerage commissions - more than the advisors - are the focus and ire of this article. If retail investors pay more than 1 percent annualized combined fees and commissions on their investments, they spend too much. And 0.50 to 1 percent is on the high end of reasonable and possible.

Nonetheless, suppose an advisor is charging less than 1 percent annualized - with zero commissioned products - and investors are happy with the performance and service. In that case, they should stay the course by all means. But if clients are inundated with excessive fees unsupported by relative returns, as are many retail investors, contemplating the alternative is perhaps in order.

Remember that disciplined investors decide with thought and contemplation instead of emotional reactions when considering new or continued financial advisor services.

Moreover, thoughtful self-directed investors focus on keeping portfolio fees and commissions as low as possible. Online discount brokers, low-cost mutual and exchange-traded fund companies for passive investors, and dividend reinvestment plans (DRIPS) are suitable places to start.

Or buy the value-priced shares of companies with high-quality business models in a commission-free online brokerage account and hold for the long-term compounding of capital and income.

***

1. Warren E. Buffett, Berkshire Hathaway, Inc., 2013 Letter to Shareholders, February 28, 2014, 20.

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