All You Need to Know About the Value of Wall Street Advice

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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.In short, Buffett’s bet is like backing a 5-year-old against a professional boxer.

Well, here we are seven years into the 10-year bet. I’ll let Fortune tell you how it’s going:

Through the seven years, Vanguard’s 500 index fund, as represented by its Admiral shares, is up 63.5 percent. That’s the portfolio carrying Buffett’s colors. Protégé’s five hedge funds of funds are, on the average — the marker the bet uses — up an estimated 19.6 percent.

What can we learn from this?

This is obviously a single trial. There are probably hedge funds that trounced both Buffett and Protégé over the same period. Still, if a 5-year-old can beat even one in a stable of professional boxers, there must be some lessons to be learned. Here they are:

  • It’s hard to beat the market. There are so many unpredictable variables affecting things like stocks, few humans can consistently outperform it.
  • You don’t always get what you pay for. Hedge funds not only charge ridiculous fees, you have to be rich before they’ll even take your money. Presumably, people who can meet million-dollar hedge fund 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 far too complex to navigate without paying them — handsomely. Warren Buffett knows better. And now, so do you.

As they say, it ain’t over till the fat lady sings. There’s a chance I’ll be writing a different version of this story when this bet concludes three years from now. But for today, I yearn for only one thing: to be invited to a cocktail party attended by Protégé Partners and its clients.

So, what do you think? Is Wall Street advice worth the money, or is it all just smoke and mirrors? Sound off below or on our Facebook page.

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