Are You Betting Against Warren Buffett With Your Portfolio?

October 05, 2017

If you could get investment advice from anyone, who would it be? Well, you could do a lot worse than Warren Buffett, the second richest person in the world. For years, Buffett has been advising anyone who will listen, including Lebron James, to avoid high cost actively managed funds and stock to simple, low cost index funds.

With much of his advice ignored, Buffett decided to put his money where his mouth is and bet $1 million to charity that an S&P 500 Index fund would beat a group of any hedge funds over a 10 year period. (Hedge funds are supposed to be the “best of the best” on Wall St. and are generally only available to wealthy individuals and institutions.) After a period of silence, Buffett finally found someone willing to take up his challenge. The 10 year period expires at the end of the year but Buffett’s opponent has already conceded since the S&P is considerably ahead of the hedge funds.

What can the rest of us learn from this?

1. Keep an eye on costs when choosing mutual funds. The primary reason the hedge funds lost was their high fees. A study by Morningstar similarly found that the “most proven predictor of future fund returns” when comparing similar mutual funds was a low expense ratio, which is the main fee charged by mutual funds. Buffett chose an index fund since they tend to have much lower fees and trading costs than actively managed funds. In a taxable account, they also tend to be more tax-efficient. If you don’t have index funds available to you in your retirement plan, compare funds’ expense ratios and turnover ratios (how often a fund trades and this generates transaction costs).
2. Have a long term perspective. Despite the odds being in his favor, Buffett knew better than to take a bet on a single year’s performance. He used ten years to reduce the impact of random luck. Don’t get caught up in short term performance. Just because a fund is outperforming for a period of time, doesn’t mean it will continue to do so. In fact, research has found that the longer the time period, the less likely top funds can maintain their outperformance, implying that it was more due to luck than skill.
3. Be willing to take calculated risks. Buffett knew the odds, but it wouldn’t have meant anything if he wasn’t willing to take a bet on them. Remember, knowing is only half the battle. Don’t let analysis paralysis or procrastination prevent you from acting. If you’re afraid of investing, start with a more conservative fund that also includes bonds and cash as well as stocks.

In retrospect, betting against Buffett may seem like a foolish bet to have made. But keep in mind that when you choose more expensive, actively managed funds, you’re essentially betting against Buffett too with your own money. Is that really a bet you want to take?

 

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