Warren Buffet’s one million dollar bet: how I stopped throwing my money away

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It’s storytime today on the blog. I want to share one of my favourite anecdotes from the financial world, one that’s inspired my investing strategy for the past four years.

Let’s call this story: The Tale of the Tortoise and the Hare – of the ETF and the Hedge Fund.

Having studied business in university, I was buffeted (haha – get it?) by stories of Warren Buffet. The man did run one of the world’s most successful hedge funds, after all. So it was all the more interesting when I heard about his one million dollar bet against hedge funds.

The story

The year was 2008. Warren Buffet had just had one too many glasses of wine (just some fictional window-dressing on my part) and decided it might be fun to pass gas on all his hedge fund colleagues: he issued a one million dollar bet to anyone in the hedge fund industry that their fund could not outperform an index fund he selected over the next ten years. Ted Seides of Protege Partners LLC accepted the bet. Hands were shook, winks exchanged (more window-dressing).

Seides’ player: undisclosed basket of hedge funds

Buffet’s player: Vanguard S&P 500 Admiral fund

The race was on.

If you remember, 2008 was not a good year for the market. The subprime mortgage crisis had caused a market crash, and the S&P 500 lost a bunch of value overnight. Meanwhile, the hedge funds were performing spectacularly because they were doing what hedge funds were build to do: hedge against market uncertainty. It looked like Buffet might lose that million dollars.

But as with the tale of the tortoise and the hare, the ETF index slowly caught up over the next four years.

The reason? Fees, baby!

Hedge funds employ complex trading strategies in order to receive high returns for their investors who are prepared to accept higher risks. As a reward, hedge fund managers take a nice sweet chunk of change out of all the profits their fund earns before passing the remaining profit onto their investors. And so, even if they’re able to outperform the market in terms of total income, the investors may still see a return below market.

And a below-market return they did see. Buffet officially won the one million dollar bet by December 31, 2017, even though Seids pretty much threw in the towel earlier in the year when it was clear the ETF’s cumulative returns had become too large to beat.

Moral of the story: No one’s as smart as they think they are

As much as the recent Gamestop, Blackberry and AMC crazes have begged to differ, I don’t see investing in the stock market as a lottery, and fund managers as the experts who have figured it out. In the end, the market only reflects the results of supply and demand, and when predicting their movements there will always be winners and losers. As someone investing their money, I’m not confident my friendly neighbourhood fund manager can play the game better than the rest of the fund managers out there, who are all equally educated, experienced, and ambitious. And if in the long run they’re just going to produce market returns, why would I want them to take a fee for doing that?

Learning about Warren Buffet’s ETF bet only confirmed to me that I didn’t want someone actively managing my money. The majority of my investments are in index funds or derivatives of index funds, which take very low fees and are passively managed. And while I don’t think I’ll get rich quick off these funds, I’m guaranteed to make the average. And that’s better than most funds can say.