Photo (cc) by epicharmus
Think your mutual fund management fees are high? Be glad you don’t have your money in a hedge fund.
Hedge funds, typically available only to those willing to put up $1 million or more, employ the best and brightest minds on Wall Street. But that expertise doesn’t come cheap. Hedge funds typically charge their investors 2 percent annually on money under management, plus anywhere from 10 to 50 percent of profits, according to Investopedia.
A low-cost, low-minimum mutual fund like Vanguard’s S&P 500 Index Fund, on the other hand, has a minimum of only $3,000, charges 0.17 percent annually and gives all the profits to the investors.
To put that in perspective, if you invested $1 million with the typical hedge fund, and it made 10 percent in a year, you’d pay $20,000 as a management fee and — assuming a 20 percent commission on profits — $20,000 more as a percent of the profits, for a total of $40,000. For the same million, Vanguard would only have charged $1,700.
Obviously, no 1-percenter in their right mind would pay the price of a luxury car unless justified by performance.
Or would they?
Buffett: Put up or shut up
Seven years ago, investing legend Warren Buffett made a bet with a hedge fund called Protégé Partners. The bet was for $1 million, and the rules were simple: If Protégé could beat the Vanguard 500 Index Fund over 10 years, Buffett would contribute $1 million to a charity of their choice. If not, they’d contribute a like amount to the charity of Buffett’s choice.
This should have been a cakewalk for Protégé. The Vanguard fund is completely unmanaged. It’s simply a basket of stocks designed to track the returns of the stocks of 500 large American companies. Hedge funds, on the other hand, are not only staffed by Wall Street’s best and brightest, they’re much more flexible. They can invest in anything, from complex derivatives to single-family homes. They can bet against the market and profit when stocks fall. They can use futures and options.