At 82 years young, Burt Malkiel has lived through every conceivable market cycle and new marketing fad. When he wrote “A Random Walk Down Wall Street in 1973”, he had no idea it would become one of the classic investment books in history.
The core thesis of his book is that market timing is a loser’s game. We will sit down and you’ll hear from Burt but for now what you need to know is that he was the first guy to come up with the rationale of an “Index fund”, which again does not to try to beat the market but simply “mimics,” or matches, the market.
Among investors, this strategy is called indexing or passive investing. This style is contrary to active investing, in which you pay a mutual fund manager to actively make choices about which stocks to buy or sell.
The manager is trading stocks—“actively” working with hopes of beating the market.
Jack Bogle, founder of the behemoth Vanguard, subsequently bet the future direction of his company on this idea by creating the first index fund.
Why? Vanguard has become the largest index mutual fund manager in the world. His best single rant: “maximum diversification, minimal cost, and maximum tax efficiency, low turnover [trading], and low turnover cost, and no sales loads.” How’s that for an elevator pitch!
Now, you might be thinking that there must be some people who can beat the market. Why else would there be $13 trillion in actively managed mutual funds in United States alone?
Mutual fund managers certainly have streaks where they do, in fact, beat the market.
The question is whether or not they can sustain that advantage over time. But as Jack Bogle said, it all comes down to “marketing!” It’s our human nature to strive to be faster, better, smarter than the next guy.
And thus, selling a hot fund is not difficult to do. It sells itself. And when it inevitably turns cold, there will be another hot one ready to serve up.
An incredible 96% of actively managed mutual funds fail to beat the market over any sustained period of time!
So let’s be clear. When we say “beat the market” as a whole, we are generally referring to a stock index.
As for the 4% that do beat the market, they aren’t the same 4% the next time around.
“ Jack Bogle said, if you pack 1,024 gorillas into a gymnasium, and teach them each to flip a coin, one of them will flip heads ten times in a row. Most would call that luck, but when that happens in the fund business we call him a genius! ”
And what are the odds it’s the same gorilla after the next ten flips?
To quote a study from Dimensional Fund Advisors, run by 2013 Nobel Prize–winning economist Eugene Fama, “So who still believes markets don’t work?
Apparently it is only the North Koreans, the Cubans, and the active managers.”
This part of the book is where anyone reading who works in the financial services industry will either nod in agreement or figure out which door they will prop open with these 600 pages! Some will even be gathering the troops to mount an attack. It’s a polarizing issue, without a doubt.
We all want to believe that by hiring the smartest and most talented mutual fund manager, we will achieve financial freedom more quickly.
After all, who doesn’t want a shortcut up the mountain? And here is the crazy thing: As much as everyone is entitled to his own opinion, nobody is entitled to his own facts!
Sure, some mutual fund managers will say, “We may not outperform on the upside but when the market goes down, we can take active measures to protect you so you won’t lose as much.” That might be comforting if it were true.
The goal in investing is to get the maximum net return for a given amount of risk (and, ideally, the lowest cost).
So let’s see how the fund managers did when the market was down. And 2008 is as good a place to start as any.
Between 2008 and early 2009, the market had its worst one-year slide since the Great Depression (51% from top to bottom, to be exact).
The managers had plenty of time to make “defensive” moves. Maybe when the market was down 15%, or 25%, or 35%, they would have taken “appropriate measures.” Once again, the facts speak for themselves.
Whether the fund manager was trying to beat the S&P Growth Index, Sensex or Nifty made up of companies such as Microsoft, Google, HDFC and Reliance or trying to beat the S&P Small Cap Index, made up of smaller companies such as Yelp, once again, the stock pickers fell short.
According to a 2012 report titled S&P Indices Versus Active Funds Scorecard—SPIVA, for short—the S&P 500 Growth Index outperformed 89.9% of large-cap growth mutual funds, while the S&P 500 Small Cap 600 Growth Index outperformed 95.5% of small-cap growth managers.
Now, having made it clear that almost nobody beats the market over time, I will give one caveat.
There is a tiny group of hedge fund managers who do the seemingly impossible by beating the market consistently.
But they are the “unicorns,” the rarest of the rare. The “magicians.” The “market wizards.”
Like David Einhorn of Greenlight Capital, who is up 2,287% (no, that’s not a typo!) since launching his fund in 1996 and has only one negative year on his track record. But unfortunately, it doesn’t do the average investor any good to know they are out there, because their doors are closed to retail investors.
Ray Dalio’s fund, Bridgewater, hasn’t accepted new investors in over ten years, but when it did, it required a minimum investment of $100 million and $5 billion in investable assets. Gulp. Paul Tudor Jones, who hasn’t lost money in over 28 years, called his investors recently and sent back $2 billion. When a hedge fund gets too big, it’s harder to get in and get out of the market—harder to buy and sell its investments quickly and easily. And being slow means lower returns.