To summarize, Bogle determined that in a recent year, the “financial services” industry effectively took $620 billion off the top for a 7% fee on $9.5 trillion value of stocks, or 2% of a $30 trillion value of bonds, or 1.5% of $40 trillion value of US securities. Now we’re not sure who Bogle has included in his definition of the “financial services industry as the “croupiers,” “the money shufflers and middlemen.” It doesn’t really matter because his point is not about the specific cost but the role of those folks in the market.
Bogle refers to Warren Buffett’s letter (PDF) in the 2005 annual report for Berkshire Hathaway. In his extended analogy, Buffett makes the general point that if one family owns all the shares of all the companies, some family members paying advisors to get a net larger slice of the pie vis-a-vis other family members is unwise because the total FCF for distribution is the same and the advisors will take away from the distributions to the family. Of course, the question of whether the family as a whole is better off is, perhaps, the right question but not the one actually being presented. Each family member in the hypothetical is trying to increase that person’s FCF without regard to the FCF of the rest of the family. (OPEC & the difficulty in keeping cartel members from cheating or the more basic prisoner’s dilemma are obvious parallels.)
Once the option exists to choose individual investments, as opposed to market-wide index funds, advice to optimize the portfolio becomes a rational alternative to consider, with the rationality of the choice a separate issue that is more complicated. Buffett, and now Bogle, seems to say that seeking advice does not make sense.
Do portfolio-pickers and brokers (and that’s the category with which Bogle seems most concerned) cost too much? Maybe. Some do, some don’t. Doesn’t the performance of the pick matter? Consider a relatively simple question of choosing a traditional market-cap weighted index fund vs. a dollar-weighted index fund or equally weighted index fund. Those returns are different. Is the investment advice that points you to the right one worth more? At least worth something?
What this article sparked for us was the recognition that companies are in fact much like Buffett’s fictional family and yet also very different. On the one hand, a company consists of a portfolio of products, services, customers, and assets. Each company would be hard pressed to justify internal competition that doesn’t have the effect of improving firm FCF. So advice doesn’t make sense.
At the same time, cannibalization is a growing in acceptance as a part of corporate strategy. So each company is like an individual family member looking to improve its position as against its competition. Certainly, advice then makes sense.
So, while TSC can be described as a financial services company, we don’t really operate in the same market that troubles Bogle. We help companies determine how to improve their free cash flow by analyzing the datastream of their business portfolio. Our insights may revolve around the acquisition of capital, the growth of revenue, the control over costs, and the reinvestment in the business, but in many ways they’re fundamentally different from pure stock market advice. Of course, we have considered the application of our algorithms and equations to private wealth portfolio management, the selection of pairs of securities appropriate for hedged opportunities, synthetic M&A trading strategies, and portfolio optimization — so maybe we are more of a financial services company than we think.