In 2007, Warren Buffett made a very public wager. He bet $1 million that over the coming decade, a simple, low-cost fund tracking the S&P 500 would beat a hand-picked basket of elite hedge funds — after all their fees were counted. It was less a gamble than a thesis about arithmetic: that the high costs charged by professional money managers would, over time, quietly devour the returns they promised to deliver.
A firm called Protégé Partners took the other side, selecting five funds-of-funds that in turn invested in a spread of hedge funds — the supposed smart money, run by highly paid professionals with every resource and incentive to win. The stakes were donated to charity. The clock ran from 2008 through 2017.
Why Buffett was so confident
Buffett’s reasoning had nothing to do with predicting the market. It rested on the drag of fees. Hedge funds famously charged along the lines of “2 and 20” — an annual management fee plus a large cut of any profits — and the funds-of-funds in the bet layered another fee on top of that. A plain index fund, by contrast, charged a tiny fraction of a percent.
That gap compounds. Even if the professionals matched the market before costs, the fees would leave their investors behind. To merely keep pace with a cheap index, the managers had to consistently outperform it by a wide margin, every year, just to cover their own expenses — a bar almost no one clears over a full decade.
Performance comes and goes. Fees never do. They are the one part of the equation you can predict with certainty.
A rocky start, then a rout
The timing looked, at first, favorable to the hedge funds. The bet began in 2008, in the teeth of the financial crisis, when the S&P 500 plunged and funds designed to hedge against losses had their best chance to shine. In that first brutal year, the hedge-fund basket did indeed fall less than the index.
But as markets recovered and the long bull run of the 2010s unfolded, the index pulled steadily ahead. Year after year, the low-cost fund compounded while the fee-laden funds lagged. By the end of the decade the result was not close. The S&P 500 index fund had returned on the order of 125% over the period, while the average of the hedge-fund basket returned only a fraction of that — roughly a third as much. The index won decisively.
What the numbers really showed
Some of the hedge funds may well have been run by genuinely skilled people. That was never the point. The bet demonstrated that skill, even where it existed, was not enough to overcome the combination of high fees and the near-impossibility of consistently outguessing a broad market made up of millions of participants.
Buffett had long argued that for the vast majority of investors — amateur and professional alike — the sensible choice was a low-cost fund holding a broad slice of the market, held for the long term. The wager turned that argument into a public, ten-year, real-money experiment, and the experiment agreed with him.
The lasting lesson: fees are the enemy you control
You cannot control what the market does next year. You can control almost exactly what you pay to participate in it, and that single choice may do more for your long-run results than any attempt to pick winners.
- Costs compound against you. A percentage point or two in annual fees sounds trivial. Over decades it can quietly claim a large share of your final balance.
- Past star performance rarely persists. Even managers with dazzling track records struggle to keep beating a cheap index once their fees are subtracted.
- Simple usually wins. A broadly diversified, low-cost fund held patiently is hard for expensive, complex strategies to beat over a full market cycle.
The bet is not investment advice for any particular person, and a single decade is not a law of nature. But its message is durable: before you go hunting for the manager who will beat the market, make sure you are not overpaying for the privilege of trying. The most reliable edge available to an ordinary investor is spending less to get the market’s return.