Episode 688: Brilliant vs. Boring : Planet Money A million-dollar bet pits a bunch of really smart money managers against the simplest investment idea in the world.

Episode 688: Brilliant vs. Boring

  • Download
  • <iframe src="https://www.npr.org/player/embed/469247400/476055868" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript


Carol Loomis has known Warren Buffett for a long time.

CAROL LOOMIS: We've been friends for - how many years? - 33 - 16 - 49 - 50 years. Yeah, we've been friends for 50 years.


Loomis is a reporter. She worked for decades at Fortune magazine. Warren Buffett, of course -- CEO Berkshire Hathaway, legendary investor, also, third richest man on the planet.

KESTENBAUM: What kind of stuff do you do together?

LOOMIS: Well, we play bridge. He's an avid online bridge player, and when the computer breaks down, it drives him crazy (laughter).

KESTENBAUM: Warren Buffett - just like your grandpa, only richer.

GOLDSTEIN: Much, much richer.

KESTENBAUM: And we called Carol Loomis because of this story she has been deeply involved in for a number of years now.

GOLDSTEIN: It's a story about a bet.

It seems like you're sort of the bookie

LOOMIS: (Laughter) No, I wouldn't say that. I would think of myself as the biographer of the bet.

KESTENBAUM: I'm still going to call her the bookie.

GOLDSTEIN: She is not the bookie. She says the story of the bet starts back in 2006. It's at the Berkshire Hathaway annual meeting which is this big thing every year. It's like this capitalist Woodstock.

KESTENBAUM: Is that what it's actually called?

GOLDSTEIN: I mean, that's, like, the unofficial joke name of it. Thousands of people fly in. Buffett is up on this stage talking, and the subject of hedge funds comes up.

KESTENBAUM: You know, hedge funds - like, investment firms for rich people with these brilliant Ph.D.s working crazy long hours. And Buffett says those guys - they are not worth the fees they are charging investors.

GOLDSTEIN: So he says I'm willing to make a bet. I can pick an investment that will beat the hedge funds.

LOOMIS: I don't know that he ever realized that anyone would pick him up on this bet. He certainly wasn't going to do it for a small amount of money, and you want to make a declaration by the size of the bet that this is a serious matter.

GOLDSTEIN: A few guys from the hedge fund world hear about this challenge, and they say sure, we'll take you up on it.

KESTENBAUM: On January 1, 2008, they make a 10-year bet.

GOLDSTEIN: So how big is the bet?

LOOMIS: One million dollars.


GOLDSTEIN: It sounds like a lot of money.

LOOMIS: It is.

GOLDSTEIN: The hedge fund guys bet on hedge funds - these groups of super smart, elite investing wizards.

KESTENBAUM: Buffet - for his side of the bet - he does not pick a few stocks. He doesn't even pick his own company. He picks one of the most brainless, boring investments there is.


GOLDSTEIN: Hello, and welcome to PLANET MONEY. I'm Jacob Goldstein.

KESTENBAUM: And I'm David Kestenbaum. Today on the show, a $1 million bet over a very deep question. Which is better - a group of really smart money managers or the simplest, stupidest investment idea in the world?

GOLDSTEIN: We ask each side - what are you thinking?


FREDERIC AUGER: (Singing) We never get away...


AUGER: (Singing) I like this. Whoa...

GOLDSTEIN: This is not just a bet pitting a billionaire against a bunch of hedge funds. If you have any money invested in the stock market - if you have something stocked away for your retirement or for your kid's college fund or whatever, you have taken a side in this bet, whether you know it or not.

KESTENBAUM: We wanted to understand both sides, so let's do the Warren Buffett side first. The weapon he chose in his battle against the hedge funds - the simple, brainless investment he picked - it was created far from Wall Street in Malvern, Pa. It was created by this man.

JOHN BOGLE: I'm probably guy you will ever meet in your life.

KESTENBAUM: John C. Bogle.

BOGLE: I don't buy anything.

GOLDSTEIN: How old are these pants you're wearing?

BOGLE: Yeah, I'd say 15.

GOLDSTEIN: Fifteen years. The sweater?

BOGLE: Well, it's out of L.L. Bean. That's probably only about 8.

KESTENBAUM: Bogle, as you may know, founded a company called Vanguard, named, by the way, after a ship in the British navy during the Napoleonic Wars.

GOLDSTEIN: Yeah. You walk around the offices out there in Malvern, and you feel like they have bought every single oil painting of every old naval battle in history.

KESTENBAUM: There is barely a picture that does not have a ship in it.

BOGLE: That's the way it is. We like ships.

KESTENBAUM: I saw this one painting that was just of an ocean. I was like - oh, there's one. It's just an ocean. And you're, like, no, that is the view from the ship.

That simple brainless investment that Warren Buffett picked in the bet is called an index fund. John Bogle created the first index fund back in 1976.

GOLDSTEIN: He had just read this article by a famous economist named Paul Samuelson. And what Samuelson wrote in this article was he could not find any good evidence that professional investors - that people whose jobs is to pick stocks - he couldn't find any evidence that they were any good.

KESTENBAUM: If you took a bunch of professional investors and looked at how they did over a long time and you took the average, they did not beat the market. Like, when you hear on the news the stock market closed up 1 percent today, you'd be better off investing in that stupid measure of the stock market than paying someone to try to beat it.

GOLDSTEIN: Samuelson wrote that maybe, quote, "most portfolio decision makers should go out of business - take up plumbing, teach Greek."

KESTENBAUM: At this point, John Bogle has been in the business for 20 years - since he graduated from college. He has basically been one of those people who Samuelson says should go out of business. But he takes Samuelson's argument seriously. In fact, he decides to check the numbers himself.

BOGLE: And I do the math. I go to these old books of investment company performance, and I added up each column, got an average for 35 years.

GOLDSTEIN: And he found that Samuelson was right. In fact, for the investment funds he looked at, when you added in the fees they charge, they did worse, on average, than the stock market.

KESTENBAUM: And you could say, well, I just won't pick a bad investment fund. I'll pick a good one that can really pick the right stocks. That turns out to be very hard to do. Stockpickers who do well one year, they don't always do well the next.

GOLDSTEIN: And there are, of course, some who do well for a few years in a row. But, you know, you would expect that if everybody was just randomly guessing. You know if you had 1,000 people flipping coins, a few of them are going to flip heads 10 times in row.

KESTENBAUM: Bogle saw all of this and thought - so what do we do? And at the end of that article that he had read by the famous economist, there was this suggestion.

BOGLE: And he basically said, to cut through his more elegant words - would somebody somewhere please start an index fund? And I thought - why not me?

GOLDSTEIN: Start an index fund. Bogle figured he would just create this super simple index fund that people could invest in. He wouldn't pick stocks. He wouldn't say - I think this company is great. I'm going to buy their stock, and I'm going to avoid that other company because I don't like them. He was just going to make a fund that was a collection of every stock in the stock market. I mean, not every single stock, but the biggest 500 companies on the U.S. stock market.

KESTENBAUM: So, if you're doing this today, Apple is the biggest company. You'd buy some of that.

GOLDSTEIN: Yeah. And then, you know, whatever. GE, also a big company, you buy that, too, but a little less in proportion to its size and on down - 500 companies.

KESTENBAUM: It's called an index fund because it is just mindlessly tracking a stock index - actually, the index that you hear on the news all the time, the S&P 500. As in, the S&P 500 closed up a quarter of a percent today.

GOLDSTEIN: So, if the stock market - if the S&P 500 has a good day, your index fund is going to have a good day. If it has a bad day, the index fund's going to have a bad day. It is not trying to do anything tricky.

KESTENBAUM: Bogle creates this in 1976, and he's ready to open it up to the world, the first index fund ever. This is a fund for everybody. You can put in a small amount of money or a lot.

GOLDSTEIN: Bogle gets a bunch of big investment firms to go out to their clients and say - here's this great new thing. You want in?

KESTENBAUM: How much money were they hoping to get?

BOGLE: A hundred and fifty million dollars.

KESTENBAUM: How much did you get?

BOGLE: Eleven million dollars. It was a flop.

KESTENBAUM: The investment firms go back to Bogle, and they say - nobody wants this thing. Let's just kill it.

BOGLE: And I said wait a minute. We have the world's first index fund. We're going to keep the $11 million, and we'll do our best.

GOLDSTEIN: Investors don't really like this idea. Also, the investment industry does not like this idea.

KESTENBAUM: Because it's an insult to everything they stand for and they're trying to do.

GOLDSTEIN: At this point in the interview - at this moment in the story, Bogle points to the wall - points to something hanging on the wall right by where we're sitting.

BOGLE: Look over there.

GOLDSTEIN: What's going on?

BOGLE: That's the first reception from Wall Street.

GOLDSTEIN: Wait. That's an actual poster you're pointing to.

BOGLE: Yes. Came out in 1976.

GOLDSTEIN: He's pointing at a poster that he says brokerage firm printed up back in the '70s - has this big picture of Uncle Sam and it says...

BOGLE: Help stamp out index funds. Index funds are un-American.

KESTENBAUM: Un-American. I get it, right? I mean, one of the things that makes (laughter) America great is that people work really hard to do better than average.

GOLDSTEIN: Yeah. And if you buy an index fund, you are buying something that is designed to be average - that is guaranteed never to be better than average. And nowhere else in your life - in no other important thing would you go for average, you know. If you're going to have surgery, would you be, like, OK. I just want to make sure I have an average doctor? No. No, right? You would call every person you know. You would do all the research you could to find a surgeon who is better than average.

KESTENBAUM: And it just makes so much sense that if you're picking a stock, there's got to be somebody out there who knows something - who can say this is a better company to invest in than that one.

GOLDSTEIN: Somebody called the index fund the, quote, "pursuit of mediocrity." Somebody else called it a formula for a solid, consistent long-term loser.

KESTENBAUM: Bogle keeps the index fund open, and he waits for the world to just come around to his way of seeing things. A year goes by - and then another. A decade passes.

GOLDSTEIN: So you've been out for 10 years with the greatest idea of your life.

BOGLE: Right.

GOLDSTEIN: And where are you?

BOGLE: Zero percent

KESTENBAUM: He's rounding down there.

GOLDSTEIN: Yeah (laughter), he's round down.

KESTENBAUM: It's a small part of the market. If you take, like, all of the funds out there, index funds are, like, 0.4 percent a decade in.

KESTENBAUM: The idea of the index fund did finally start to catch on the 1990s. One of the reasons - index funds had very low fees.

GOLDSTEIN: Yeah. And think about it this way - you know, if you're running a traditional fund, you have to pay people to pick stocks, pay them to read reports and crunch numbers and fly out to meet with the CEO and visit the factory. If you're running an index fund, you don't have to pay people to do any of those things, so you can charge investors lower fees.

KESTENBAUM: If you take a typical stock fund today and you invest, say, $10,000, they're going to charge you a fee of $100 every year.

GOLDSTEIN: The Vanguard index fund? They're going to charge you $5.

KESTENBAUM: In recent years, a lot of people have said OK, I give up. A bunch of money has flowed into index funds.

GOLDSTEIN: We wanted to see what giving up looks like, so we went to the room where they run their index funds. And, I mean, it wasn't much, you know (laughter). Like, it was quiet. There were a few computers - could've been, like, any office. There's a handful of people in there, and they're very intentionally not picking stocks.

KESTENBAUM: It does seem boring. It does feel like giving up.

BOGLE: It is the essence of boredom. I'll concede it. If you're in investing for excitement, you are a damn fool. You're watching the market every day - up and down, 100-point - 200, 300, 400-point swings day after day. It's exciting, but it's meaningless.

KESTENBAUM: So that is the story of the boring, super simple investment that one Warren Buffett picked for his side of the bet.

GOLDSTEIN: And to be clear, he actually picked that very fund - the Vanguard S&P 500 index fund.

KESTENBAUM: Now for someone from the other side of the bet, the humans-can-win, we-can-do-better side of the bet.

GOLDSTEIN: His name is Ted Seides. He's worked for years in the hedge fund world. He heard Warren Buffett's challenge and figured, yeah, I know some really smart people who can do better than average.

TED SEIDES: I thought I had a rare chance to catch somebody like Warren potentially being the patsy at the poker table.

GOLDSTEIN: I'm sorry. You said to catch him being what?

SEIDES: The patsy at the poker table.

KESTENBAUM: This is the summer of 2007, and Seides sends Buffett a letter, like, an actual letter in an envelope with a stamp - old school. He says he's interested in taking the other side of the bet.

SEIDES: And so let's talk about what stakes you propose. And my typical stakes might be over dinner. Yours might be a little higher than mine, but let's see what happens.

GOLDSTEIN: A little while after that, Seides gets this email, and there's a PDF attached. He opens up the PDF, and what's happened is Buffett has taken that letter and just scrawled some notes on it and then somebody scans it in and sends it back to him. So they go back and forth for a while. Now they start negotiating the bet.

SEIDES: Safe to say, he was comfortable with higher stakes than I was.

GOLDSTEIN: (Laughter) You're making a bet with one of the two or three richest men in the world.

SEIDES: (Laughter) Correct.

GOLDSTEIN: They settled on that $1 million dollar bet. Buffett picked the Vanguard S&P 500 index fund. Seides and his partners picked a collection of hedge funds.

KESTENBAUM: Seides knows all that data that John Bogle mentioned about how stockpickers can't beat the market. But these hedge funds, they do more than stock picking.

GOLDSTEIN: Yeah. I mean, they're incredibly elite, incredibly smart people. And, you know, they can sell shares short. They can bet against companies. They can get in and out of the market. They can invest in derivatives.

KESTENBAUM: Some hedge funds are filled with quants - mathematicians, former physics types. They are not naive about what they are doing.

GOLDSTEIN: And Seides has spent his career working inside this world - this world of people who believe they really can beat the market. He started out at Yale helping manage the school's endowment. And that particular endowment, the Yale endowment, is run by this guy who has been beating the market for decades.

KESTENBAUM: Seides says when you go to work with that guy every day, you realize he is not lucky. He is really, really good. You know who else is really good he says? The person on the other side of the bet - Warren Buffett.

SEIDES: Another way of framing the question is - do you believe that Warren Buffett has skill? Or is he just anomalous because there are so many people who are picking stocks he just happens to be the guy who's outperformed? And what I would tell you is that when you spend time with Warren and you spend time with many, many, many other money managers, you can come away with a very high degree of confidence that if Warren started investing for the first time today, he would outperform in the future.

KESTENBAUM: So you're sure you're not tricking yourself there?

SEIDES: In what way?

KESTENBAUM: He's a charismatic guy. You meet him. You think - this guy's great.

SEIDES: It's not the charisma piece. It's temperament, discipline, insight.

KESTENBAUM: I know. That all sounds like very vague management stuff. The question is - like, I keep wanting to go back to the numbers because I - you know, you meet people, and they've done well the last X years or maybe the one person who's done well their whole life, you know. And so you tend to think that person has something, but maybe not. Maybe they're just lucky.

SEIDES: Well, I think that's the eternal question in investing.

KESTENBAUM: The eternal question in investing. The 10-year, $1 million bet over the eternal question in investing is now almost at an end. It started January 1, 2008. Here's how it's gone since then.

GOLDSTEIN: The first year, 2008, was a terrible year for Warren Buffett - a terrible year for the index fund. As you probably remember, that was the year of the financial crisis. The stock market, the index fund got hammered.

KESTENBAUM: Yeah, Buffett had terrible timing, right - the worst time to start this bet. By early 2009, things were looking really good for the hedge fund side - for Ted Seides.

SEIDES: We were way ahead.

KESTENBAUM: Like what to what?

SEIDES: The market would have been down about 45 percent. And the hedge funds were probably down about 25 percent.

KESTENBAUM: So if I'm imagining two runners on the track, like, your runner is really kind of pulling ahead at this point.

SEIDES: It's safe to say our runner was - hadn't moved much. And the market runner had gone backwards...


SEIDES: ...A few miles.

KESTENBAUM: The next year, that was a good year for Buffett - also the year after that, also the year after that. The index fund kept beating the hedge funds. That stupid, simple investment was better than roomfuls of really smart people.

GOLDSTEIN: Where we stand now, as of the end of 2015, the index fund is up 66 percent. The hedge funds? Up only 22 percent.

SEIDES: It's a huge gap.

GOLDSTEIN: Like, you're not even close.

SEIDES: No. No, that's right.

KESTENBAUM: There is not much time left. The bet ends soon - December 31, 2017.

GOLDSTEIN: Seides says the only way the hedge funds could win at this point is if there's, like, another huge stock market crash. And he says he doesn't want to see the happen - obviously.

KESTENBAUM: Are you bummed about probably having lost this bet?

SEIDES: A little bit. Sure.

KESTENBAUM: Yeah, you had a chance to beat Warren Buffett.

SEIDES: Yeah - with the odds in my favor. And it didn't play out the way I thought it would.

KESTENBAUM: You thought the odds were in your favor.

SEIDES: (Laughter) I still think the odds were in my favor.

GOLDSTEIN: He actually says he would take the bet again if he could - if he could go back to 2008. He says it's essentially a fluke that the stock market has done as well as it has over the past 8 years.

GOLDSTEIN: So you're saying you made the right bet. You just got unlucky.

SEIDES: Yeah, that is how I feel about it.

GOLDSTEIN: And Buffett's only going to win because he got lucky.

SEIDES: I think he did end up on the lucky side of the distribution.

KESTENBAUM: Isn't it also possible that it is just very, very hard to beat the market?

SEIDES: Oh, it's not possible. That's a truth.

KESTENBAUM: What's your advice to ordinary people who do not have a lot of money but want to put some of the money in the stock market?

SEIDES: I think they should index.

KESTENBAUM: From the hedge fund side of the bet.

GOLDSTEIN: You know, like, I actually think his whole position frankly makes some sense. Like I do think there are some people out there who really can beat the market, who are not just getting lucky.

KESTENBAUM: Somebody's got to be first.

GOLDSTEIN: But, you know, for me when I'm deciding - what am I going to do with my money? - I don't think I can figure out who that person is. I don't think I can pick the next Warren Buffett. So, full disclosure here - getting near the end of the show - I put my money in index funds.

KESTENBAUM: Me, too. With the exception of the dollars in my wallet, basically everything is an index fund.

GOLDSTEIN: You want to do your rant here?

KESTENBAUM: Yeah (laughter).

GOLDSTEIN: I mean, you do it all the time in real life.

KESTENBAUM: Yeah. It drives me crazy when I'm talking to a friend or someone at a party and they're like, you know, my mom knows how to pick stocks. She knew IBM was going to do great. It just drives me bananas because, like, they were just lucky.


KESTENBAUM: Like, that doesn't prove anything.

GOLDSTEIN: That's one of your charming, cocktail party conversational techniques.

KESTENBAUM: Yeah. I'm really fun. Please invite me.

GOLDSTEIN: So, all right, you don't think you can pick the next Warren Buffett. I don't think I can pick the next Warren Buffett. Also, one other person who doesn't think he can pick the next Warren Buffett - Warren Buffet.

KESTENBAUM: Warren Buffett.

GOLDSTEIN: Yes. In a public letter last year, Buffett described the instructions for the money he's leaving to his wife in his will. And he said to invest almost all of it in, quote, - ready? - "a very low-cost S&P 500 index fund."

KESTENBAUM: Lots of people are taking Warren Buffett's advice. There are now trillions of dollars in index funds. But there are many trillions more in funds where people are being paid to pick stocks. In other words, most people are still hoping they can be better than average.


HARLIN JAMES: (Singing) If the night is a victim and if all of the stars are a crime, oh...

KESTENBAUM: Jacob, I have four codas I want to do.

GOLDSTEIN: OK, I think I know one of them. Let me do the first one. Details about the bet - both sides actually put some money into a fund.

KESTENBAUM: They each put half.

GOLDSTEIN: They each put in half. The money will go to charity. The winner gets to decide which charity will get the money.

KESTENBAUM: Coda number two -- if you're wondering why the market is so hard to beat, please listen to episode 644 where we try to weigh a cow.

GOLDSTEIN: No idea what the next coda is.

KESTENBAUM: Coda number three is that hedge funds - and Ted Seides would point out - that they are not necessarily out there to beat the market. They are just trying to be a different kind of thing to invest in so that in years where the stock market goes down, they don't do as badly.

GOLDSTEIN: True. Although in this bet, they are clearly betting against the stock market. Coda number four.

KESTENBAUM: But yes, but I think it's a fair point. Coda number four - I just wanted to point out that even in John Bogle's family - John Bogle, the guy who invented the index fund - this is not resolved question. His son is a stockpicker.

GOLDSTEIN: The show today was produced by Nick Fountain. If you're looking for something else to listen to, check out the NPR Politics podcast.

KESTENBAUM: It's a podcast about politics. And if there were ever a year to listen to a podcast about politics, this is it. They have some good material.

GOLDSTEIN: You can get the NPR Politics podcast wherever you get your podcasts. I'm Jacob Goldstein.

KESTENBAUM: I'm David Kestenbaum. Thanks for listening.


JAMES: (Singing) Throw it to the breeze. Here's to life. You got to let it go. Done with make-believe, so won't you tell me just what's on your mind.

Copyright © 2016 NPR. All rights reserved. Visit our website terms of use and permissions pages at www.npr.org for further information.

NPR transcripts are created on a rush deadline by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.