In 2008, Warren Buffett made a friendly bet with a hedge fund company that the hedge fund couldn’t beat the S&P 500 index over a 10-year period.
The term friendly is loosely applied as the bet was for a million dollars, not exactly chump change. The proceeds will be donated to charity.
The S&P 500 is a group of the 500 largest publicly traded stocks on the New York Stock Exchange and NASDAQ.
The S&P 500 is just one of many indexes. There are bond indexes, real estate indexes and so on.
After an explosion in mutual funds popularity, investors discovered that most funds don’t beat their respective indexes or benchmarks. People got wise and simply started investing in the indexes.
Buffett was betting that this particular hedge fund would be like many others and not be able to beat the S&P 500.
So far he is right — very right. With time running out on the 10-year bet, Buffett is so far ahead the hedge fund would need a miracle to come out on top.
Although this is probably more of a PR gimmick, it does illustrate the power index funds have over many managed investments.
Many managed investments charge a fee for the services that is high enough to make beating their respective indexes an improbability.
Index investing can be counter intuitive, if not ironic. Indexes don’t have an active manager. There is no economist at the helm making buy and sell calls.
To illustrate the genius of Warren Buffett, during the time of this bet, his company, which is neither a fund nor an index, far outperformed the S&P 500.
These principals remind me of California’s famous gold rush. Many prospectors bitten by the gold bug flocked to California to create their wealth.
Wealth was, in fact created, just not by the gold diggers. The real wealth was created by those supplying goods to the prospectors. Men like Levi Strauss made a lot of money selling Levi’s.
Some investments are similar to the gold rush. Those supplying the investments are making significant money while those buying the investments make little.
Not every investment that charges an above average fee is terrible. The mutual fund industry has quite a few managers who have been able to beat the indexes long term, but they are few in numbers.
Likewise, not every index fund is a great investment.
I have seen several companies try to capitalize on the popularity of index funds by creating indexed funds and hoping investors don’t notice that the fee is higher than many mutual funds.
Using index funds provides no guarantee of high performance. Like always, I recommend people measure success by how they meet their personal retirement goals rather than by whether they beat an index or not.
However, there is enough evidence to require many retirees to consider index investing.