The Truth Behind Buffett's Big Bet

Ten years. Two contenders. One winner of a $1 million prize.

On one side, legendary investor Warren Buffett. On the other, fund-of-hedge-funds operator Protege Partners. The battle? Whose net returns will be higher over the next decade: five of the world's most successful hedge funds ... or the passive Vanguard 500 Index Fund?

If it's not obvious by now ...
Buffett believes the index fund will win. It might seem shocking that he'd put so little confidence in such bright investors, but a judgment of investing prowess isn't the reason behind Buffett's bearish bet.

Instead, as he explained in a recent Fortune article, the hedge fund managers' efforts "are self-neutralizing, and their IQ will not overcome the costs they impose on investors." [Emphasis mine.]

Buffett's not insulting the investing acumen of hedge-fund managers. But he is making a pretty bold statement about the fees they're charging, and how quickly they destroy investors' wealth.

It all comes down to the price you pay
Every year, the typical hedge fund collects 2% of the amount invested, as well as 20% of any profits made. It's not difficult for any student of mathematics to understand that over time, this seemingly small amount can become quite significant.

And although you might not invest in hedge funds, odds are you have a mutual fund or two -- maybe even more -- in your portfolio. Those funds might charge similar fees that could prevent you from cashing in on gains made with your money.

Compare these two seemingly identical index funds:

 Metric

Vanguard 500 Index

MainStay S&P 500 Index A

Front Load

None

3.00 %

Expense Ratio

0.15%

0.60%

Some of Top 25 Holdings

ExxonMobil (NYSE: XOM  ) , Procter & Gamble (Nasdaq: PG  ) , Wal-Mart (NYSE: WMT  )

ExxonMobil, Procter & Gamble, Wal-Mart

3-Year Annualized Returns

(8.30%)

(8.69%)

Morningstar data as of Jan. 6, 2009.

As you can see, the difference in fees between these two funds with identical holdings makes a difference in losses felt, even in as little as three years. Over a decade or more, we're talking about potentially missing out on thousands of dollars.

But it's even more unfortunate, as the Buffett example drives home, that paying high fees for actively managed funds can produce performance far worse than even a cheap, passive index fund.

Here are two funds for which investors paid handsomely, only to reap an even heftier loss over the same time frame:

 

Boyar Value

Natixis Harris Associates Focused Value A

Front Load

5.00%

5.75%

Expense Ratio

1.75%

1.49%

Some of Top 25 Holdings

Disney (NYSE: DIS  ) , Citigroup (NYSE: C  )

XTO Energy (NYSE: XTO  ) , Teradata

3-Year Annualized Returns

(11.01%)

(16.59%)

Data from Morningstar as of Jan. 6, 2009.

All of the above reasons help explain why, in our Motley Fool Champion Funds newsletter service, we recommend mutual funds run by managers who outperform the market over the long term without charging you an arm and a leg. Our average fund recommendation has an expense ratio of 0.93%, compared with the average domestic fund's expense ratio of 1.11%, and none of our picks has a front-end load. Collectively, they are beating the market by just less than 10 percentage points.

If you'd like to browse through the cheap, money-making mutual funds we've elevated to Champ status, click here to try out the newsletter free for the next 30 days.

This article was first published June 26, 2008. It has been updated.

Adam J. Wiederman owns no shares of the companies mentioned above. Wal-Mart Stores and Walt Disney are Motley Fool Inside Value recommendations. Walt Disney is a Motley Fool Stock Advisor selection. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy never bets against the house.


Read/Post Comments (0) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 807726, ~/Articles/ArticleHandler.aspx, 10/25/2014 4:20:04 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 7 hours ago Sponsored by:
DOW 16,805.41 127.51 0.76%
S&P 500 1,964.58 13.76 0.71%
NASD 4,483.72 30.92 0.69%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

10/24/2014 4:00 PM
C $51.80 Up +0.39 +0.76%
Citigroup Inc CAPS Rating: ***
DIS $88.61 Up +0.62 +0.70%
Walt Disney CAPS Rating: *****
WMT $76.38 Up +0.13 +0.17%
Wal-Mart Stores CAPS Rating: ***
XOM $94.49 Up +0.38 +0.40%
ExxonMobil Corp CAPS Rating: ****
XTO $41.81 Down +0.00 +0.00%
XTO Energy, Inc. CAPS Rating: *****

Advertisement