Can active trading deliver higher returns than passive investing? Buffett’s bet with hedge funds provides great lessons.
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Throughout my career, I had many discussions with investors, and it turns out that many believe they can achieve higher returns with active trading than with passive investing. Trading is also much more exciting and fun, while passive investing is boring. But how hard it really is to outperform the market
In 2006, Warren Buffet — a legendary investor and one of the wealthiest people in the world, worth $88 billion — challenged the hedge fund industry. He publicly stated that over a period of ten years, an S&P Index Fund would outperform a collection of hedge funds and that he was willing to bet $500,000 on it. An index fund mirrors the performance of the market and usually charges only a small annual fee. Hedge funds, on the other hand, are the epitome of active trading. Their objective is to provide stable returns and outperform the market by utilizing various trading strategies. They usually charge very high fees for their wizardry: the standard is “2 and 20”, meaning 2% management fee and 20% performance fee (i.e., they take 20% of realized profits).