Think like Buffett: Save on fees, invest in ETFs

With a shot at the damage caused to investors by high fees, Warren Buffett has given a fresh, rousing endorsement to the performance of index investing.

In his latest annual letter to investors, the 86-year-old billionaire CEO of Berkshire Hathaway Inc. updated his bet that even super smart hedge fund managers will have trouble outperforming a simple low-fee exchange-traded fund (ETF) based on the S&P 500 composite index.

Buffett revisited his 10-year wager that the S&P 500 will outperform a portfolio of funds of hedge funds, net of fees and expenses, between January 1, 2008 and the end of the 2017 calendar year. Why? Because the negative of fees outweighs the positive of investing acumen over time.

Here’s his rationale: “A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.”

Buffett’s wager, valued at $500,000 with the proceeds to go to charity if he wins, only managed to attract one investor on the hedge side of the bet. To date, that fund professional’s average gain for five pooled funds is up 2.2% vs. a 7.1% advance for Buffett’s index bet, so there is little chance he’ll lose.

“There are of course,” he added, “some skilled individuals who are highly likely to outperform the S&P over long stretches. In my lifetime, though, I’ve identified – early on – only 10 or so professionals that I expected would accomplish this feat.”

MoneySense is a big believer in index investing and actively backs a low-fee ETF-based Couch Potato portfolio as a way for investors to build wealth, whether they are just starting out or have amassed a healthy nest egg already.

• Read the ultimate guide to the Couch Potato portfolio, with three options that include mutual funds as well as ETFs
• Which Couch Potato approach is right for you? Take the quiz

In his letter, Buffett says even “mega-rich individuals, institutions or pension funds” are reluctant to follow his indexing advice because they are vulnerable to “the siren song of a high-fee manager” and don’t want to invest like average investors. Wealthy individuals, pension funds and college endowments “have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars.” The impact? He says a rough calculation on the money lost when elite U.S. investors search for “superior investment advice” is more than US$100 billion in the past decade.

Good advice doesn’t always lead to change, however. Even when it comes from the Oracle of Omaha. “Human behaviour won’t change,” he laments.

“Wealthy individuals, pension funds, endowments and the like will continue to feel they deserve something ‘extra’ in investment advice. Those advisors who cleverly play to this expectation will get very rich. This year the magic potion may be hedge funds, next year something else. The likely result from this parade of promises is predicted in an adage: ‘When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.’”