Warren Buffett believes that, over a ten-year period (or longer), the S&P 500 Index will perform better than most professional actively traded funds.

He believes this so strongly that he entered into a million-dollar bet with a group of professional hedge fund managers.

The bet ran from 2006 – 2016. Who do you think won?

S&P 500 Index vs Managed Funds

Who is Warren Buffett?

I suppose there might be some people still who haven’t heard of Warren Buffett. If you fall into that camp, here’s a short bit of background.

Wikipedia does a good job with its concise description, so let’s just look at what they say about Warren Buffett:

“an American business magnate, investor, and philanthropist. He is considered by some to be one of the most successful investors in the world, and as of March 2017 is the second wealthiest person in the United States, and the fourth wealthiest in the world”

In other words, he’s a pretty smart guy who has shown consistent success in building wealth – both for himself and others. One of the most interesting facts about him is he’s all about simplicity. He’s not an active stock trader and he avoids complexity whenever possible.

This leads us to the million-dollar bet…

The million-dollar bet details

Warren Buffett believes that investing in a low-cost S&P 500 Index fund would be the smartest decision for most investors. He believes it so much that he picked a low-cost Vanguard mutual fund to put against a group of actively traded funds.

“Consistently buy an S&P 500 low-cost index fund, I think it’s the thing that makes the most sense practically all of the time.” – Warren Buffett in a CNBC interview

Buffett and the fund manager group each put up $500,000 for a cool million dollars – that will be donated to charity.

S&P 500 Index versus…

To make the bet even more interesting Buffett decided to let the fund managers pick five – that’s right, five – different funds that can all compete against the S&P 500 Index.

The funds they entered into the bet aren’t standard off-the-shelf funds. They are actually hedge funds that are limited to investments by high-net-worth individuals.

What is a hedge fund?

The team at NASDAQwrites “Well, simply put, a hedge fund is nothing more than an investment company that invests its clients’ money in alternative investments to either beat the market or provide a hedge against unforeseen market changes.”

In reality, a hedge fund uses highly risky techniques with the intention of protecting itself during downturns and producing better-than-average returns during bull markets. In any given year they can go way up, or way down. The plan is that over a longer time period – often stated as at least five years – the returns will normalize to better than investors can do on their own.

For this expertise and professional trading, hedge funds generally have really high fees. If you think the average mutual fund fee is bad, you won’t like these fees either. They can often run well over 2% per year.

Who is winning the bet?

At the end of 2016, we were nine years into the ten-year bet. Who do you think was ahead? Do you think it was a close race?

At the end of the ninth year, the Vanguard index fund logged a compound annual increase of 7.1% per year. Not bad. At that rate, you would double your money in 10 years. In fact, through the nine years, the fund was already up more than 85%. It was well on its way to potentially doubling!

How are the hedge funds doing?

The average of the five funds has produced a compound annual increase of 2.2%. No, that isn’t a typo. The average total gain of the five funds is right around 22%. Yes, almost 1/4 of the S&P 500 Index’s gain. The best of the five funds was up a total of around 63% – still way below the S&P 500 Index’s performance.

That’s embarrassing. For professional fund managers.

Actively managed funds – worth the cost?

By definition, an actively managed fund is going to have trading taking place. The professional managing the fund is always looking to pick investments that they believe are going to do well based on current (or estimated future) market conditions.

Since there is a lot of work that goes into constantly tracking the market and making trades, these fund managers charge pretty high fees. The average mutual fund (not a hedge fund) has a fee of around 1.5% annually.

If the returns of the funds were beating the market indexes by at least the level of fees, this might make sense. Unfortunately though, over the past 15 years, only about 10% of actively managed funds have beaten the indexes.

“The trick is not to pick the right company, the trick is to essentially buy all the big companies through the S&P 500 and to do it consistently and to do it in a very, very low cost way” – Warren Buffett

With the professionally managed funds doing so poorly, it makes you wonder what exactly you get for those high investment fees some advisors charge.

Should YOU invest in the S&P 500 Index?

Warren Buffett seems to think so.

I don’t think he’s wrong.

It is worth considering your overall portfolio mix though to make sure you get an appropriate level of return for the risks you’re willing to take.

Better yet would be to talk to a professional to make sure your investing lines up with an overall financial life plan.

As a fee-only financial advisor, I can help you clarify your dreams and priorities, then develop an actionable plan to achieve your goals. Having a financial plan for your life includes much more than just investing, but intelligent investing is definitely part of the solution. Just select Start Here and let’s talk about how I can help you maximize your money to achieve the life of your dreams.

Are you surprised that the Vanguard S&P 500 Index fund is beating out the professionally managed fund so much? Do you think the hedge funds have a chance of an EXTREME year in 2017 to make up the difference in the bet? Would you, or do you already, invest in an S&P 500 Index fund? Let us know in the comments below.