3 Lessons From Buffett’s Million-Dollar Wager

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A hedge fund bested Warren Buffett for only the second time in the first eight years of a decade-long bet. What can you learn from the Oracle of Omaha's wager?

What happens when a specialized hedge fund company accepts a million-dollar bet from a value-investing legend?

It’s not pretty for the hedge fund industry — at least not in the case of the 10-year bet that New York’s Protege Partners accepted from Berkshire Hathaway CEO Warren Buffett in 2008.

Last year marked only the second time in eight years that hedge funds chosen by Protege Partners beat the mutual fund chosen by Buffett — and they just barely did so, according to Fortune magazine, which has exclusively reported on the bet each year since 2008:

Even so, the winning margin was slight. The five funds, on the average, gained 1.7% during 2015 vs. the 1.36% return rung up by Buffett’s index fund.

So what does this have to do with the average investor? Let’s start at the beginning.

Here’s Buffett’s original challenge, as detailed by the Long Now Foundation, which is holding each side’s money (which will go to a charity chosen by the winner):

Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the Standard & Poor’s 500 stock market index (S&P 500) will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.

Buffett chose the Vanguard 500 Index Fund, which is a type of stock mutual fund known as an index fund. Index funds are not actively managed and therefore have low fees. An index fund is simply a basket of stocks designed to track the returns of the stocks of the 500 large American companies that comprise the S&P 500.

Money Talks News founder Stacy Johnson, who uses the Vanguard 500 Index Fund in his retirement account, describes it as “one of the lowest cost and most popular in the world.”

Protege Partners accepted Buffett’s challenge and selected five funds of hedge funds, which have not been disclosed. Hedge funds are managed by Wall Street’s best and brightest and therefore are known to have high fees and costs.

Eight years into Buffett’s 10-year challenge, he has a commanding lead overall. Fortune reports:

For the first eight years of the bet, the index fund he’s backing is up 65.67% against 21.87%, on the average, for the five funds of funds.

When the challenge started, Buffett gave himself a 60 percent chance of winning, while Protege Partners put its odds of winning at 85 percent.

As Stacy Johnson has noted in years past, there are three lessons that anyone can take away from Buffett’s bet:

  • It’s hard to beat the market. There are so many unpredictable variables affecting things like stocks that few humans can consistently outperform it.
  • You don’t always get what you pay for. Hedge funds not only charge high fees, they require high initial investments. Presumably, people who can meet million-dollar minimums aren’t stupid. But if they’re not, why are they paying so much and getting so little?
  • All hat, no cattle. Those in the business of selling their “expertise” want you to believe markets are too complex to navigate without paying them. Buffett knows better, and now you do too.

What point do you think Buffett was hoping to make by publicly challenging the hedge fund industry? Share your thoughts below or on Facebook.

Stacy Johnson

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