Would Buffett’s index tracking wager have paid off for income-seekers?

Great excitement surrounds the publication of Warren Buffett’s annual letter to shareholders of his investment company, Berkshire Hathaway. Part of his appeal is his unique brand of folksy wisdom that makes becoming one of the world’s richest men appear so easy that anyone could do it.

This year’s letter includes the results of a wager Buffett made in 2007, that a low-cost US stockmarket tracker fund would outperform a group of hedge funds chosen by an experienced industry insider.

By now I’m sure you have heard the outcome – he won the bet, further burnishing his legendary status. The S&P 500 tracker fund rose 125% over the 10 years to the end of 2017 while the best hedge fund chosen gained 88% and the worst just 2.8%.

It’s an encouraging lesson that you don’t have to be a rocket scientist or genius stockpicker to accumulate wealth. In fact, for anyone making regular extra contributions, as they might into a pension, the tracker fund results would have been even more compelling.

However, not everybody is an accumulator – retired people often need to draw regular income from their investments to pay the bills. Would the tracker investment seem such a no-brainer for them?

Let’s assume income withdrawals of 5% of the fund value at the end of each year, which is not too unreasonable considering level annuity rates at that time for a 65-year-old man were 7.5% and heading higher.

In this scenario, the £100 original investment would have grown to £135 over the 10 years. Given inflation of 32% over the same time, that means the fund would have maintained its purchasing power – a feat in itself – with just a smidgeon of growth too.

However, that reasonable end result masks a rocky ride. 2008 had many of the features of economic Armageddon. After a year the original £100 would have been worth only £63 before taking income. Anyone brave enough to sit tight and enjoy the 26% rebound in 2009 would still have had to wait four more years for the fund value to recover to its starting point and to 2017 to see a gain after inflation.

The income performance was pretty patchy too. An income seeker investing £100 may have expected £5 or more from their 5 per cenet withdrawal. Instead they would have received £3.15 after year one and less than the £5 anticipated in every year up to 2013. Overall they would have received £50.15 over the 10-year period, including £7.12 at the end of 2017.

Would a pensioner consider it a successful experiment? On the positive side, after 10 years of withdrawals and nine years of rising markets, they will still have control of an amount equal to their original fund, and the income flow is looking up. But it’s probably fair to say that an annuity would have delivered greater peace of mind during the dark times, as well as nearly 50% more cash to spend without worrying where the next income cheque was coming from.

Reviewing his 53 years of investment performance, Buffett mulls on the possibility of future market slumps: “No one can tell you when these will happen,” he writes, including his own emphasis. “The light can at any time go from green to red without pausing at yellow.”

Of course, with little debt and heaps of cash, Buffett looks forward to such “extraordinary opportunities”, although you wouldn’t call him gung ho. “But Charlie [Munger, his right hand man] and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.”

Buffett’s magic is to make investing look simple. Divesting is far more of a challenge.

Stephen Lowe is group communications director at Just Group.

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

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