Warren Buffett’s Index Fund Experiment | Simple Steps for a Retirement Portfolio Course

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When the first index fund hit the market in 1976, many professionals in the finance industry
lambasted the idea.
Because the objective of an index fund is to match market returns--not outperform the
market--critics thought that it meant settling for mediocrity.
Some even called the idea "un-American."
In actively managed funds, professionals research, evaluate, and handpick each investment.
The concept that a passively managed index fund could perform as well as an actively
managed fund upended the widely held belief that professional fund managers had a special
ability to choose and manage investments.
Because of their combination of low fees, diversification, and consistent returns, index
funds began to grow in popularity.
However, hedge funds, which are actively managed by professionals, also grew in popularity.
Legendary investor Warren Buffett believed that index funds could achieve better returns
for long-term investors than actively managed funds.
To prove his theory, in 2007, Buffett issued a challenge to the hedge fund industry.
He wagered that over the course of 10 years, an unmanaged, low-fee S&P 500 index fund would
outperform hedge funds chosen by a professional.
Buffett expected that a bevy of hedge fund managers would eagerly accept his bet but
was met with silence.
Finally, a single hedge fund manager accepted the bet and selected five hedge funds to put
up against Buffett's S&P 500 index fund.
The investor whose fund yielded greater returns--minus fees--over the course of 10 years would receive
$1,000,000 to the charity of his choice.
During the first year, Buffett's index fund was losing big time.
But because the time frame for the bet was 10 years, the index fund outperformed the
hedge funds in the long run.
By year 10, Buffett's index fund returned 7.1%--pretty typical for the stock market
over time--whereas the five hedge funds averaged 2.2%.
Buffett's index fund was so far ahead of the hedge funds that the manager surrendered
months before the 10-year time frame was officially over, and Warren Buffett received $2.2 million
to donate to a charity that empowers young women.
Buffett's win suggests that index fund investing doesn't mean settling for mediocrity.
Because consistently outperforming the market isn't always possible, index fund investing
can be an effective strategy for long-term investors.

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Warren Buffett’s Index Fund Experiment | Simple Steps for a Retirement Portfolio Course

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