Stop looking for pricey investments and stick to the long-term plain vanilla investment.
Once again, we have proof that Wall Street’s high price offerings usually don’t work for the average investor and that simple index investing works best for most people over the long term.
The latest example comes from one of the greatest value investors of all time, Warren Buffett. He learned much from the legendary investor Benjamin Graham.
Buffett, a.k.a. “The Oracle of Omaha,” recently won a wager he made almost ten years ago. In the winning the bet, he has shown that the high-priced investment spread loses by a lot to the plain vanilla investment.
The One Million Dollar Bet
Buffett made a $1 million bet at end of 2007 with a hedge fund manager Ted Seides of Protégé Partners. Buffett wagered that the low-cost S&P 500 would perform better than a group of Protégé’s hedge funds. A much-debated kind of investment, the average hedge fund uses complicated strategies. The hedge fund manager receives a lot of money when the fund does well and even when it doesn’t. A hedge fund costs a lot to run while an index fund requires very little trading and is one of the cheapest investments around. That’s why Buffett says it tends to be the best investment for the average person.
Buffett’s index investment, which requires little work, trades infrequently and incurs dirt cheap expenses, is so far ahead that Seides recently conceded the match, although the game doesn’t officially end until Dec. 31st. The problem for Seides is his five funds through the middle of this year have been only able to gain some 2.2 percent a year since 2008 compared to some over 7.06 percent a year for the S&P 500. A little under five percent more a year may not seem like much over a year or two. However, over a decade, it can really add up.
Let’s look at the investment scoreboard. Seides’ $1 million of hedge funds have only earned some $220,000 in the same period that Buffett’s low-cost pick has gained some $854,000. The Oracle is far ahead of the high-priced competition. That’s even though the game still has some three months to go.
I Give Up
“For all intents and purposes, the game is over. I lost,” Seides recently wrote. The $1 million will go to a Buffett charity, Girls Incorporated of Omaha. A sports gaming firm says it makes sense for Seides to pay up now.
“Our odd makers believe there is a 96.78 percent chance that Buffett will win. In turn, they are giving Protégé Partners about a three percent chance to win at this point,” according to Jacob Crossman, a spokesman with Diamond Sportsbook International, which has tracked the bet. “It’s comparable to a football team coming back to win while down 35 points in the fourth quarter or a 45-point underdog winning outright.”
Why did he lose?
In conceding defeat, Seides said the high cost of the average hedge fund was a critical factor.
Good for the Hedge Fund, not So Good for the Investor
Hedge funds tend to be a nice deal for the people who run the funds, who pass on big bills to the investors.
“Is running a hedge fund profitable? Yes. Hedge fund managers typically demand management fees of 1% to 2% of assets under management,” according to Capital Management Services Group (CMSG), which tracks the hedge fund industry. “Performance fees for managers can be 20 percent to 50 percent of trading profits,” CMSG adds.
By contrast, the costs of an average index fund are minimal. A fund that tracks the S&P 500 fund might have an expense ratio of as little as 0.02 percent.
Indeed, Seides, in a sentiment that sounds as though he was now using the Buffett playbook, wrote that “the higher the price an investor pays for an asset, the less he should expect to earn.”
Still, the argument for the pricey form of investing, say supporters of hedge funds, is surviving bad times. Seides said he was at a disadvantage over the last decade because there was no crash.
Nevertheless, over the long term the average investor is usually better off buying a low-cost index fund, putting money in it on a regular basis in bad times as well as good, than paying through the nose for a hedge fund or some other high-priced investment. That is the lesson that Buffett has illustrated yet again for millions of average investors.
Heed his advice. The Oracle of Omaha is the essence of MoneySense.
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