Back in 2007, Warren Buffett bet $1 million that an unmanaged, low-fee index fund would beat the returns of a heavily managed hedge fund, Protégé Partners, over ten years. He won decisively: through the end of 2015, Protégé’s picks had returned about 21.9%, while Buffett’s index fund had returned 65.7%. The lesson Buffett wanted people to take away was narrow: hedge fund fees of 2% to 3% often aren’t justified by the returns. But the bet got stretched into a broader myth, that everyone should just buy index funds and stop thinking about it. For higher-net-worth investors, that’s not quite right.
Markets Are Efficient, Except When They Aren’t
Over long periods, markets tend to price assets appropriately. In the short term, they don’t. Investors panic, chase hype, and misprice assets based on emotion rather than fundamentals, which is exactly the environment that creates opportunities for careful stock selection. Buffett himself has never been a fan of the efficient market hypothesis, the idea that stock prices always reflect all available information. In a well-known 1984 speech at Columbia, he pointed to himself and other value investors who had consistently beaten index returns by finding mispriced companies.
Why Value Stocks Tend to Win Over Time
A value stock trades at a discount to peers despite having similar fundamentals, usually because of a temporary setback: a missed earnings estimate, a product that flopped, a CEO departure. A growth stock, by contrast, is priced for above-average future growth, which means the price already assumes good news keeps happening. Historical data backs value: according to Brandes Investment Partners, the 10% of U.S. stocks with the lowest price-to-earnings ratios outperformed the highest-P/E 10% by 9% annually from 1968 to 2010. Hewlett-Packard’s 72% stock jump between summer 2012 and summer 2013, after being written off as a value pick trading at a decade low, is a concrete example of that pattern playing out.
Individual Stocks Beat Funds on Tax Efficiency
Mutual funds create a hidden tax problem for investors holding them outside a retirement account: the fund manager’s trading inside the fund can generate a taxable capital gains distribution even if you personally never sold a share and even if your own position lost money. Individual stocks avoid that entirely, and they let you tax-loss harvest directly, selling a losing position to offset a gain elsewhere in your portfolio, then reinvesting the proceeds.
Dividends and Lower Volatility
From 1926 to 2015, the S&P 500 returned 9.8% annualized, and 40% of that return came from dividends. Companies that consistently grow their dividend have historically outperformed both companies that merely maintain their dividend and companies that pay none at all, while also showing meaningfully lower volatility. That combination, better returns with a smaller maximum drawdown, is exactly what higher-net-worth investors taking regular distributions from a portfolio need: a 50% market crash forces a much larger percentage withdrawal from a shrunken portfolio if you’re pulling a fixed dollar amount out every year.
None of this argues for abandoning index funds and ETFs entirely. The point is that individual stocks, dividend growth strategies, and passive index exposure all play different roles, and for investors with meaningful taxable assets, the mix matters more than picking one approach and ignoring the rest.
Educational only, not tax, legal, or investment advice. Check primary sources and speak with a qualified professional before making financial decisions.
