What Warren Buffet’s Comments About Future Returns Really Means

He says it throughout his annual report. In the section titled, Fanciful Figures – How Public Companies Juice Earnings he talks at great depth about the low likelihood that we are going to see the same gains we saw in the 20th century. He states a 5.3% compound return for the period. Yeah, that is not a high return figure! However, that is not his point. The point is that we should not expect to see returns even as high as 5.3% going forward. This seems to be the fact that everyone is harping on – the low returns that we can expect to see in the foreseeable future. This quote from the annual report provides us with a glimpse of Buffet’s thinking:

I should mention that people who expect to earn 10% annually from equities during this century – envisioning that 2% of that will come from dividends and 8% from price appreciation – are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about double – digit returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

This is the stuff that everyone is focused on. I believe the real focus is on some of the other things he says, particularly about returns in relation to fees. With low returns on the horizon, super low investment costs become even more important as we are going to need as much of these minimal returns as we can possibly keep. Think about that for a moment. Let’s say we see a return of 5.3% over the next 20 years on a $100,000 investment in our index fund which has a MER of 0.30%. The end value of this is $265,329.77. Now let’s say we again see a return of 5.3% over the next 20 years on a $100,000 investment, but this time it is in an index fund with a 2% MER. The end value on this amount is now only $180,611.12. That is a difference of $84,718.65. With this small return as it is, the impact of that 2% in fees is very dramatic.

Without oversimplifying it, the answer is pretty simple. When structuring your own portfolio, think primarily of costs and being as inactive as possible and remember, Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

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