Here is a question, would you bet a million pounds against the world’s smartest investor?
Six years ago, Warren Buffett – without a doubt, the smartest investor on the planet today bet $1M (a negligible amount of money when you consider his fortune) and most importantly his reputation on the idea that an index fund… Vanguard’s S&P index fund, will outperform a selection of hedge funds by Protege Partners over the course of a decade.
So far, Buffett’s el cheapo index fund is winning handily at 43.8% against average of 12.5% on Protégé’s fund of funds, as at the end of 2013.
This is widely seen as an endorsement for those of us who embrace the evidence-based investing approach, using low cost index funds. No victory dance for index fund investors as yet though, there are four more years to go, and who knows, the clever hedgies could pull some of their magic. But it doesn’t really matter what the outcome is, what I find intriguing that the world’s smartest investor was willing to stake his hard-earned reputation on such a simple idea in the first place.
The more you think about it though, the more you realise this is a very clever thing to do. The fact is, vast majority of active fund managers fail to beat their relevant benchmarks. And if you take the trouble to review the work of some of the smartest economists, including notably Nobel Laureates Harry Markowitz, William Sharpe, Robert Merton, Daniel Kahneman and Gene Fama, you will quite easily see why placing a bet on index funds is in fact, a very clever thing and probably the best for the vast majority of investors.
I picked these people because their work has been widely critiqued by their fellow academics and practitioners alike, and rightly or wrong their ideas seem to have risen to the top. I came to a simple conclusion years ago that I couldn’t possibly be smarter than any one of these people, let alone four or five of them.
The overwhelming body of work on evidence-based investing should at least lead anyone to approach active fund management with a high degree of skepticism. In effect, investing in an active fund manager means you are effectively betting on that manager. Considering that most people who invest are doing so for very important reasons – retirement, children’s education, financial freedom, whether it’s a million pounds or a thousand pound, the question is – are you prepared to bet it on active fund managers or would you rather take a clue from Mr Buffett?
And before you place your bet, ask yourself this question – what do you know that about investing that Warren Buffett and these Nobel Laureates somehow missed?
