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!
My Portfolio
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
*yawn*
In any case, I’ll be back in a year to give you another update.
Experiment Only
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.
It is an interesting challenge, isn’t it? I posted my article, to challenge assumptions, and people who use labels such as “active” or “passive”, without thinking through it.
I hope both of us are around to complete it, and share what we learned from it.
I am really behind on this, but should try to post something soon!
Dividend Growth Investor recently posted…Dividend Aristocrats for 2019 Revealed
I like the way you think DGI.
And everyone else out there, I know that DGI also came out ahead of the S&P in year one. I’ll link to his post when he publishes it.
You are clearly on your way to oracle status. That’s better than being knighted.
Haha, check back in 9 years.
my individual stocks beat the index by 5% last year, but i own 35 names worth several hundred g’s. they’ve really come back strong this year too. i let people know on the blog what they are so they can run far away and laugh at my foolish nature when it all goes in the pooper.
i’m running an index vs. index experiment of my own but using the nasdaq 100 vs. the vtsax (total market index). the qqq is winning by a couple of % points so far and i used real money because both my readers deserve accountability.
freddy smidlap recently posted…Financial Commandments for a Young Employee – Part 5 – Your Set-Up
Ha, your experiments and mindset sound similar to mine. I do think beating the indices over the long-term is possible, but you have to have both the time to do the research to acquire a deep understanding of the field of what you’re investing in and also the temperament to ride out some rough times. Regarding the former, aside from Waymo employees, I could probably talk about the company more than almost anyone on the planet. Regarding temperament, it’s a mixed bag. I sold all of my Apple a couple years ago. Now, I realize that its services business will probably replace much of the money lost by decreasing hardware sales. Ooopsie.
Sometimes you just have a happy accident! (at least that’s what I thought when I bought Cisco 4 years ago and it doubled in price in 2 years. I harvested those wins. Same with FANG (not to be confused w/ Facebook, Amazon….blah…blah) went up 20% in 2 months. I sold that too). Most of my stuff is in index funds or sector specific low cost funds. Whoo for “the simple path to wealth”!
The Simple Path is the right path for most!
Time to start your own fund and charge a ton of money Carl? 🙂
Haha, come back in 9 years…
So fun. In 1998 I bought a few shares (like less than 5) of Amazon and sold them 3 weeks later for a profit of $300. I don’t want to know what they’d be worth today.
Now it’s all index plus 200 shares of AAPL, which I keep meaning to sell at its peak. Forgot again last October. Maybe next time.
I’m doing my own little experiment right now and am far ahead of the market (+14.2%), but also understand it could come crashing down any minute. I got beat by the market last year by a few percentage points, but I believe my current investing philosophy is considerably better (doesn’t every broke bastard) and removes all emotion from the equation.
You’re crushing it! Keep up the great work…
JRobi recently posted…Will Durant (or Aristotle?) Quote….
Nice job on year one. I’m doing the same challenge too, but I’m betting my net worth VS VFINX. That’s harder than it sounds. Yes, we have income to boost our net worth, but they’re not all invested. We have a lot of drag too like bond allocation and home equity. We beat VFINX in year one, but that’s just because of the December drop. Anyway, good stuff.
Ah, the iron of beating Warren Buffet at his own bet by investing in Berkshire Hathaway! Nice job on picking a winner with Amazon too.
I think you’re absolutely right that over the long term most people are not going to beat an index. One year it could be Amazon that’s the big winner. Next year it might be Apple. Predicting who’s going to be the market appreciation winner every year is difficult, and very close to impossible.
If you look at how investor-billionaires like Buffet made their money, it becomes very clear that it isn’t done by picking the top market appreciation winners.
Just food for thought for all those that like to think.
I bought 100 shares of Alrtria (MO), about $3,400 worth, right after college as my first stock pick back in 2003. I thought that the pending litigation cases that it had were depressing the stock too much. That little investment over 15 years has kicked off over $7,500 in dividend cash-flow on top of the capital appreciation of almost $15,000. Finding that rare gem is definitely tough, but it pays off when you find it. I heard a podcast talking about how hard it is for people to hold on to their winners vs. selling them too early.
MFJ recently posted…Who wants to be a Millionaire…
Yep, I’d say managing your emotions is the hardest part. Buffett has said before that temperament is the most important part of successful investing.