Warren Buffett bet huge on index funds – here are 5 reasons why you should too.

(Photo by SMW)

 

Warren Buffett is the CEO of Berkshire Hathaway and widely regarded as one of the most successful investors in the world. If you’re not too familiar with him as a professional, just know that many people attempt to model their investment strategies after his. Oh, and he’s worth billions, if you’re interested in that sort of thing.

 

As reported by Fortune and National Public Radio (and many other outlets), about 8 years ago Buffett took a bet of $1,000,000 against Protege Partners, a money management firm.

 

What was the bet?

 

Over a 10 year time period, who can pick the more successful investment? Simple as that.

 

How did this bet take shape? 

 

Buffett challenged the hedge fund world in a speech – Protege Partners took the bait.

 

Where do the winnings go? 

 

The winnings (which were invested themselves – and now actually worth over $1.4 million) will go to Girls Incorporated of Omaha if Buffett wins, and Friends of Absolute Return for Kids, Inc. if Protege wins. Both sides agreed to give at least $1 million in a losing effort (anything above $1 million would also be donated if the funds gained additional value).

 

Current status. 

 

They’re 8 years into a 10 year bet, and so far Buffett’s investment is leading (up) 65.67% against the Protege Partners investments (up) 21.87%. There’s been a little back and forth about the market crash of 2007-’08 affecting the bet, but hey, a bet’s a bet – and both teams are playing on the same field.

 

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Protege Partners took a smart strategy of diversification into the bet. The specific funds haven’t been revealed (to avoid influencing the market performance), but the group selected 5 funds of funds (each of the 5 funds owns shares of many other funds).

 

Buffett’s strategy on the other hand… One fund. An index fund – The Vanguard 500 Index Fund Admiral Shares.

 

Also a collection of many funds, an S&P 500 index fund is an investment in 500 of the largest US based companies. Because of this, the S&P 500 is a commonly recognized barometer of the US economy. By investing in an S&P 500 index fund, you are basically investing your money with the goal of improvement in the US economy.

 

Why does this matter to us? 

 

I’m not looking to make an example out of Buffett’s opposition but a good portion of my investment strategy is modeled after Warren Buffett’s approach to this bet. Investing in index funds has helped me climb out of the ’07-’08 crash, build up a down payment for our home, and build wealth for the future.

 

Here are 5 reasons why I invest in index funds: 

 

1) Simple and easy to do – You don’t need to track 100s of different mutual funds to chose the 5 you want to invest in. Neither do you have to monitor your 5 fund’s performances on a weekly or daily basis. You don’t need to read 5 different prospectus letters or briefings for the heads of your 5 funds…

To responsibly invest in stocks, mutual funds, ETFs, or other funds, these are things you can – and should – do.

By investing in our S&P 500 index fund all you need to do is track one fund – probably the most popular fund – the US economic barometer. Just turn on the news and you’ll see how your investment is doing.

 

2) Less costly – Many of the different fund types mentioned above are managed by a group of individuals or an investment firm. To do all the research, investing, trading, and tracking, these groups charge significant fees. Depending on their fee schedule you may have to take a significant portion of your earnings off the top and hand it over to them.

 

One huge benefit of Index funds is that they have famously low fees. Their investment monitors the S&P 500 which is run by a separate committee. Less work for the investment firms = lower fees.

 

3) Powerful results – Since its inception in 1928, the average annual rate of return for the S&P is close to 10% (about 7% when adjusted for inflation) – meaning an investment of $1,000 becomes about $1,100 next year.

 

This strategy is not a ‘get-rich-quick’ scheme, it is a long-term approach to building significant wealth. When you add compounding interest and 20 or 30 years’ time to the scenario above, you have a significant amount of money in your personal fund.

 

4) The S&P 500 is the benchmark – This is the barometer mutual funds try to beat every year. It is considered an achievement to beat the S&P in a fiscal year. So much of an achievement that in 2014 – about 86% of investment managers did not beat it!! That number varies year-to-year, but a large portion of investors fall short every year.

 

When you add their additional fees and the effort it takes to find a money manager (and bet they’re better than 80% of the field) into the equation, it can become a poor investment to go with something other than index funds.

 

5) Warren Buffett is a big advocate of this strategy – Buffett has a decent track record and so far it’s working out pretty well for him.

 


 

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The bet has about 1.5 years to go. Although Warren Buffett’s lead isn’t insurmountable, Protege partners have determined their only course for victory is a “severe market contraction.” They’re also on the record that they’d rather lose than witness a victory at that expense.

 

This is a 10-year snapshot of the American economy and doesn’t necessarily represent the future of investing, but so far Warren and I are in agreement – Index funds should be a staple of many investor’s portfolios.

 

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Do you have a question or comment? Let us know by commenting on the post or emailing Mike. We’re glad you’re here. Thanks again and talk soon!

 

– Mike
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2 Comments

  1. Very informative article Mike. Interesting stuff concerning the bet between Buffet and Protege Partners. Always wanted to see a heavy hitter such as Buffet take on one of these investment groups in this way. Thanks

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