At the start of 2008, Warren Buffet made a million-dollar bet with the CEO of money management firm Protégé Partners. He bet on an index fund that invests in the S&P 500, while Protégé bet it could pick five “funds of funds” that would perform better.
Warren Buffet’s thesis that the best thing a young man could do was to put his money in an ETF tracking the S&P 500 and just forget about the money. The compounding will do the rest. Warren Buffet was not born a billionaire. He made his money the same way.
It’s not that Warren Buffet doesn’t think that some talented people are sitting on these hedge fund committees; rather, it’s that he thinks investors should be exposed to the growth of the industry without trying to pick stocks ahead of time. The market has rewarded patient people over and over, but those who pick stocks are exposed to specific risks of the stock. Moreover, they are paying high fees to those who manage the money, whereas the fees of ETFs are negligible.
Buffet has some great quotes summarizing his view: “By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.” (1993); “A low-cost fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.”; “”When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
Hypothetically, Protégé had every reason to believe they would win. These funds of funds are essentially hedge funds operated by sophisticated professionals, aiming to always beat the market.
Those Wall Streeters that Buffet doesn’t really like had a thesis of their own. First, Wall Street was near record all-time highs at this point, and hedge funds assumed that a correction was coming. Hedge funds are supposed to be better at handling a bear market, as hedge funds aim to hedge their risk and gain a premium return over the market specifically in bad times since they diversify their portfolio with assets that are either negatively correlated to the market or not correlated at all.
The financial crisis that started in September 2008 was supposed to further hurt Buffet’s chances, as the S&P 500 had lost approximately 50% of its value from September 2008 to March 2009. However, as Buffet predicted, another bull market started, which still holds true today. The S&P 500 has almost quadrupled since March 2009, and Buffet has run away with his pride and the money.
When all said and done
Today, as we are nearing the end of the betting period (four months), you won’t be surprised to find out that Buffet is winning big time (as he always does). While the average annual return of these hedge funds for the period was an unimpressive 3%, the average annual return of the S&P 500 return was approximately 7.5%, and if you read my post about compounding, you know that the difference becomes a lot more extreme than this 4.5% after 10 years—a 106% return for Buffet’s bet but only a 34% return for Protégé.
Buffet obviously doesn’t need the money, and he will donate it (as he has pledged to do with most of his fortune), but what’s important to understand here is that once again it’s been proven that it’s almost impossible to beat the market for a long period of time. Passive investing works for even the most sophisticated investors.
Warren Buffet did not do anything special. But you don’t have to be special in the stock market.