Warren Buffett's $1M Bet: Why 'Simple' Index Funds Crushed Hedge Funds By 7.1% To 2.2% Over A Decade

Warren Buffett's $1 million bet against hedge funds wasn't just about bragging rights—it was a challenge to Wall Street's high-fee investment strategies. 

Back in 2007, he bet that a simple S&P 500 index fund would outperform a carefully selected group of hedge funds over a decade. Ted Seides, a hedge fund pro from Protégé Partners, took the other side, convinced that active management could beat the market.

The timing couldn't have been more dramatic. The bet kicked off on Jan. 1, 2008—right as the financial crisis hit. At first, it looked like the hedge funds had the upper hand. They lost 23.9% while the S&P 500 tanked by 37%. But as markets recovered, Buffett's index fund started pulling ahead. 

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By the end of 2016, the Vanguard 500 Index Fund Admiral Shares VFIAX—Buffett's choice—had delivered an average annual return of 7.1%. The hedge funds? Just 2.2%. That's a massive difference. If you had invested $100,000 in VFIAX, it would have grown to about $185,000. The hedge funds were at only $121,000.

So, what went wrong for the hedge funds? Fees. Hedge funds typically use the "two-and-twenty" model—2% in management fees and 20% of any profits. Over time, those fees add up. 

According to a recent study by LCH Investments, since the inception of hedge funds in 1969, investors have paid nearly half of their profits as fees. Compare that with  index funds, which charge as little as 0.03%, and it's easy to see why Buffett's bet played out the way it did.

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Buffett has always been a big believer in keeping things simple. He once said, "When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients." The numbers back him up.

Even today, the trend holds. A recent Vanguard study found that 401(k) investors saw an average annual return of 9.7% over the five years ended in December 2023. Hedge funds? They averaged 6.6% over the same period, according to the Barclay Hedge Fund Index. Over decades, that difference adds up in a big way.

The takeaway? For most people, keeping it simple wins. Morningstar reports that approximately 29% of actively managed funds outperform their passive counterparts over the decade ended last June. Buffett's bet just reinforced what research keeps proving: for the average investor, a low-cost index fund is one of the best ways to grow wealth over time.

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