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Jan 26 2013

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Why Make a Financial Bet Against Warren Buffett?


Myth:  If you pay really smart people to manage your money, it will be easy for them to beat the returns of a simple index fund over time.

Reality:  Their odds of doing so, after fees, are pathetically low.

This is what Warren Buffett has been saying for years, and a group of Hedge Fund selectors took offense to this notion in 2008, betting Warren Buffett a million dollars that they could beat the market over a decade. 

Warren Buffett took the challenge. 

He said that an index investor would win.  When it comes to money, you probably shouldn’t bet against Warren Buffett.  He’s currently winning with an impressive margin. 

You can read about it here.

About the author

andrew hallam

I'm a freelance finance writer, lucky enough to have been nominated as a finalist for two Canadian National Publishing Awards. I'm also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School, a book explaining how I became a millionaire on a teacher's salary, while still in my 30s. Working to empower people financially, I'm available to motivate and inspire people on basic retirement planning and index investing. I'm happy to comment on your questions, first, please read the Terms of Use.

Permanent link to this article: http://andrewhallam.com/2013/01/why-make-a-financial-bet-against-warren-buffett/

16 comments

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  1. avatar
    Cole

    Hi Andrew,

    I've read your book, followed your blog posts and I've got a questions about someone who isn't trying to build a retirement portfolio, but live off of one. Do you follow your same strategy of own your age in bonds and split the rest between a U.S and International index fund? If not, what do you recommend? Cheers!

    1. avatar
      Andrew Hallam

      Hi Cole,

      I think that depends on what other sources of income you have and what your goals are for that money, after you have gone. If you have a defined benefit pension, you would have the portfolio as supplementary income. You could afford to take more risk and you would also be able to bequeath more money when you die, because your money would likely grow more substantially with a higher equity component.

      I won't have a pension or any kind of social security/pension. But I also have a high tolerance for short term risk. As such, I could handle having just 50% of my money in bonds/fixed income, with 50% in stock indexes. If market fluctuations frighten you, perhaps you would be better off with a bond portion matching your age. You could choose inflation-protected bonds or short term bond index, which would give you reasonable odds of beating inflation with those, while allowing for growth potential with your equities.

      What do you think? Do you have a pension as well? And how do you feel about short term market fluctuations? Much of this, of course,will depend on your personality.

  2. avatar
    Colleen

    Hi Andrew,

    I read your book and follow your blog. Can you please tell me for tax purposes which ETF is best to hold in my RRSP, TFSA and non registered savings (VEA, VTI or XSB)?

    I canèt remember if you covered this in the book and I currently have it leant our to my sister.

    Cheers,

    Colleen

    1. avatar
      Andrew Hallam

      Hi Colleen,

      You could put the bond index (go for VSB.To) in your RRSP. It's cheaper than XSB….new since I wrote my book.

      There's also now a cheaper option for your U.S. index now that Vanguard has a non-hedged U.S. stock ETF on the Toronto stock exchange. Put that one and VEA in your TFSA and other non-registered account. Shoot! I have to look it up. I'll get back to you!

      1. avatar
        Steven

        Hello all,

        I'm a bit confused. Is it more advantageous to hold particular index funds in certain accts like an RRSP and not in others like a non-registered acct.?

        I have set up my RRSP, Non Reg. acct and TFSA using all the same index mix of VSB, VCE, VUS and VEF. Should I be strategically using one index in the RRSP rather than in every account?

        Also would you suggest using a non-hedged U.S. stock ETF as opposed to a hedged one?

        Thank you in advance for any clarification.

      2. avatar
        Steven

        Hello Andrew,

        I am very grateful for all the knowledge people are sharing here, and wanted to personally thank you Andrew for helping me realize the benefits to index investing. However…

        I am a bit confused. I have been using the etf's VSB, VCE, VUS, and VEF in EACH of my RRSP, TFSA and non-Registered accts . Is there an advantage to using certain index funds in one account and not in another? Is there a more efficient way to diversify each portolio than the way I have?

        Also I have used Can hedged etf's. What is the advantage to using a non-hedged U.S. stock ETF?

        Thank you in advance for your help

        Steven

        1. avatar
          Kunwak

          Hi Steven,

          AFAIK tax implications are what makes certain etfs better in some accounts

          RRSP: This is the most advantageous account for US holdings such as VTI, VEA, VWO. The reason is that you will not pay withholding tax on dividends etc. This is due to a deal that US and Canadian govs have.

          TFSA: This is good for etfs that pay interest, such as VSB and anything else canadian, since you do not pay tax on gains. It is also good for investments where you hope for capital gains ("play money" perhaps, to dabble in a few stocks).

          All other accounts: These are great for VCE, VTI, anything that is canadian and pays dividends. The dividends of canadian dividend-paying stocks are currently taxed favourably (lower than interest from a bond), hence it is good in the account where you take the full tax hit.

          Talk to experts on tax issues to get the full story. I am definitely not an expert!

        2. avatar
          Andrew Hallam

          Kunwak is right Steven. But if you have built a diversified portfolio into each account, it's really not a big deal. For simplicity, if I were living in Canada, I probably would have done that myself. Your BIGGEST benefit (outweighing all others) is going to be your savings discipline, coupled with your ability to ignore market forecasts and dispassionately re-balance your portfolios.

          Cheers,

          Andrew

          1. avatar
            Lisa

            Sorry, now I am confused…I understood Kunwak as saying that it is better to put certain ETFs in certain accounts e.g. US to RRSP and Cdn dividend to non-registered accounts. I have read this before and I see your advice to Colleen above is to do that. However, you then said, "if you have built a diversified portfolio into each account, it's not a big deal." I see the possible tax implications, but if I start to separate the ETF types will it not be difficult to rebalance each year? I am at the beginning stages of this set-up so if I have a large amount of money is it better to put my 60:40 into each account or just buy the bond fund for the RRSP and the stocks to non-reg/TFSA depending on my limits? I now get the feeling that this may be more complicated than I realized and rebalancing will be a bit of a chore. Andrew – any thoughts you have would be appreciated.

          2. avatar
            kunwak

            Hi Lias,

            I did not mean to confuse. Putting certain ETFs into certain accounts is fine tuning. I am with Andrew and I don't think that optimizing your accounts with regard to TAX is the most important thing. However, if you can/are willing to put the extra effort in and know how to, it's probably a good idea.

            I personally have

            RRSP account: VTI and VEA

            TFSA: VSB and VCE/XIU

            Margin: a bit of everything (VEA, VTI, VCE, and VSB)

            If you are a strong saver, you will never be able to have all your money in tax-sheltered/deferred accounts. Hence, I just keep on rebalancing in my margin account (mostly by buying the laggard as Andrew suggests), and once a year I push some of the stuff into RRSP and TFSA until they are maxed out.

            It will be quite rare that you need to rebalance across accounts, since you will have enough of everything in your margin account. It is, in fact, quite rare to sell anything. Just buying the laggard often does the trick. You need a fairly big portfolio to make it worthwhile to sell something to buy something else.

          3. avatar
            Andrew Hallam

            Hi Lisa,

            To be honest, I would likely use the lazier option myself: just building a couch potato portfolio into each account. But if you are a stickler for details and want to earn every last, small scrap of return, then you may want to split it somewhat, as Kunwak notes.

            But I have to stress that your biggest challenge is going to be saving and annual rebalancing–not such fine-tuning in taxable/tax-sheltered accounts. Few individuals have the ability to dispassionately stick to a game plan of re-balancing a passive portfolio and diligently saving. The media and the markets will swing your emotions in every direction imaginable. If you can stick to the plan Lisa, you will beat the returns of 99% of those who are fiddling with their portfolios in a tax-advantaged way. I'm only saying this because very few people seem wired to re-balance and save, while ignoring forecasts. Most investors you might consider sophisticated will do poorly. Their emotions will sink them. Build those portfolios into each account Lisa. And mentally fight against urges to fiddle. You'll do well if you are emotionally strong enough over time. Keep it simple. That's going to be tough enough, emotionally!

          4. avatar
            Lisa

            Thanks Andrew and Kunwak! I have been looking at setting up a self-directed indexed portfolio for quite a while now, and reading the books and the blogs (currently, I have the typical mutual fund/stock portfolio through an advisor, which is doing well over the last 3 years, and a small self-directed account). Now I am totally worried! I thought this was for my level of DIY – I always thought that was what the couch potato proponents were promoting. Now I wonder if I need help to get there. I see on the Cdn Couch Potato site that Dan is offering an investor service now! Is this not as 'simple' (not the word I am looking for) to set up as I thought with? Is it too much for a newbie to pick the ETFs, balance into 60:40, keep an eye on taxes etc? As Andrew just mentioned, I always knew that a tough part would be to leave it alone and not 2nd guess it (I am already a diligent saver), but I am wondering if now I need help on implementation too . So, should I pay the not insignificant fee to get this going, and am I being naive to think I can still so-it-myself?

          5. avatar
            Andrew Hallam

            The process is very easy Lisa. And if you ask Dan, on his site, he will also agree. But some people need someone to help them—much of it being a psychological push.

  3. avatar
    Lee Atkinson

    Andrew,

    Thanks for teaching me so much through your book!

    Having recently switched career into being a primary school teacher in the UK, I now have a little bit of spare cash to invest. However, i have always tried to go into things with my eyes open so was looking for advice and to learn about investing.

    The title of your book attracted me, 'Millionaire Teacher', yes please I will have some of that!!

    I cant believe how much I got from that book.

    I have ditched my old funds am now transferring as much cash into my new Vanguard Life strategy 60% as I can realistically afford. I have also switched an old stagnant pension into the Vanguard 80% fund. I am being charged £2 per month to hold each fund and paying 0.32% TER.

    Does that sound about right?

    (I will get a pension from my teaching post so not sure if i am being too cautious!)

    I was also wondering will these products rebalance themselves as you discuss in your book?

    1. avatar
      Andrew Hallam

      This is great to hear Lee. The LifeStrategy fund you purchased does likely re-balance, but you may want to give Vanguard UK a ring, just to be sure. Either way, I'm sure it's an excellent product. If you would prefer to send me a link to the specific life strategy fund you own, I could also answer any questions you might have after reading up on it myself.

      Cheers,

      Andrew

  4. avatar
    Lee Atkinson

    Thanks for the quick reply!

    I have (hopefully) attached a couple of links to the fund:

    http://www.fundslibrary.co.uk/fundslibrary.datare

    and

    http://www.hl.co.uk/funds/fund-discounts,-prices-

    http://www.fundslibrary.co.uk/fundslibrary.datare

    It seems to offer me a ready made diversified portfolio of equities and bonds.

    Before seeing this, I had selected three funds to use. A ftse 100 tracker, world stock market tracker and a bond tracker. But I would have to pay £2 per month per fund to the platform I am using ( £72 per year). By clubbing them together in this product I only have to pay the platform £24 per year. I know its not much, but the lower the costs, the better right?

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