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Warren Buffett’s $1,000,000 bet...and what you can learn from it

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$76.7 billion

That’s Warren Buffet’s net worth – generated almost

exclusively through shrewd investing.

(To put that number in context (sort of) - if you converted Buffett’s billions into 1 dollar bills and linked them together forming a chain, it would wrap around the Earth298 times.)

Anyway, the man knows how to invest.

The Backstory and The Bet

Buffet outlined his beliefs on active investment management in the 2005 letter to Berkshire Hathaway shareholders. He asserted that amateurs, doing nothing but investing in an index fund, would outperform hedge funds, largely because of the hedge funds’ multiple layers of fees.

Buffett publicly wagered that no professional investor could select a set of five hedge funds, that over the next 10 years, would beat a low-cost Vanguard S&P 500 index fund**. The performance of those five hedge funds would be averaged and compared to the performance of Buffett’s selected fund at the end of the comparison period.

That’s Interesting...

You might have expected hedge fund managers to have proudly stepped forward in droves, ready to defeat Buffett, demonstrating their investing prowess to the world.

That didn't happen.

Only one person publicly accepted Buffett’s challenge: Ted Seides of Protégé Partners.

The Challenger

Ted Seides selected five fund-of-funds. These five invested their money in over 100 underlying hedge funds, meaning that the overall performance would not be unduly biased by any particular manager. With this fund-of-funds approach, Seides and Protégé Partners’ specialty was selecting the numerous underlying hedge funds into which money would actually be invested.

What Happened

The 10-year bet officially ends when markets close on Friday, December 29, 2017 – the last trading day of 2017.

However, Buffett is so far ahead, it’s unlikely that Seides’ can come back in the remaining months.

Take a look...

Had you put $100,000 into Protégé Partners’ funds, your investment would have a projected value of $122,040, a gain of $22,040 at the end of 2016. $100,000 invested in Buffett’s Vanguard S&P 500 Index Fund would have grown to $185,413, a gain of $85,413 at the end of 2016.**

This $63,373 difference, amplified over multiple decades, can drive substantial differences in projected financial planning outcomes. It doesn’t take long for a gap like this to translate into retiring earlier or covering more of your kids’ college expenses.

Side Note

Comparing Protégé Partners’ funds to an S&P 500 Index Fund may not be a perfect comparison. Most hedge funds do not invest only in the S&P 500’s index constituents. However, as Buffett’s challenger, Ted Seides was free to select any funds he wished. You can assume that he would have chosen funds with the best prospects of winning over the subsequent 10 years.

Why does this matter for you?

If you take away one thing, make sure you understand the fees levied on your investments at each level.

For example, Protégé Partners likely charged a fee on client dollars which it invested in other hedge funds, through its fund-of-funds strategy. Those underlying funds also applied their own fee structures on the dollars which Protégé placed with them. That’s two layers of fees.

While there’s nothing inherently wrong with hedge funds or other more esoteric investment vehicles, you need to be aware of how much fees eat away at your performance. While a fund’s anticipated performance is far from guaranteed, the fees, on some level, will absolutely be present.

Unsure if fees are devouring your investment returns? We should chat.

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**Note: Past performance and past volatility are not indicative of future results. Taxes have not been applied to either investment. Applying taxes would lower the projected returns. Advisory fees were not applied to the performance of Vanguard's S&P 500 Index Fund. Applying advisory fees would lower the returns. One cannot invest directly in an index. This article discusses various investment vehicles in an educational context. Nothing here should be taken as an recommendation to buy or sell any of the securities mentioned.