Retirement Buzzer Beater: Savings Accounts vs. Actively Managed Hedge Funds vs. S&P 500 Index Funds
Your retirement shot clock is ticking down and it's time to pass your “ball” to your best shooter. Who do you trust to bring it home like Michael Jordan vs. the Cleveland Cavaliers in 1989?
Savings Account
Average Hedge Fund Manager
S&P 500 Index Fund
If you dished it to your savings account,
I’m sorry to tell you, but your investment will likely reduce in value due to inflation. While you will not have actually lost any money, your net worth will potentially be less because inflation will have eaten into your purchasing power. If you are wondering if earning interest will help, the answer is yes, but your savings account may not grow quick enough to offset your loss from inflation completely. Still think you picked your best shooter? Well, see it this way, if you had put $10,000 in your savings 30 years ago, it would now be worth a whopping $4,500... In the famous words of Randy Jackson, “it’s definitely a no for me, dawg.” - NEXT!
Maybe you “played it safe” and did what you believed to be a slick behind-the-back pass to the average head fund manager.
Well, did you know that those same managers are paid a lot of money to generate returns that beat the S&P 500, but on average less than half do so? In addition, they collect fees from you every year regardless of the fund's performance. So you may have just handed your retirement over to someone that aims for the rim, but often sees the thought to be game winning ball end up short and in the bleachers. Oh, not to mention they will likely still walk off the court smiling because they still got paid, even though you lost. You aren’t alone here, I too used to think this was my best option.
Finally and certainly not least, maybe you had the courage to pass it to the underrated and often forgotten individual in the corner, that you know is lights out and the most consistent sharp shooter on the team.
Yes, I’m talking about an S&P 500 Index fund. For those who do not know, an index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index. They often have lower expenses and fees than actively managed funds and provide better returns over the long term. Don’t believe me? Below are two options in my actual 401k — compare their returns and expense ratios yourself!
Are you curious to know whom else believes in this strategy?
Well, look no further than Warren Buffet (a.k.a. Warren the Great a.k.a. the sixth richest person in the world).
In 2007/2008, Warren Buffet bet $500,000 that a low-cost Vanguard S&P 500 index fund would outperform a set group of at least five actively managed hedge funds over 10 years.
Results:
As seen above, the S&P 500 won by a landslide, and the earnings, which were put into zero-coupon Treasury bonds, grew to $1 million and was awarded to Warren Buffet, who then donated it to Girls, Inc. in Omaha, Nebraska.
It is also good to note that in 2014, Warren Buffet revealed an excerpt from his will that ordered his children’s inheritance to be invested in an S&P 500 index fund because the “long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals who employ high-fee managers.”
All that being said, a $10,000 investment starting in 2000 and ending in 2020 would have grown to $31,200 — that’s with the awful terrorist attack(s) in 2001 and the 2008 financial crisis!
Links to resources:
Warren Buffett Just Won a 10-Year Million-Dollar Bet: Here's Why (The Motley Fool - January 2018)
The Impact of Inflation on Your Savings & Investments (Western & Southern Financial Group - March 2020)
Buffett's Bet with the Hedge Funds: And the Winner Is … (Investopedia)
The World’s Real-Time Billionaires (Forbes)
Guide to Index Fund Investing (Investopedia)
Put $10,000 in the S&P 500 ETF and Wait 20 Years (Investopedia)