The Million Dollar Bet

"I'd compare stock pickers to astrologers, but I don't want to bad-mouth the astrologers."

• Eugene Fama, Nobel Laureate

Poll results:

Thank you to those who participated in our poll last week. To no surprise, we discovered that 67% of our reader base is above average when it comes to investing, and probably many other activities.

Almost a decade ago, Warren Buffett made a bet that a simple low-cost index fund (i.e. an S&P 500 ETF) would outperform active fund managers over a 10 year period. Only one fund manager (Ted Seides) was brave enough to step forward and take the bet against Buffett. Seides selected a basket of 5 hedge funds to compete with Buffett's Vanguard S&P 500 ETF.

The bet began on 1 Jan 2008. From 2008 to 2016, the annualized return for Seides' 5 hedge fund-of-funds was 2.2% vs. 7.1% for the S&P 500 ETF. This means a $1 million investment in the basket of hedge funds only grew to be worth $1.22 million vs. $1.85 million for the S&P 500 fund.

Fees had a lot to do with the results. Most of the funds that Seides picked at the time charged a fee of 2% (management fee) + 1% (fund-of-funds fee) annually + 20% profit share. This is compared to Vanguard's S&P 500 ETF (VOO) which currently charges 0.04% annually.

By year 9, Buffett had paid just over $5,500 in fees vs. $350,000 by Seides.

It is one of Wall Street's worst-kept secrets that active managers have rarely beat passive index investing, ever. It seems hard to believe that the idea of doing nothing can beat active investing, but 90% of active stock managers failed to beat their index targets over the previous 1, 5 and 10 year periods (2016 study by S&P Dow Jones Indices).

By Buffett's calculation, investors have wasted over $100 billion on fees alone in the last decade trying to beat the market. A good question to ask yourself is: "why am I paying these guys?"