Buffett, Mutual Funds, Hedge Funds, SP 500, and Real Estate
By David S. J. Meng
SP 500
The SP 500 compounding rate of return, with dividends reinvested, has averaged 9.7% annually from 1965-2018 (according to Berkshire Hathaway 2018 annual report). Of course, there are ups and downs, with some years increasing by more than 30% and other times dropping more than 30%. But the average annual return in over half a century has been about 9.7% per year.
Warren Buffett
Mr. Warren Buffett, Chairman and CEO of Berkshire Hathaway, is one of the best and wealthiest investors of all time. The Berkshire Hathaway 2018 annual report shows an average annual return of 18.7% from 1965-2018.
This is an amazing and unparalleled achievement. $10,000 invested with Buffett in the beginning of 1965 becomes in 2018: $10,000 x 1.187**54 = 100.5 million.
It should be noted that Mr. Buffett’s returns have decreased as the company has grown larger. As Buffett said, he is not as nimble as he was in his earlier days when he had less money to invest. While his average annual return was 18.7% from 1965-2018, it has decreased in the last quarter century (1994-2018) to 14.34%. More recently, his annual return in the past 10 years (2009-2018) has further decreased to 11.88%.
Although Buffett's returns have moderated recently, he is still one of the best and wealthiest investors in history. People can and should study him and learn a lot from him.
Hedge Funds
Mr. Buffett made a famous bet with hedge funds. In 2007, Buffett bet $1 million that an index fund such as the SP 500 would outperform a basket of hedge funds, over a long-term period, such as a decade.
Mr. Buffett chose the Vanguard's SP 500 Admiral fund (VFIAX).
Asset manager Protégé Partners selected a basket funds of hedge funds.
In 10 years from 2007 through the end of 2016, SP 500 index fund returned an annual average of 7.1%.
In 10 years from 2007 through the end of 2016, the competing basket of hedge funds returned an average of 2.2% annually.
So Buffett won the bet handily, and the proceeds went to his chosen charity.
Granted, fund managers are highly intelligent people. They charge hefty fees. They are highly competitive and hard-working professionals. But the reality is that the majority of fund managers underperform when compared to the long-term return of the SP 500 index.
Some hedge funds may make a bet and win big in a year or two and become famous, but their bets may lose in the following years. It is a very difficult task to consistently beat the SP 500 over the long-term.
Mutual Funds
Most stock mutual funds underperform the SP 500 index. According to http://www.aei.org/publication/more-evidence-that-its-very-hard-to-beat-the-market-over-time-95-of-financial-professionals-cant-do-it, the vast majority (92% to 96%) of mutual funds were unable to beat their respective benchmarks over a time period of fifteen years.
Therefore, only a small percentage (4-8%) of the fund managers were able to beat their respective benchmarks consistently in the long-term.
These numbers are generally consistent with another report on large companies (the SP 500 represents large companies). According to https://www.cnbc.com/2019/03/15/active-fund-managers-trail-the-sp-500-for-the-ninth-year-in-a-row-in-triumph-for-indexing.html, the majority (85%) of large cap funds underperformed the SP 500 index in a time period of ten years.
When the time period was increased, the number became even worse. Nearly 92% of large cap funds underperformed the SP 500 index in a time period of fifteen years.
Therefore, if you pick stocks by yourself and you can match the annual return of 9.7% of the SP 500 in the long-term, you are ranked in the top 8% of all the large cap fund managers.
Furthermore, if you can achieve a long-term compounding annual return of 14% in the stock market, you have matched “The Oracle of Omaha”, whose record was 14% in the past quarter century (1994-2018).
Indeed, if you can pick stocks and consistently outperform the SP 500, you are a bright star on Wall Street. The investment companies would be competing to pay big salaries and bonuses to recruit you.
Sir John Templeton is known for his famous advice: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” His investment return over a span of 40 years was approximately 14% annually. And Templeton was a legend.
According to https://www.thebalance.com/good-annual-mutual-fund-return-4767418: A “good” long-term return (annualized, for a period of 10 years or more) is 8%-10% per year for stock mutual funds. For bond mutual funds, a good long-term return is 4%-5% annually. Certainly, the poor funds would do much worse than these numbers.
Fees
Mutual fund fees and hedge fund fees can cost you significant amounts of money. This may catch most people by surprise, because they usually do not think that a mutual fund fee, such as 1%, is a big deal.
Is a small 1% fee a big deal?
The fee eats into your money in three ways. (1) It reduces your annual return for the year. (2) Most of these fees are annual, so the fund managers charge you, say, 1% every year. After a decade or two, with the growth of your money, that 1% fee is also taking away a larger and larger sum of your money. (3) It reduces your compounding power. Remember, compounding is the 8th wonder of the world.
To illustrate the point, simply assume that you invest a one-time $100,000 at the age of 30 into a mutual fund. It charges a 1% fee. By the time you retire at the age of 67, it’s been 37 years.
Simply assume that the fund returns a decent 9% annually on average in those 37 years (there are plenty of funds that do worse). After the 1% fee, you get a net 8% return (again, 8% annually compounding for 37 years is quite decent among mutual funds. Many funds do worse than this). After 37 years, your initial investment of $100,000 becomes:
$100,000 x 1.08**37 = $1.72 million.
Do not be surprised by the seemingly large number of $1.72 million. It will be worth much less in terms of purchasing power after 37 years, due to inflation.
What happens if you use the SP 500 instead?
Assume that you put the $100,000 into a SP 500 index fund that charges a fee of 0.04% (I have all of my 401k money in such a fund). Let’s use the historic average annual return of 9.7% for SP 500 (1965-2018). After the fee, 9.7% - 0.04% = 9.66%. After 37 years, your initial investment of $100,000 becomes:
$100,000 x 1.0966**37 = $3.03 million.
This is much larger than what the decent mutual fund produced.
$3.03 million - $1.72 million = $1.31 million.
This hurts. By choosing the decent mutual fund instead of the simple, passive and low-fee SP 500, you have lost $1.31 million that otherwise is yours.
And if you are among the higher income group and have more money, and invest more than $100,000, you will lose even more than $1.31 million.
Furthermore, if the fund you choose is not so decent and returns less than 8% annually after all fees, you will lose even more than $1.31 million.
This is a simple example that does not consider other factors, including that you likely will put more money into the fund every month or every year, instead of a one-time investment. It is not an exact calculation, but you get the point.
That is why 100% of my 401k is in SP 500. I do dollar cost averaging and look at it once a year.
The 9th Wonder of the World
People talk about the 7 wonders of the world.
Albert Einstein said:
"Compound interest is the 8th wonder of the world. He who understands it earns it… he who doesn't… pays it."
David Meng says:
"This is the 9th wonder of the world:
People are willing to give $1 million in fees to mutual fund managers who underperform the SP 500, yet they are unwilling to pay $15 to buy a book that can teach them to make millions of dollars for themselves and for their loved ones."
Stock Trading
Most individual stock traders do not succeed. According to the article “Scientist Discovered Why Most Traders Lose Money – 24 Surprising Statistics”, the most commonly-used trading-related statistic around the internet shows that 95% of all traders fail. It shows that while all traders start with the dream to get rich, 80% of them quit in the first two years. Only 1% of all traders make a significant profit. (https://www.tradeciety.com/24-statistics-why-most-traders-lose-money/)
In a Forbes article, Neale Godfrey shows: “The success (meaning: not losing money) rate for day traders is estimated to be around only 10%, so … 90% of them are losing money.” “Only 1% of day traders really make money.” (https://www.forbes.com/sites/nealegodfrey/2017/07/16/day-trading-smart-or-stupid/#5642a3d41007)
A few gifted individuals do very well investing in stocks; congratulations to them. I respect them. However, they are among a very small percentage.
Some people trade stocks as a hobby, and that is fine too, if you treat it as a hobby and not as a way to make money. Just play with the money that you can afford to lose.
I ask myself: “Am I among the top 1% in selecting stocks?” The answer is no.
“Do I want to compete with Wall Street experts who play golf with the company CEOs?” No.
“Do I have the time to research the companies?” No.
“Do I want to endure the ups and downs and mood swings?” No.
Personally for me, (and I am not trying to force this on others), I like a relaxed and enjoyable life. I want to have plenty of time to think and read. I like to take long walks, with about 20,000 steps per day. I do some push-ups and sit-ups. I spend a lot of time to serve our church. I spend a lot of time with my family. I like to cook dinner and wash the dishes. My kids all know and laugh that washing dishes is my hobby.
With real estate, I delegate as much of the duties as possible to my team.
With stock market, I put money into SP 500 and then forget about it. I do dollar cost averaging and hold for the long-term
Real Estate
In sharp contrast to hedge funds and mutual funds, real estate investing with a proper and cautious use of leverage, as described in my book “$5 Million in 8 Years”, can beat the market. It is quite doable to achieve annual rates of return of above 15%, sometimes above 20% or 25%.
In the humble small case of my wife and I, we achieved $150,000/year of positive cash-flow. With our net worth from $0.8 million to $5.5 million in 8 years, 5.5/0.8 = 1.27**8. Therefore, our rate in net wealth accumulation was 27% annually on average in the past 8 years.
Small landlords can substantially exceed the stock market returns.
If you can bet on the right company in the stock market and win big, congratulations. You are lucky and among a very small percentage of investors. Your achievements cannot be reproduced by the vast majority of ordinary people.
For the vast majority of people, slow-and-steady is the assured way to achieving financial freedom. As demonstrated in my book “$5 Million in 8 Years”, small landlords can steadily accumulate wealth and reach financial freedom.
In addition to net worth, it is the substantial amounts of passive cash-flow every month that enables financial freedom.
Comparison of Rates of Return
Buffett's annual return (1965-2018): 18.7%.
Buffett's annual return (1994-2018): 14.3%.
Buffett's annual return (2009-2018): 11.9%.
SP 500 (1965-2018): 9.7%.
Good stock mutual fund: 9%.
Good bond fund: 5%.
Small landlord David Meng: 27%.
Acknowledgment. Returns for Berkshire Hathaway (led by Buffett, one of the best investors of all time) and SP 500 are from: https://www.berkshirehathaway.com/letters/2019ltr.pdf. Returns for good stock mutual funds and bond mutual funds are from: https://www.thebalance.com/good-annual-mutual-fund-return-4767418.
Yes real estate produces higher return but takes more time and effort. My personal way is to build a team and rely on other opeple's time and other people's talents. This may reduce the rate of return because you have to pay them. But if you do it by yourself and returns 25%, you can use your team and pay them and still get, say, 20%. That's still higher than SP500. In addition, because you delegate and have more time and energy, you can focus on the bigger picture, and you can grow your real estate bigger. You give a slice of your cake to pay your team, but you grow a bigger cake. These are discussed in more detail with real life examples in my book. Thanks.
Buffett, Mutual Funds, Hedge Funds, SP 500, and Real Estate
By David S. J. Meng
SP 500
The SP 500 compounding rate of return, with dividends reinvested, has averaged 9.7% annually from 1965-2018 (according to Berkshire Hathaway 2018 annual report). Of course, there are ups and downs, with some years increasing by more than 30% and other times dropping more than 30%. But the average annual return in over half a century has been about 9.7% per year.
Warren Buffett
Mr. Warren Buffett, Chairman and CEO of Berkshire Hathaway, is one of the best and wealthiest investors of all time. The Berkshire Hathaway 2018 annual report shows an average annual return of 18.7% from 1965-2018.
This is an amazing and unparalleled achievement. $10,000 invested with Buffett in the beginning of 1965 becomes in 2018: $10,000 x 1.187**54 = 100.5 million.
It should be noted that Mr. Buffett’s returns have decreased as the company has grown larger. As Buffett said, he is not as nimble as he was in his earlier days when he had less money to invest. While his average annual return was 18.7% from 1965-2018, it has decreased in the last quarter century (1994-2018) to 14.34%. More recently, his annual return in the past 10 years (2009-2018) has further decreased to 11.88%.
Although Buffett's returns have moderated recently, he is still one of the best and wealthiest investors in history. People can and should study him and learn a lot from him.
Hedge Funds
Mr. Buffett made a famous bet with hedge funds. In 2007, Buffett bet $1 million that an index fund such as the SP 500 would outperform a basket of hedge funds, over a long-term period, such as a decade.
Mr. Buffett chose the Vanguard's SP 500 Admiral fund (VFIAX).
Asset manager Protégé Partners selected a basket funds of hedge funds.
In 10 years from 2007 through the end of 2016, SP 500 index fund returned an annual average of 7.1%.
In 10 years from 2007 through the end of 2016, the competing basket of hedge funds returned an average of 2.2% annually.
So Buffett won the bet handily, and the proceeds went to his chosen charity.
Granted, fund managers are highly intelligent people. They charge hefty fees. They are highly competitive and hard-working professionals. But the reality is that the majority of fund managers underperform when compared to the long-term return of the SP 500 index.
Some hedge funds may make a bet and win big in a year or two and become famous, but their bets may lose in the following years. It is a very difficult task to consistently beat the SP 500 over the long-term.
Mutual Funds
Most stock mutual funds underperform the SP 500 index. According to http://www.aei.org/publication/more-evidence-that-its-very-hard-to-beat-the-market-over-time-95-of-financial-professionals-cant-do-it, the vast majority (92% to 96%) of mutual funds were unable to beat their respective benchmarks over a time period of fifteen years.
Therefore, only a small percentage (4-8%) of the fund managers were able to beat their respective benchmarks consistently in the long-term.
These numbers are generally consistent with another report on large companies (the SP 500 represents large companies). According to https://www.cnbc.com/2019/03/15/active-fund-managers-trail-the-sp-500-for-the-ninth-year-in-a-row-in-triumph-for-indexing.html, the majority (85%) of large cap funds underperformed the SP 500 index in a time period of ten years.
When the time period was increased, the number became even worse. Nearly 92% of large cap funds underperformed the SP 500 index in a time period of fifteen years.
Therefore, if you pick stocks by yourself and you can match the annual return of 9.7% of the SP 500 in the long-term, you are ranked in the top 8% of all the large cap fund managers.
Furthermore, if you can achieve a long-term compounding annual return of 14% in the stock market, you have matched “The Oracle of Omaha”, whose record was 14% in the past quarter century (1994-2018).
Indeed, if you can pick stocks and consistently outperform the SP 500, you are a bright star on Wall Street. The investment companies would be competing to pay big salaries and bonuses to recruit you.
Sir John Templeton is known for his famous advice: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” His investment return over a span of 40 years was approximately 14% annually. And Templeton was a legend.
According to https://www.thebalance.com/good-annual-mutual-fund-return-4767418: A “good” long-term return (annualized, for a period of 10 years or more) is 8%-10% per year for stock mutual funds. For bond mutual funds, a good long-term return is 4%-5% annually. Certainly, the poor funds would do much worse than these numbers.
Fees
Mutual fund fees and hedge fund fees can cost you significant amounts of money. This may catch most people by surprise, because they usually do not think that a mutual fund fee, such as 1%, is a big deal.
Is a small 1% fee a big deal?
The fee eats into your money in three ways. (1) It reduces your annual return for the year. (2) Most of these fees are annual, so the fund managers charge you, say, 1% every year. After a decade or two, with the growth of your money, that 1% fee is also taking away a larger and larger sum of your money. (3) It reduces your compounding power. Remember, compounding is the 8th wonder of the world.
To illustrate the point, simply assume that you invest a one-time $100,000 at the age of 30 into a mutual fund. It charges a 1% fee. By the time you retire at the age of 67, it’s been 37 years.
Simply assume that the fund returns a decent 9% annually on average in those 37 years (there are plenty of funds that do worse). After the 1% fee, you get a net 8% return (again, 8% annually compounding for 37 years is quite decent among mutual funds. Many funds do worse than this). After 37 years, your initial investment of $100,000 becomes:
$100,000 x 1.08**37 = $1.72 million.
Do not be surprised by the seemingly large number of $1.72 million. It will be worth much less in terms of purchasing power after 37 years, due to inflation.
What happens if you use the SP 500 instead?
Assume that you put the $100,000 into a SP 500 index fund that charges a fee of 0.04% (I have all of my 401k money in such a fund). Let’s use the historic average annual return of 9.7% for SP 500 (1965-2018). After the fee, 9.7% - 0.04% = 9.66%. After 37 years, your initial investment of $100,000 becomes:
$100,000 x 1.0966**37 = $3.03 million.
This is much larger than what the decent mutual fund produced.
$3.03 million - $1.72 million = $1.31 million.
This hurts. By choosing the decent mutual fund instead of the simple, passive and low-fee SP 500, you have lost $1.31 million that otherwise is yours.
And if you are among the higher income group and have more money, and invest more than $100,000, you will lose even more than $1.31 million.
Furthermore, if the fund you choose is not so decent and returns less than 8% annually after all fees, you will lose even more than $1.31 million.
This is a simple example that does not consider other factors, including that you likely will put more money into the fund every month or every year, instead of a one-time investment. It is not an exact calculation, but you get the point.
That is why 100% of my 401k is in SP 500. I do dollar cost averaging and look at it once a year.
The 9th Wonder of the World
People talk about the 7 wonders of the world.
Albert Einstein said:
"Compound interest is the 8th wonder of the world. He who understands it earns it… he who doesn't… pays it."
David Meng says:
"This is the 9th wonder of the world:
People are willing to give $1 million in fees to mutual fund managers who underperform the SP 500, yet they are unwilling to pay $15 to buy a book that can teach them to make millions of dollars for themselves and for their loved ones."
Stock Trading
Most individual stock traders do not succeed. According to the article “Scientist Discovered Why Most Traders Lose Money – 24 Surprising Statistics”, the most commonly-used trading-related statistic around the internet shows that 95% of all traders fail. It shows that while all traders start with the dream to get rich, 80% of them quit in the first two years. Only 1% of all traders make a significant profit. (https://www.tradeciety.com/24-statistics-why-most-traders-lose-money/)
In a Forbes article, Neale Godfrey shows: “The success (meaning: not losing money) rate for day traders is estimated to be around only 10%, so … 90% of them are losing money.” “Only 1% of day traders really make money.” (https://www.forbes.com/sites/nealegodfrey/2017/07/16/day-trading-smart-or-stupid/#5642a3d41007)
A few gifted individuals do very well investing in stocks; congratulations to them. I respect them. However, they are among a very small percentage.
Some people trade stocks as a hobby, and that is fine too, if you treat it as a hobby and not as a way to make money. Just play with the money that you can afford to lose.
I ask myself: “Am I among the top 1% in selecting stocks?” The answer is no.
“Do I want to compete with Wall Street experts who play golf with the company CEOs?” No.
“Do I have the time to research the companies?” No.
“Do I want to endure the ups and downs and mood swings?” No.
Personally for me, (and I am not trying to force this on others), I like a relaxed and enjoyable life. I want to have plenty of time to think and read. I like to take long walks, with about 20,000 steps per day. I do some push-ups and sit-ups. I spend a lot of time to serve our church. I spend a lot of time with my family. I like to cook dinner and wash the dishes. My kids all know and laugh that washing dishes is my hobby.
With real estate, I delegate as much of the duties as possible to my team.
With stock market, I put money into SP 500 and then forget about it. I do dollar cost averaging and hold for the long-term
Real Estate
In sharp contrast to hedge funds and mutual funds, real estate investing with a proper and cautious use of leverage, as described in my book “$5 Million in 8 Years”, can beat the market. It is quite doable to achieve annual rates of return of above 15%, sometimes above 20% or 25%.
In the humble small case of my wife and I, we achieved $150,000/year of positive cash-flow. With our net worth from $0.8 million to $5.5 million in 8 years, 5.5/0.8 = 1.27**8. Therefore, our rate in net wealth accumulation was 27% annually on average in the past 8 years.
Small landlords can substantially exceed the stock market returns.
If you can bet on the right company in the stock market and win big, congratulations. You are lucky and among a very small percentage of investors. Your achievements cannot be reproduced by the vast majority of ordinary people.
For the vast majority of people, slow-and-steady is the assured way to achieving financial freedom. As demonstrated in my book “$5 Million in 8 Years”, small landlords can steadily accumulate wealth and reach financial freedom.
In addition to net worth, it is the substantial amounts of passive cash-flow every month that enables financial freedom.
Comparison of Rates of Return
Buffett's annual return (1965-2018): 18.7%.
Buffett's annual return (1994-2018): 14.3%.
Buffett's annual return (2009-2018): 11.9%.
SP 500 (1965-2018): 9.7%.
Good stock mutual fund: 9%.
Good bond fund: 5%.
Small landlord David Meng: 27%.
Acknowledgment. Returns for Berkshire Hathaway (led by Buffett, one of the best investors of all time) and SP 500 are from: https://www.berkshirehathaway.com/letters/2019ltr.pdf. Returns for good stock mutual funds and bond mutual funds are from: https://www.thebalance.com/good-annual-mutual-fund-return-4767418.
房子越多，所花时间越多。
Yes real estate produces higher return but takes more time and effort. My personal way is to build a team and rely on other opeple's time and other people's talents. This may reduce the rate of return because you have to pay them. But if you do it by yourself and returns 25%, you can use your team and pay them and still get, say, 20%. That's still higher than SP500. In addition, because you delegate and have more time and energy, you can focus on the bigger picture, and you can grow your real estate bigger. You give a slice of your cake to pay your team, but you grow a bigger cake. These are discussed in more detail with real life examples in my book. Thanks.