Ten years ago, investor Warren Buffett made a wager with Wall Street. This New Year, he  won. "I argued that active investment management by professionals - in aggregate - would over a period of years under-perform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of 'helpers' would leave their clients - again in aggregate - worse off than if the amateurs simply invested in an unmanaged low-cost index fund," he recapped, writing in Berkshire's annual shareholder letter.  He used LongBets, a site created by Jeff Bezos, to put it out there.

If you're ever going to save, taking a look at how you'll get the most value for your savings is going to matter, too. Or if you take care of money for someone else, perhaps as a trustee or just helping a family member, becoming more informed about the investment environment can help there, too.  So how does one of the world's smartest investors see the investment world? At first, it was quiet.

While it would seem dozens of investment professionals would jump at Buffett's bet, only one did--Ted Seides.

"I hadn't known Ted before our wager, but I like him and admire his willingness to put his money where his mouth was," Buffett said in Institutional Investor. "He has been both straight-forward with me and meticulous in supplying all the data that both he and I have needed to monitor the bet."

Buffett invested in a Vanguard S&P 500 Index Fund. Seides invested in five hedge fund 'funds of funds'--an aggregation of several strategies in line with Buffett's initial wager.

To serve the bet, both set aside about 1/3 of the million.

Here's something you can learn right away. Neither of these guys socked $1 million away to service the wager ten years down the road. Instead, both invested less than a third of the amount--$320,000. They put their payday money initially in a Treasury Bond, confident that it would reach the target $1 million in the time period. As you save for goals, consider the time/value of money in your own life. It's not just a retirement principle--it's a send-the-kids-to-college, buy the house, pay-for-the-round-the-world-trip principle.

Both strategies made money.

The costs of the hedge fund management fees whittled down the returns made in the hedge fund industry, though, while the stock market did relatively well. Buffett's "dumb" strategy--a Vanguard Index Fund--had very low costs.

Seides shared more about the journey, writing in Bloomberg. "The S&P 500 index fund fell 50 percent in the first 14 months of the bet. Many investors lacked Warren's unparalleled fortitude and bailed out of the markets when the pain became too severe. An investor who panicked and only later re-entered the market would have found that his bank account at the end of the bet was a lot smaller than a hypothetical account in which he earned the index-fund returns for the whole period."

The beneficiary of the wager is Buffett's choice--Girls Inc. of Omaha.

What you can learn for your own financial bets

When you're looking at your own financial strategies, are you going with the advice of an army of associates, or focusing on a few innovators you have reason to believe see the world in a smarter way? The cost of financial advice is high--yet "fees never sleep," as Buffett said. If you're paying fees for a strategy, make sure there's a reason. Buffett wrote, "Bill Ruane - a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul - said it well: "In investment management, the progression is from the innovators to the imitators to the swarming incompetents." 

If you really want to make money like Buffett, find a way to invest in outstanding private companies at a reasonable cost.

This is how Buffett and Berkshire Hathaway make money--by consistently finding outperforming companies and acquiring them, or part of them, at fair costs. Not necesariy cheap--just affordable relative to the value the business should bring. Consider his biggest deal ever--the acquisition of Precision Castparts for $32 billion in cash.

Buffett is a value investor whose investment vehicle is a company--Berkshire Hathaway. His last open letter to shareholders makes the point clearly about investing in creating value-- "Berkshire's gain in net worth during 2016 was $27.5 billion, which increased the per-share book value of both our Class A and Class B stock by 10.7%. Over the last 52 years (that is, since present management took over), per-share book value has grown from $19 to $172,108, a rate of 19% compounded annually." 

To sum it up, Buffett says remember this one thing--his golden rule.

"Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices."

Published on: Jan 8, 2018