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Off-the-Law: Would you Bet Against Warren Buffett

Yes, I have interests other than Illinois divorce law.  As a registered CPA with a background and education in accounting and tax matters, investment issues are important to me.  These issues are also important to my divorce clients.  Often, after a divorce, a client is handling their own financial and investment decisions for the first time.  So when I read an article about a bet between Warren Buffett and a hedge fund manager, I fond the result informative (and in my case confirming my personal beliefs).

The set up was a bet between Warren Buffett and a hedge fund manager made seven years ago.  Mr. Buffett bet that a simple index exchange traded fund that tracks the broad market would outperform hand-picked investment advisors.  Mr. Buffett put his bet on a Vanguard fund tracking the S&P 500.  the hedge fund manager hand-picked those managed funds he thought would perform best.  Seven years later, Mr. Buffett is up 63% while the hedge fund manager is up only 20%.

Part of the difference is a result of the significant fees charged by managed funds.  While most ETFs and tracking mutual funds have expense ratios of .1-.5% of assets under management, it is not uncommon to see expense ratios for heavily managed mutual funds and other managed investments of 1.5-2.0%.  Think about that — if your using a managed fund and your investment returns 6% and the expense ratio of 2%, you paid the manager 33% of your before-tax profit.  Even worse, if the fund loses money, you still make that payment to the fund manager.  Research indicates that even the best investment managers cannot beat the overall market consistently for extended periods.  So why pay the high fees?  For those of us who cannot spend the time and effort or have the knowledge to properly evaluate individual investments, it seems that low-cost ETFs are the way to go.

Just to highlight why this is so important, consider this comparison:  $10,000 invested with a 6% return and an expense ratio of .1% would be worth $55,831 in thirty years, but $10,000 invested with a 6% return with an expense ration of 2.0% would be worth $32,434 in thirty years.  That’s a huge difference.  Put another way, to equalize the results, the 2.0% expense ratio investment would have to return almost 8% per year to make up the difference.  Put in whatever percentages you want, but beating the market consistently by 33% is a difficult, if not unachievable, goal.