“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees.” Warren Buffett
I recently quit Wall Street to help improve the investment industry. I do this through promoting intelligent investing in the form of low-cost indexing – google it, literally. Despite the emphasis Wall Street places on active investing strategies – stock picking, mutual funds, etc. – the arguments in favor of low-cost indexing have been made over and over and over. In fact, the arguments are so simple, factual, and conclusive that they can be condensed into a handful of bullets:
- Active investors fail: Stock picking is a fool’s errand and few mutual funds beat the market. Over the past 20 years, more than 80% of active investors FAILED to beat the market.
- Asset allocation matters: Active investors fail because gambling on the direction of the market (market timing) and stock picking (security selection) don’t work and don’t matter. Instead asset allocation accounts for 90% of the variability in returns.
- Distinguishing luck from skill: At the very least it’s difficult to distinguish luck from skill – see Fama and French. As Michael Lewis once wrote, “If millions of monkeys throw a bunch of darts at the Wall Street Journal, at least one monkey would pick a group of winning stocks.”
- Indexing is not dismissive of active managers: The market isn’t efficient and exceptional investors exist (e.g. Bruce Berkowitz). Unfortunately, it’s near impossible to systematically take advantage of inefficiency and to identify and bet on exceptional investors over the long-run (e.g. Bill Miller).
- The only predictor of investment performance is low-cost. It’s a fact. Even Morningstar concludes that low fees are a better predictor of performance than its own ratings.
- It’s not a “stock picker’s market”: Poor U.S. index performance over the last decade doesn’t imply it’s a stock picker’s market – the index still beat almost all stock pickers. Instead it implies that global asset allocation matters most.
Unfortunately, despite the conclusive arguments in their favor, index fund assets only account for around 5% of mutual fund assets. As Charles Ellis writes, “leaving almost 95 percent of assets in the hands of wealth-destroying active managers.” Why? Because we don’t invest; we gamble. Improving Wall Street and the investment industry means changing this. It’s that simple.
**ADDENDUM: To my readers in the mutual fund and alternative asset industries. I am a student of investing and am enamored by truly exceptional investors – the value school and men like David Einhorn and George Soros. My views on investing are factual and targeted at the aggregate, not you or your fund in particular. Please stop sending me emails telling me how wrong I am and telling me how much alpha you create. It’s not about you. It’s about your industry. I’m sure you are all above average.