In December of 2017, Dividend Growth Investor (DGI) asked me if I wanted to bet against Warren Buffett. Well, kind of. Allow me to explain.
Buffett’s Big Bet
Way back in 2007, Buffett challenged the hedge fund industry to a bet. All the hedge funds had to do was beat the S&P 500 over a 10 year period. Buffett didn’t get many takers, but he crushed those that took up the challenge.
This bet was interesting because Buffett didn’t put his own Berkshire Hathaway up against the hedge funds. He just picked a simple index. However, this isn’t surprising either because Buffett has voiced strong support for index funds and their creator, Jack Bogle.
My Small Bet
Anyway, DGI asked if I’d take up a similar challenge. Did I think I could beat the S&P 500 over a 10 year period? Like an idiot, I immediately answered:
Yes! I’d love to do this!
I believe that it’s easy to beat an index over a short period of time. Get lucky with a couple of stock picks and you may do very well. However, an index is very hard to beat over the long term. Empires die all the time and I’d argue that the pace is quickening.
Nokia? Blackberry? Sears? Hello? Anyone home?
Stock picking is mostly a fool’s errand. But I’m a fool sometimes, so it’s all good!
For the purposes of the bet, I set up a small portfolio on Motif, a service that allows you to choose a small basket of stocks and buy it in one transaction, saving on commissions. The nice thing about Motif is that it also provides performance data.
For the purposes of
- Amazon: Wait, they sell more than books? And what’s this AWS thing?
- Alibaba: China rising.
- Berkshire Hathaway: Consistently undervalued.
- Alphabet: A behemoth that’s just getting started. Waymo is gonna win.
To put money where my mouth is, I invested $1,000. Here is where I stand after one year (I was lazy and took these screen captures on January 2, so it’s been a little over a year):
Woo hoo! I’m beating the S&P by 7.6%! And here is where the individual holdings stand:
The interesting thing about my stocks is that out of my 4 picks, only one is doing really well, Amazon. But that one is REALLY winning.
My little portfolio is a good lesson on how the markets work. Most stocks don’t beat the indices. This excellent article by Morgan Housel states:
The S&P 500 rose 22% in 2017. But a quarter of that return came from 5 companies – Amazon, Apple, Facebook, Boeing, and Microsoft. Ten companies made up 35% of the return. Twenty-three accounted for half the return. Apple alone was responsible for more of the index’s total returns than the bottom 321 companies combined.
The S&P 500 gained 108% over the last five years. Twenty-two companies are responsible for half that gain. Ninety-two companies made up three-quarters of the returns.
The Nasdaq 100 skews even more. The index gained 32% last year. Five companies made up 51% of that return. Twenty-five companies were responsible for 75% of the overall return.
It’s incredible to think about. The real purpose of an index fund isn’t to own every stock, but to own the very small percentage of ones that will severely outperform. The next question you may ask is this:
Why can’t I just buy the ones that outperform?
Good luck with that.
If I asked 100 people on the street what the best performing stock of all time is, how many would get it right? Would you get it right? Hint: If you invested $1,000 in this stock in 1968, you would have $6,638,000 in 2014.
The answer is cigarettes.
One more thought experiment. What if you said this:
OK, I can’t buy the outperformers, but why don’t I cut the underperformers like Sears and JC Penny. After all, these two may go bankrupt this year.
Apple almost went bankrupt too.
One Year In
The hedge funds were also beating Buffett badly after year one. However, the S&P roared back in subsequent years and ended up severely clobbering the hedgies.
Will I be able to beat the S&P over the course of 10 years? Probably not, but maybe.
The one advantage I have is that I answer to no one. If a hedge fund has a
In any case, I’ll be back in a year to give you another update.
I’m a big believer in index funds now. I do these experiments for my own amusement only. Don’t follow me.
For why I’m convinced that index funds are the correct way to invest for 99.999% of people, read The Simple Path to Wealth.
One more thing: UK Chautauqua
Hey look, I’m speaking at Chautauqua again! I’m surprised too. After my dinosaur hijinks at the last one, I thought they’d ban me permanently. I sometimes borrow unattended phones and take dinosaur photos:
You’ve been #dinosaured!
In any case, go here to get your ticket. Act soon (half of the weeks are already sold out).
Join the 10s who have signed up already!
Subscribing will improve your life in incredible ways*.
*Only if your life is pretty bad to begin with.