Are You Measuring Your Investments Properly?

This article first appeared in the Manila Bulletin. You can read the original here: https://mb.com.ph/2025/1/1/don-t-settle-for-average-returns

In 2008, Warren Buffett made an interesting bet.

He bet 1 million dollars that a hedge fund would be unable to beat a basic index fund over a decade. Hedge fund manager Ted Seides accepted his challenge and made a portfolio of 5 hedge funds for the bet.

The bet started in favor of Ted. When the market crashed in 2008, Warren Buffett's index fund lost 37% of its value, while the hedge funds only lost 23.9%. Markets would eventually recover with both portfolios booking gains.

After a decade, Ted ended with a final result of +36.3%.

I’ll get to Mr. Buffett’s results later, but first, a question:

Is +36.3% a good or bad result?

People often say: "As long as it beats the bank, I'll be happy." By their standards, 36.3% should be fantastic. After all, bank account interest rates are so low that you'd be lucky to hit 8% in a decade. That must mean the hedge fund did great, right?

But if we look at it from another angle, a different story emerges.

While the hedge fund ended with a nice +36.3%, Warren Buffett ended the bet with a gain of +125.8%, using only your garden-variety, zero-effort, low-cost index fund.

An index fund represents your average stock market investment. Index funds are usually composed of the largest companies in a given market segment, making them great representatives of a market as a whole. In the Philippines, the Philippine Stock Exchange Index (PSEi) is composed of recognizable companies like SM, Ayala, and Meralco.

Given that the hedge fund manager lost by 89.5% to Buffett's index fund – which is a benchmark of average performance – we can conclude that the +36.3% was a bad result relative to the average.

But so what? Why does that matter when I’m making more than the bank either way?

Because index funds are always an option for investment. As stewards of our hard-earned money, we must not be satisfied with passable investments when better options are available. If you can’t beat the index, buy an index fund!

Bank accounts are not comparable to stock market investments because they have different goals and risk characteristics. The purpose of a bank account is stability. With bank accounts, you can expect your cash balance to be stable and liquid as long as the bank is standing.

The purpose of a stock market investment, on the other hand, is growth. With stocks, you're putting your capital at risk, and you can either gain or lose money depending on the companies you invest in.

Comparing stocks to bank accounts is like comparing driving and walking.

When asked: “Do they drive fast?", it would be strange to answer: "Yes, they are incredibly fast because they drove faster than I could walk!"

And yet, when asked: "Is that stock a good investment?" many would say: "Yes! This stock is great because it made more than my bank account!"

To judge whether a driver is fast, we must compare his speed to the average driver. And to judge whether a stock market portfolio is performing well, we must compare it to the average stock investment by checking its relevant stock market index.

This is important because when we see that our results are sub-par relative to other securities in our chosen asset class, we can reposition and invest in superior assets, improving our returns over the long run.

Compare apples to apples, and compare stocks to stocks.

While few people could win a bet against Warren Buffett, everyone can always increase their odds of making money by measuring their investments using the right benchmarks.

You might feel good using stagnant bank accounts as a benchmark for investment results since you’re doing great against such a low bar. However, this inaccurate information is probably handicapping your decision-making.

To improve as an investor in 2025, start with an honest assessment of your results. The road to improvement begins with setting the right benchmarks, and for stock market investors, there is no better benchmark than an index!