High Stakes Bet

By Jamie Ostrander 

Why the “Oracle of Omaha” believes in index funds; and you should too!

How many of us would make a 10 year long bet? Would you make a wager that takes 10 years to win or lose, and do it publicly, with full accountability? The challenge was simple and profound.

Warren Buffett made a bet that a passive S&P 500 index fund would outperform a basket of hedge funds over a 10 year period. The 10 year period just expired at year end of 2017. Buffett won the bet by a large margin. His investment averaged out to a 7.1% annual return, while the hedge fund basket of funds averaged out to 2.2% per year over the same period.

Why was Warren so confident? In our opinion:


Hedge funds have large costs that are hard to overcome. Some are “2 net 20”, which means they charge 2% (or 200 basis points) on the assets annually and 20% of the gain every year.  That is a heavy gravity to overcome; an S&P ETF has minimal costs as do most index funds, usually less than 30 basis points.

Market timing

There’s an old adage in the investment world that goes; “it’s not timing the market that matters, but time in the market.”

A Gamble for Good…

The bet between Buffett and Mr. Ted Seides at Protégé’ Partners (the only Hedge fund manager to publicly accept the wager), did end up doing some real good. Buffet donated the winnings to Girls Inc., of Omaha, NE, a charity for girls in his hometown that inspires girls to be strong.

The original bet was for $1 million, but the 2 gamblers put up $320k each and invested it in bonds. They later agreed to put their jackpot into the Berkshire Hathaway company stock. The grand total donated to the charity at the end… over $2.2 million 2.

In other words, Mr. Buffet knew that the hedge-funds would indeed hedge their bet, by guessing on which asset class to be exposed to at the incorrect time they underperform a well-diversified index, or even one global index. Risk and reward are directly connected, and in the scenario of the wager, Mr. Buffett maintained a higher risk portfolio all the way through the 10 year period. He took no educated guesses, he simply stayed invested in a bellwether of American capitalism, the S&P 500.

Impossible to identify a persistent winner…

How long would you have to follow someone’s success before you were convinced they could outperform the market? A year?  Five?  Ten?   Bill Miller, who managed Legg Mason’s Value Trust fund, beat the S&P500 for 14 years straight but missed so badly in year 15 that over the fifteen year period he actually underperformed the S&P500 1. Consequently, if you kept track of his performance for 10 years, and invested in year 11, you were crushed in comparison to the benchmark.

In developing your strategy to accomplish your goals, we understand that you are not trying to win a bet. Be active in your planning, and in discovering what matters most to you. When it comes to putting your assets to work to achieve those goals, it makes the most sense to follow Buffett’s lead. Instead of chasing performance, trust your ability to identify and define what matters most to you. In contrast to Buffet’s victorious wager on the S&P 500 index, do not rely on good fortune and gamble on a single market benchmark, rather develop a customized portfolio that is driven by your tolerance for market performance and is driven by your goals.  Chart out an active and dynamic plan to achieve it. Design an efficient portfolio that you understand, stick to your allocation, and enjoy the journey.

If you would like to review your asset allocation and how it relates to what’s most important to you, call our wealth services firm in Satellite Beach, FL – Melbourne/Brevard area at (321) 773-7773 to schedule your complimentary consultation.

1 www.businessinsider.com/2008/12/the-fall-of-bill-miller

2 http://fortune.com/2017/12/30/warren-buffett-million-dollar-bet/

You should not assume that any discussion or information contained in this publication serves as the receipt of, or as a substitute for, personalized investment advice from FirstWave Financial. A copy of the FirstWave’s current written disclosure statement discussing our advisory services and fees is available upon request.