Why Warren Buffett’s bet matters . . . and doesn’t

By John Woerth / Vanguard

In 2008, the world’s most famous investor made a bet. Warren Buffett, also known as the Oracle of Omaha, wagered Protégé Partners that the returns generated by its hedge fund strategy would not outpace that of a low-cost index fund seeking to track the performance of the S&P 500, a widely followed proxy of U.S. stocks, over a ten-year period.

At stake: $1 million, with the proceeds donated to the winner’s choice of charity.* Not surprisingly, the bet generated some news, and it’s recently been in the headlines as Buffett is winning with less than two years to go.

My colleague Andy Clarke opines on the topic in his recent blog, Buffett’s bet, but I wanted to weigh in with this perspective: The bet matters . . . and it doesn’t.

It matters because it brings attention to a powerful, yet simple, investment strategy: low-cost, market-cap weighted indexing. Vanguard and others have demonstrated that low-cost index funds have displayed a greater probability of outperforming higher-cost actively managed funds.

From my vantage point, if Buffett’s bet and the accompanying publicity lead investors to drink from the indexing well, then they’ll likely have a much better chance of investment success. This is not to say other factors are unimportant, such as the proper asset allocation, a sufficient savings rate, and the discipline to stay invested during market downturns.

On the other hand, the bet doesn’t matter. It doesn’t matter to the extent that beating the return of a hedge fund is an irrelevant goal. Your goals should be more personal and practical—ensuring a secure retirement or funding a child’s higher education.

Indeed, beating a hedge fund or the stock market isn’t the aim. I recall this passage from then Vanguard CEO Jack Brennan’s 2002 book, Straight Talk on Investing: What You Need to Know, which has stuck with me and is memorialized below in its entirety:

Some investors become so obsessed about beating the market (or other investors) that they lose sight of the reason they’re investing at all. They measure their funds against the S&P 500 Index of the Nasdaq or the Dow from quarter to quarter as if everything depended on staying ahead all the time. But it’s misleading to obsess over whether your fund is two lengths of a point ahead of this index or half a point behind that one. In fact, the only meaningful measure of your success is whether you eventually reach your investment objective, whether that’s a down payment on a home or a retirement nest egg.

One of my all-time favorite commentaries on the beat-the-market obsession was a January 2000 column by Jason Zweig in Money magazine. Among other things, he pointed out that it’s hard to beat indexes because they don’t have any expenses, and that many investors who think they are ahead of the markets really aren’t. Zweig ended the column with a great anecdote:

“I once interviewed dozens of residents in Boca Raton, one of Florida’s richest retirement communities. Amid the elegant stucco homes, the manicured lawns, the swaying palm trees, the sun and sea breezes, I asked these folks—mostly in their seventies—if they’d beaten the market over the course of their investing lifetimes. Some said yes, some said no. Then one man said, “Who cares? All I know is my investments earned enough for me to end up in Boca.”

We all would do well to think like that investor. Whether your “Boca” is a comfortable retirement or a college education for your kids, or an estate to bequeath to your heirs or to charity, the idea is to focus on getting there and worrying as little as possible about how your portfolio is performing relative to something else.

So, bets aside, getting to Boca—reaching your financial goals whatever they may be—is what it’s all about.

By John Woerth / Vanguard

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