Warren Buffett Bets on Index Funds

I've talked before about how Warren Buffett recommends index funds for most investors, but I never knew how much he liked them. He's now placing his money and, more importantly, his reputation on them. The details:

Will a collection of hedge funds, carefully selected by experts, return more to investors over the next 10 years than the S&P 500?

Protégé has placed its bet on five funds of hedge funds - specifically, the averaged returns that those vehicles deliver net of all fees, costs, and expenses.

On the other side, Buffett, who has long argued that the fees that such "helpers" as hedge funds and funds of funds command are onerous and to be avoided has bet that the returns from a low-cost S&P 500 index fund sold by Vanguard will beat the results delivered by the five funds that Protégé has selected.

[The bet is] between Buffett (not Berkshire) and Protégé (the firm, not its funds). And there's serious money at stake. Each side put up roughly $320,000. The total funds of about $640,000 were used to buy a zero-coupon Treasury bond that will be worth $1 million at the bet's conclusion.

The piece goes on to say that the hedge funds must do much, much better than the S&P 500 index because of the hefty fees they charge. As I've noted before, these costs are very difficult to make up for most active investors, and that's why index funds beat most actively managed funds on an after-fees basis.

It's always funny to me that many people point to Warren Buffett as an example of why NOT to invest in index funds (I get comments to this effect quite often). And yet, Buffett himself advocates index funds for the vast majority of investors. Kind of ironic, huh?

Comments

[megamike]

Which index fund(s) should a little investor like me buy? There are so many!

[FMF]

Megamike --

Check this out:

http://www.freemoneyfinance.com/2008/05/an-investment-p.html

[Russ]

You've got to love WB's "put up or shut up" approach to this. I'm also a big supporter of low-cost, highly diversified index and asset class funds, so my money's on Mr. Buffett

[Ben]

I read about this bet - I think it is great exposure and I admire WB's conviction. I hope he wins! The cool part of the bet is the winner gets to choose which charity the proceeds go to. Gotta love making a point with philanthropic outcome.

[Uri]

I wish people would stop advocating the use of index funds and instead advocate the use of low-cost funds. Some index funds charge more than actively managed funds and pre-cost it's not clear that they outperform actively managed funds on a risk-adjusted basis. Changing the rule to low costs funds doesn't include many actively managed funds but those funds are good choices. The threshold for cost depends on how efficient the market a fund is targeting. A large cap fund has to have a very low cost while an emerging markets fund can outperform an index with a higher cost. For these reasons, if you look at asset allocation funds, they often index in places with higher market cap and actively manage in places with lower market cap.

[Rick]

Actually, the link isn't broken. It works just fine for me. And I agree with it... if you're going to go with index funds, the ones recommended in the link are a superb choice -- and the same as what I've done in my own retirement account. Vanguard Total Stock Index, Total International Stock Index, and Total Bond Fund.

I still think that picking your own stocks is better -- AS LONG AS you're willing to spend the time and effort to learn the inner workings of the stock market. Most people are not, and index funds are the way to go for them.

[Jenny]

People point to Buffett as an example of why not to invest in index funds? That is strange indeed. He's long been clear about the fact that he doesn't believe that an investor can beat the market long-term. The reason he can is because he buys controlling interests and fixes the companies - i.e., he becomes a manager, not just an investor. He's looking for bargains, sure, but he's also taking an active role in the way they're run. That's not an option for most investors.

[mapgirl]

You mistake what Warren Buffett believes. He believes in Graham's philosophy of playing with only 10% of your portfolio and letting all the rest be professionally managed. That is why Buffett also believes most investors should sit on index funds.

I'm putting my faith into Warren Buffett. About 80% of my retirement money is in BRKB now. I plan to sit on that for a while too. About 5% of my money is play investment money and the remaining 15% is in mutual funds. The allocation will tip as I keep adding to my current 401k. I hope to even it all out. ;-)

[GenYRetireRich]

Megamike, those fund percentages in free money finance are fine for younger, aggressive investors, provided you have additional money set aside in a checking account and an emergency fund. You really don't want more than 20% of your total portfolio, including these cash accounts, in equities. If you are a little older or a little less agressive, you might want to consider putting only 70% or 60% of your money into equities. use the funds suggested because they are great funds.

Unfortunately, you won't know what your risk level is until you start investing and hit your first downturn. I generally tell people to start out by assuming that they are normal investors, rather than aggressive investors. After the first really bad downturn, if they find that they slept through it, they can up the ante.

As far as Buffett goes, he personally practices the exact opposite of what index funds preach. He concentrates his money on a relatively few companies/stocks. But he realizes that the rest of us will never be like him, and he advises that we use low cost index funds. This is good advice for the 99.5% of us who will never be that good at investing.