There’s just three years left in the 10-year bet between billionaire Warren Buffett and a New York hedge fund firm, and it seems clear that Buffett will win handily.
More investment magic from one of the world’s richest men? Not at all. Buffett’s side of the bet was one anybody could have taken: Buy the S&P 500 starting in January 2008 through a very low-cost index fund and wait. The hedge fund could do whatever it wanted and presumably owns a collection of hedge funds.
The initial bet was $320,000 in bonds that would be worth $1 million in a decade’s time, with the gains going to charity. (Buffett put up his own money.)
As of early 2014, Morningstar reports, the hedge fund approach was up 12.5% after fees, while Buffett’s index fund was up 43.8%. A good part of the difference comes down to fees: Buffett bought an index fund that charges just 0.05% as an expense ratio, while hedge funds typically cost 2% and a whopping 20% of profits.
In more terrestrial terms, a retirement portfolio of $100,000 using the index fund approach would cost $50 a year to maintain, while the hedge strategy would cost $2,000 and a full one-fifth any upside, sucked out of your account quarterly.
If the market returned, say, 10% in a year, the hedge fund manager would soon back out $4,000 in fees. Rather than adding up to $110,000 the portfolio would be at $106,000. If the market returned negative 2%, the hedge fund would still remove its 2% fee ($1,960), leaving the investor with $96,040 in the fund.
How are they doing now? It’s hard to say, but the numbers for hedge funds are in and it’s not pretty. Far too many of them bet heavily on commodities, which have tanked. The average hedge fund has returned just 2% so far this year, according to Bloomberg News, and we’re on pace for another record year of hedge fund closings.
The news service reports that 461 hedge funds closed in the first half of 2014. The worst year for closures, perhaps unsurprisingly, was 2009. That year, 1,023 hedge funds closed up shop after the stock market hit rock bottom.
If you had simply stayed in an index fund, which was Buffett’s strategy, all of that “lost” money came back in due course. There was no need to find some alternative strategy — commodities, shorting, a wild bet on frontier markets — to turn things around. The Vanguard 500 Index Admiral Class (VFIAX) fund that Buffett bought has returned 13.16% year to date and has posted 15.49% annually over the past five years.
All you have to know
It doesn’t take much research to buy and hold an index fund. In fact, it takes zero. You don’t have to know what will happen to the economy in a year or three years or more. You don’t have to know which board will fire which CEO. You don’t have to worry about which companies might fold and which will prosper.
All you have to know is when you expect to retire and then hold a level of stocks vs. bonds appropriate to your time horizon while rebalancing judiciously.
That’s exactly why Buffett is winning. Yes, he does a lot of very tricky, private-equity-type things with his investors’ money at his own firm, Berkshire Hathaway. Yes, he does a lot of hardcore research before buying anything for his own shareholders.
That’s the burden he carries as the overseer of many billions of dollars of other people’s money, which is fine. But, as Buffett has said before, his own heirs should just put their money into index funds and be patient. Prudent retirement investors would be wise to do the same.