Diversification, index funds, low expenses, tax efficiency…they’re all so boring. Isn’t there a better way? Can’t I use research, insight, intuition, and intelligence to beat the market? Who actually believes this boring stuff anyway?
The guy in the fancy suit on TV doesn’t seem to believe it. The writers of financial publications are constantly telling us which funds are going to be hot this year, or month, or week. There are millions of investment ideas on the Internet which include all kinds of fancy charts and systems and fantastic results. It doesn’t seem like anyone believes in index fund investing and boring ideas like diversification. Everyone seems to have some secret for how they’re going to beat the market, so why shouldn’t you as well?!
Look Who’s Talking
Before you begin to think that index fund investing is only for schmucks, let’s take a minute to look at who supports these various investment ideals. First, the side of active management, market timing, and various other strategies to “beat the market”:
- Stock Brokers and Investment Managers – For a fee or commission (or both!), these guys will help you pick the “right” funds or stocks at the “right” time so you get nice returns every single year. They’ll even send you a gift card or free sports tickets every once in a while just to show you how much they appreciate you!
- Some Mutual Fund Companies – Sure they charge higher expenses than Vanguard does, but they’re giving you access to the “best” mutual fund managers in the world. With their team of 5,208 researchers, they’re bound to uncover information that will give them the ability to beat the market. And don’t forget about those mutual fund companies with a long family background of managers. All that experience is sure to come in handy.
- Market Timing & Stock Picking Newsletters – In the do-it-yourself mood? Just subscribe to one of the many market timing or stock picking newsletters, and Slick Sam will tell you exactly when you should get in and out of which stocks. He might even set you up with a service where his recommendations can be traded automatically in your brokerage account. You don’t even have to do a thing and you’ll make a 389% return in a matter of months!
- The Investment and Financial Media – Dow drops 600 points! Stock futures headed down this morning because the commissioner has a cold! Is your portfolio safe? Ah, the financial media. They constantly keep us up-to-date on the latest market news and even give us advice about the next top mutual funds. All we have to do is keep watching their shows or buying their newspapers and magazines and we can reap the benefits of all their knowledge.
Do you see what I see? Every single one of these players has a vested interest in selling you something—especially in selling it to you again, and again, and again. My father once told me everyone has something to sell, and he’s right. Even the most objective advisor has to get paid somehow. But we have to look carefully at the seller’s motives before we buy—more so when the product is financial advice.
Now what about the side of index fund investing, diversification, low expenses, and tax efficiency? Let’s look at the supporters of these really boring investment ideas:
- Dr. Harry Markowitz – A Nobel Laureate in Economics for his pioneering work in the theory of financial economics. He helped develop Modern Portfolio Theory, which looks at the effects of asset risk, correlation, and diversification on investment returns.
- Dr. William F. Sharpe – Also a Nobel Laureate in Economics for his pioneering work in the theory of financial economics. His work revolved around the ideas of the risk and return model and the Capital Asset Pricing Model, which is part of Modern Portfolio Theory.
- Dr. Paul Samuelson – Another Nobel Laureate in Economics. His findings can be summarized as: market prices are the best estimates of value, price changes follow random patterns, and future stock prices are unpredictable.
- Dr. Eugene Fama – A professor in economics and finance at the University of Chicago. His research covers the randomness and unpredictability of stock market prices, the Efficient Market Hypothesis, and the Fama-French Three Factor Model, which explores the factors that explain an investment security’s return.
- Dr. Kenneth French – A professor of finance at the Tuck School of Business, Dartmouth College and former professor at MIT, the Yale School of Management, and the University of Chicago Graduate School of Business. He is most famous for his work with Dr. Eugene Fama on the Three Factor Model.
- Dr. Michael Jensen – Former professor at the University of Rochester and Harvard Business School. He found that only 26 of 115 actively managed mutual funds outperformed the market in his paper “The Performance of Mutual Funds in the Period 1945-1964”.
- Dr. Burton Malkiel – A professor of economics at Princeton University. He authored A Random Walk Down Wall Street
, which discusses the randomness of asset prices and the Efficient Market Hypothesis.
- John Bogle – Founder of The Vanguard Group
- Warren Buffet – Famous Investor. He recommends the average investor put his/her money in index funds.
What do you notice in this group? A few less marketing gurus and a few more academics? So whose advice are you going to trust for the future of your retirement? A fast-talking salesman who rushes through the facts, or a research-driven Nobel Laureate whose life has been dedicated to teaching?
I know who I’m going to listen to.
