Getting Paid To Breathe

Alex has been logging some serious time behind the wheel lately. We've been doing the drive to and from school together, which means navigating Fruitville Road traffic, changing lanes, merging onto the highway, the kind of driving that would make a lot of new drivers nervous. He's handling real traffic like it's no big deal. Pretty proud of this kid.

Chris is getting ready to head to Southeastern University in Lakeland this fall, and things are moving fast. We're in the middle of arranging dorms and picking classes, which I have to say I'm enjoying for one specific reason: the school won't let me do anything. He has to handle it all himself. And honestly? He's doing great. He seems genuinely excited, and he has already received a congratulatory box from the school packed with Southeastern gear and goodies. It's fun to watch. Once he's gone, Dalanee and I will be down to two kids at home. Hard to believe.

And, yes, we are trying to get him to shave his mustache. 

Have you ever heard the term "hedge fund"? Maybe you have, maybe you haven't. Either way, it sounds mysterious and exclusive. Let's pull back the curtain on why I call these investments garbage.

So what is a hedge fund?

Think of it as a mutual fund's fancier, more expensive cousin. A few key differences:

•You have to be an "accredited investor," meaning you're worth more than $1 million.
•They don't have to be nearly as transparent as a mutual fund. Less reporting, less accountability.
•They invest in non-traditional assets: options, derivatives, currencies, venture capital, private real estate, art, and other things that are hard to value.
•They aim to be "non-correlated" with the stock market, meaning they might not drop as much when the market falls, or could even post a gain.
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That all sounds pretty impressive. And frankly, it sounds a little unfair that only wealthy people get access to these exclusive investments, right?

Not so fast.

How hedge fund managers get paid
Most hedge funds use what's called a "2 and 20" model. They take 2% of your account value every year, plus 20% of any profits. Those fees are extraordinarily high compared to a traditional mutual fund. But if they're making you more money, who cares about the fees?

Here's the problem. They're not making you more money.

Warren Buffett's famous bet
In 2008, Warren Buffett challenged several hedge fund managers to a ten-year competition. His pick: a simple, boring Vanguard S&P 500 index fund. Their pick: a combined average of five major hedge funds. The stakes were one million dollars.

After ten years, the hedge funds posted a seemingly respectable 36% return. They even showed slightly less volatility than the overall market along the way.
Warren Buffett's boring index fund? 125%.

It wasn't even close. Two things killed the hedge funds: fees and reliance on exotic investments that proved less durable over time.

Why do people still fall for it?
Hedge funds prey on the pride and greed of wealthy people. They are marketed as exclusive, sophisticated vehicles that only the truly successful deserve access to. Go look at some of their websites. You'd think you were browsing the Ritz-Carlton or Rolls-Royce.

There are many very rich hedge fund managers out there. One of them owns the Boston Red Sox. Another bought the New York Mets. I am completely serious.

Every time I see one of these managers interviewed about losing Warren Buffett's bet, they say exactly the same thing: "That was then. This is now. This time is different."

It's not.

And here's what really gets me. They didn't actually do anything. They didn't build a product. They didn't create a valuable service. They sat in their New York offices, watched sports, and moved money around. Yet they're treated like financial royalty.

As Warren Buffett once said: "It's like they're getting paid to breathe."

Be Blessed,

Dave