The Ten-Year Bet Warren Buffett Won by Keeping It Simple

In December 2007, Warren Buffett put a simple claim into the form of a public wager. He believed a low-cost fund following the S&P 500 would beat a carefully selected group of hedge funds over ten years after every fee and expense was counted.

Only one investment professional accepted. Ted Seides, then a co-manager of Protégé Partners, took the other side. The contest began on January 1, 2008, just as one of the worst financial crises in modern history was approaching.

The story belongs in Section 5 of Setright's principles because it turns an abstract lesson about index funds, active management, and fees into a result anyone can follow. It also contains an important warning: the winner was never guaranteed, and simplicity did not prevent painful losses along the way.

The rules of the wager

Buffett chose a low-cost Vanguard fund that followed the S&P 500. Seides selected five funds of funds. Those five, in turn, held interests in more than 200 hedge funds over the life of the contest. Their names remained confidential, but Buffett received audited results.

The comparison ran from the start of 2008 through the end of 2017. Returns were counted after fees, costs, and expenses. That last rule was the heart of the bet. Buffett was not claiming that no talented manager could ever beat the market. He was arguing that, as a group, active investors cannot all do better than average—and that their higher costs leave less for their clients.

Protégé made a thoughtful counterargument. Hedge funds can use strategies that ordinary stock funds cannot, and many aim to protect money during bad markets rather than lead during strong ones. Protégé believed skilled selectors could find managers whose results justified the extra charges. The two positions remain available on the original Long Bets record.

Each side spent $318,250 on zero-coupon U.S. Treasury bonds that would be worth $500,000 at the end, creating a $1 million prize for the winner's charity. That prize was separate from the imaginary performance comparison between the funds.

The complicated side won the first year

The timing initially favored Protégé's case. In 2008, the S&P 500 fund fell 37%. The five funds of funds lost between 16.5% and 30.1%. Every one of them beat the index that year.

That result matters. A low-cost index fund does not protect you from a falling market. Anyone who treats this wager as proof that an index always wins in every year has missed the opening chapter.

But the bet had nine years left. As markets recovered, the index fund gained 26.6% in 2009 and 15.1% in 2010. The five competing funds still made gains in many years, but as a group they trailed the index in every year after 2008.

The final score

At the end of 2017, the S&P 500 fund had gained 125.8%, equal to an average annual gain of 8.5%.

The five funds of funds finished with total gains of 21.7%, 42.3%, 87.7%, 2.8%, and 27.0%. Their average annual gains ranged from 0.3% to 6.5%. Even the strongest of the five finished well behind the index. One of the five was liquidated during the final year.

The full yearly table appears in Buffett's 2017 letter to Berkshire Hathaway shareholders. It shows a contest that was not won by spotting one lucky year. It was won by staying in place while small differences in yearly results accumulated.

Skill was not the only thing being measured

There were smart, motivated people on both sides. The difference was the machinery surrounding them.

Protégé's selections carried two layers of decision-making and two layers of charges: the hedge-fund managers chose investments, while the fund-of-funds managers chose hedge funds. Buffett later estimated that fixed fees across those layers averaged about 2.5% of the money each year, before some managers received a share of gains through performance fees.

Those charges did not pause after a disappointing year. They reduced the money still working for the client, and dollars removed in one year could not share in later recovery. The index fund had no special insight. It simply followed its rules at very low cost.

This is why fees are more than a line in small print. Future returns are uncertain. Charges are among the few parts of an investment result that you can know before you begin.

What the bet did—and did not—prove

The wager did not prove that every hedge fund is poor, that every active manager will lose, or that the S&P 500 is a complete plan for every person. The index covered large U.S. companies, not smaller companies, international markets, or bonds. A person's full mix should still reflect when the money will be needed and how much loss the plan can withstand.

The bet demonstrated something narrower and more useful: complexity must earn its cost. A manager who charges more begins behind a low-cost alternative and must make up that gap after fees, year after year. Identifying that manager in advance is harder than admiring a past winner.

There was a charitable ending, too. In 2012, both sides agreed to sell the Treasury bonds backing the prize and buy Berkshire Hathaway shares instead. Buffett guaranteed that the charity would still receive at least $1 million. By the time the wager ended, Girls Inc. of Omaha received $2,222,279.

For an everyday investor, the takeaway is not to copy the bet or chase its winner after the fact. It is to ask three plain questions: What does this fund own? What will it cost every year? What evidence says the added complexity is likely to leave me better off after those costs?

Often, the quiet option has one advantage that does not depend on a forecast: it leaves more of your money working for you.