In 2008, Warren Buffett bet $1 million that a hedge fund would be unable to beat a basic investment over a decade. Fund manager Ted Seides accepted his challenge and built a portfolio of five hedge funds.
The bet initially favored Ted. When the market crashed in 2008, Warren Buffett's portfolio lost 37 percent of its value, while the hedge funds only lost 23.9 percent. But markets eventually recovered, and both portfolios saw gains.
After a decade, Ted ended with a final result of +36.3 percent.
I’ll get to Mr. Buffett’s results later, but first, a question: Is +36.3 percent a good or bad result?
I’ve often heard people say: "As long as it beats the bank, I'll be happy." Well, by their standards, +36.3 percent should be fantastic. After all, bank account interest rates are so low that you'd be lucky to hit eight percent in a decade. So that must mean the hedge fund did great, right?
But if we look at it another way, a different story emerges. While the hedge fund ended with a nice +36.3 percent, Warren Buffett ended the bet with a gain of +125.8 percent using nothing more than your garden-variety, zero-effort, low-cost index fund.
An index fund lets you invest in the index of a given market, which is a measure of that market’s average performance. In the Philippines, the Philippine Stock Exchange index (PSEi) comprises the largest companies like SM, Ayala, and Meralco. Philippine equity index funds invest in the same companies as the PSEi. An example is the First Metro ETF.
Given that the hedge fund manager lost by 89.5 percent to Buffett's index fund – which is a benchmark of average performance – we can conclude that the +36.3 percent was a bad result relative to the average.
But so what? Why does that matter when I’m making more than the bank either way?
Because index funds are always an option. As stewards of our hard-earned money, we must not be satisfied with passable investments when better options are available. If you can’t beat the index, buy an index fund!
Bank accounts are not comparable to stock market investments because they have different goals and risk characteristics. The purpose of a bank account is stability. With bank accounts, you can expect your cash balance to be stable and liquid as long as the bank is standing.
The purpose of a stock market investment, on the other hand, is growth. With stocks, you're putting your capital at risk, and you can either gain or lose money depending on the companies you invest in.
Comparing stocks to bank accounts is like comparing driving and walking. When asked, “Does he drive fast?" it would be quite strange to answer, "Yes, he is fast because he drove faster than I could walk!"
And yet, when asked: "Is that stock a good investment?" many would say, "Yes! This stock is great because it made more than my bank account!"
To judge whether a driver is fast, we have to compare his speed to the average driver. And to judge whether a stock market portfolio is performing well, we must compare it to the average stock investment by checking its relevant stock market index — not to a slow, stagnant bank account.
This is important because when we see that our results are sub-par relative to the average of our chosen asset class, we have the opportunity to reposition and invest in superior assets, improving our returns over the long run.
To avoid this opportunity cost of mediocre investments, compare apples to apples, and compare stocks to stocks.
While few people would be able to win a bet against Warren Buffett, everyone can increase their odds of making money by measuring their investments using the right benchmarks.
To improve as an investor this 2025, start with an honest assessment of your results. The road to improvement starts with setting the right benchmarks, and for stock market investors, there is no better benchmark than an index!
******
Keith Lim writes about personal finance and making money through the stock market. He blogs at keithblim.com.