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The $1 Million Bet: How Buffett Proved Index Funds Beat Hedge Funds

By sagebytes —

Investment Best Practices from Warren Buffett

Distilled from Berkshire Hathaway's 2016 Annual Letter

Index Fund Superiority

  • Low-cost S&P 500 index funds outperform most actively managed funds over the long term
  • The 9-year bet between Buffett (S&P 500 index fund) and Protégé Partners (hedge funds) showed the index fund ahead by 85.4% vs. average of 22.3% for hedge funds
  • "Both large and small investors should stick with low-cost index funds"

Fees Matter Tremendously

  • High fees are "the main enemy of the investor" - they significantly erode returns
  • Buffett's example showed ~60% of hedge fund gains diverted to managers through fees
  • "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"

Market Timing Is Futile

  • "Widespread fear is your friend as an investor, because it serves up bargain purchases"
  • "Personal fear is your enemy"
  • Market declines and even panics are inevitable but unpredictable
  • American business and consequently the stock market are "virtually certain to be worth far more in the years ahead"

Long-Term Perspective

  • Buffett praises Jack Bogle for helping "millions of investors realize far better returns on their savings"
  • Investors who simply hold "a collection of large, conservatively-financed American businesses" for extended periods "will almost certainly do well"
  • Market declines should be viewed as buying opportunities

Share Repurchases

  • Only make sense when shares are bought below intrinsic value
  • "What is smart at one price is stupid at another"
  • Companies should establish clear price thresholds for repurchases

Business Fundamentals

  • Focus on businesses with "earning power that even under terrible economic conditions would far exceed interest requirements"
  • Look for companies with durable competitive advantages ("moats")
  • Pay attention to returns on tangible net worth
  • "It's the growth of the Berkshire forest that counts" - don't focus too intently on any single business

Accounting Vigilance

  • Be skeptical of "adjusted earnings" that exclude real costs
  • Pay attention to true economic costs that may differ from accounting figures
  • "CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be 'helpful' as well"

Investment Temperament

  • "It is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects"
  • Maintain rationality during market turbulence
  • Recognize that "innovation, productivity gains, entrepreneurial spirit and an abundance of capital" will continue to drive business growth