Warren Buffett: Small investors have one big advantage

Bloomberg

The little guy can trade on the cheap.

Retirement investors have a major advantage over Wall Street that few fully appreciate, says billionaire investor Warren Buffett — buying and selling is cheaper than ever. 

For the serious long-term investor, the result has been an undeniable edge over those who continue to pay high and rising money management fees.

"The investor incurs really quite little in the way of transaction costs in investing in stocks. Compared to real estate and other types of investment it's way less, and compared to 25 years ago it's less," Buffett told CNBC .

"Now the other side of that is, they are paying more, those who are using managers to manage their money. If you look at the fees that are extracted by Wall Street, on balance, they've gotten quite substantial compared to 25 years ago."

Those two trends are powerful examples of just how bad a deal Wall Street has become for the retirement investor. And the solution is simple: Investors should own a basket of highly diversified index funds or index ETFs, thus getting the lowest possible cost and the best, most reliable long-term return.

Prices should be falling across the board. As hedge funds and high-speed traders duke it out over pennies, liquidity has risen. On the whole, that's a good thing. Coupled with advances in computerized clearing, the markets today versus the early 1980s are like night and day.

Think about it: People aren't surprised that it's easier to find out home prices or new car prices online. They’ve long gotten used to insurance companies bidding to quote them without an agent, again through the Internet.

Nobody questions the falling prices of nearly anything you care to buy on Amazon.com. We expect hotels to cut each other's throats for our vacation dollars.

It's really only in the investment arena that we still feel the tug to pay too much, even though an efficient, highly reliable system for buying and selling a virtual good — the future earnings of the economy as represented by the stock market — is making it cheaper and cheaper.

Bogle's view

Meanwhile, a small coterie of highly paid, mostly self-anointed gurus are trying to drive up the cost, largely to justify their own existence. If we were talking about airlines, you'd laugh and say "No way!" But somehow buying equities is freighted with an otherworldly importance.

We feel we need a guide, someone who can pick which stocks to buy and help us avoid financial problems. Yet the fees advisers charge for that "service" is the financial problem. As the research outfit Morningstar long ago concluded, the single most reliable indicator of a mutual fund's future performance is cost: Low fees equals better returns.

The whole idea in investing is to buy into good businesses and if the business does well, you do well in investing — if you don’t pay too much. That was true 25 years ago and it will be true 25 years from now.

— Warren Buffett

"The game hasn't really changed," Buffett continued. "The whole idea in investing is to buy into good businesses and if the business does well, you do well in investing — if you don't pay too much. That was true 25 years ago and it will be true 25 years from now.

Amen and hallelujah. This is the fundamental argument made by Jack Bogle, founder of the Vanguard Group. Keep things cheap by design and you cannot help but outperform. "Strategy follows structure," he told The New York Times in 2012.

By that, Bogle means Vanguard was built to stay cheap by virtue of its ownership, the shareholders of the funds themselves. "The only way anyone can really compete with us on costs is to adopt a mutual ownership structure," Bogle said. "I've been waiting all these years for someone to do it, but no one has."

Reliable return

Is Wall Street coming around to this idea? In fits and starts. You see more index funds available at the big brokerages than before. Ordinary brokers long ago accepted that commissions would fall.

Yet management fees have stayed high, on the order of 1% and even higher. Add in the underlying mutual funds they buy and you could be paying 2.5% or more. Then consider the costs of heavy trading, which are substantial and come right out of your portfolio. It adds up.

Just owning the index, meanwhile, costs a tiny fraction of all that while providing a solid, reliable, compounding return. Anyone could do it and everyone should.

Wall Street is working to maintain the mystery, to keep shouting "Never mind that man behind the curtain!" while furiously working the gears and knobs. As long as we look right past the obvious flimflammery, we're likely to keep paying