An overwhelming amount of evidence exists to clearly demonstrate that, in aggregate, active management is a loser’s game. And this is true regardless of whether markets are efficient or inefficient, or whether they are in a bull or bear phase.
But if the evidence doesn’t convince you, perhaps some of the market’s smartest and most-well-respected investors will. What’s more, you just may be surprised about who thinks what when it comes to indexing and passive management. Take the following quiz, and see if you can match the quote below to the person who said it.
Good luck!
1. “[Investors] think of the so-called professionals as having all the advantages. That is total crap. They’d be better off in an index fund.”
A) John Bogle, founder of the Vanguard Group B) Warren Buffett, chairman of Berkshire Hathaway C) Peter Lynch, former manager of Fidelity’s Magellan Fund D) Robert Arnott, founder of investment management firm Research Affiliates
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C. Despite being one of the most successful mutual fund managers of all time, Peter Lynch admitted investors are better off using index funds, not actively managed funds. Warren Buffett agrees. Here’s what he had to say on the subject: “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. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals. Seriously, costs matter.”
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2. “Compelling data show that nearly certain disappointment awaits the mutual-fund shareholder who hopes to generate market-beating returns.”
A) David Swensen, chief investment officer of the Yale Endowment Fund B) Gus Sauter, former chief investment officer of the Vanguard Group C) Gene Fama, professor of finance at the University of Chicago D) Peter Bernstein, author of “Against the Gods”
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A. David Swensen wrote this in his book, “Unconventional Success.” He adds: “Overwhelmingly, mutual funds extract enormous sums from investors in exchange for providing a shocking disservice. That is, mutual funds charge their investors big fees and usually fail to deliver returns that beat the market.”
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3. “By periodically investing in an index fund the know-nothing investor can actually outperform most investment professionals.”
A) John Bogle, founder of the Vanguard Group B) Warren Buffett, chairman of Berkshire Hathaway C) Rick Ferri, author of “All About Index Funds” D) Jason Zweig, personal finance columnist for The Wall Street Journal
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B. Warren Buffett offered this sage advice in the 1993 Berkshire Hathaway Annual Report.
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4. “For professional investors like myself, a sense of humor is essential. We are very aware that we are competing not only against the market averages but also against one another. It’s an intense rivalry. We are each claiming that, ‘The stocks in my fund today will perform better than what you own in your fund.’ That implies we think we can predict the future, which is the occupation of charlatans. If you believe you or anyone else has a system that can predict the future of the stock market, the joke is on you.”
A) William Miller, former manager of Legg Mason Capital Management Value Trust B) Julian Robertson, founder and former manager of Tiger Management Group C) Peter Lynch, former manager of Fidelity’s Magellan Fund D) Ralph Wanger, former manager of the Acorn Fund
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D. Ralph Wanger was the highly regarded lead manager of the Acorn Fund from its inception in 1977 until his retirement in 2003. During this period, the fund returned 16.3 percent per year versus just 12.1 percent for the S&P 500 Index. Wanger is also the author of the book “A Zebra in Lion Country.” It was in his book that he made this startling admission.
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5. “Despite volumes of research attesting to the meaninglessness of past returns, most investors and personal finance magazines seek tomorrow’s winners among yesterday’s. Forget it.”
A) Kenneth French, professor of finance at Dartmouth College B) Fortune magazine C) John Bogle, founder of the Vanguard Group D) John Rekenthaler, vice president of Research at Morningstar
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B. Fortune made this admission in its March 15, 1999 issue. Of course, like most financial publications, Fortune regularly anoints the latest hot fund manager as a “guru” and touts the latest funds you just have to own.
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6. “Prostitution may be the world’s oldest profession, but selling risky investments is surely the most lucrative.”
A) Rex Sinquefield, former co-chairman of Dimensional Fund Advisors B) William Bernstein, author of “The Four Pillars of Investing” C) Laurence Kotlikoff, professor of economics at Boston University D) Michael Lewis, author of “The Big Short”
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C. Laurence Kotlikoff was a senior economist for the president’s Council of Economic Advisers. Together with personal financial columnist Scott Burns, he co-authored “Spend ‘Til the End,” in which this observation was made.
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7. “I’m the lousiest market timer in the history of the world.”
A) Charles Clough, former chief global investment strategist for Merrill Lynch B) Peter Lynch, former manager of Fidelity’s Magellan Fund C) Benjamin Graham, legendary investor D) Sir John Templeton, legendary investor
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A. This statement is a pretty amazing admission, given Charles Clough’s former role.
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8. “I have not looked at any of my holdings and don’t intend to. I don’t want to be tempted to jump because I think I’d be more likely to jump in the wrong direction than the right one. My advice has always been to choose a sensible diversified portfolio and stop reading the financial pages. I recommend the sports section.”
A) Meir Statman, professor at the University of Santa Clara B) Weston Wellington, Vice President at Dimensional Fund Advisors C) John Bogle, founder of the Vanguard Group D) Richard Thaler, professor of behavioral finance at the University of Chicago
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D. But Warren Buffett offered the same advice when he stated: “Inactivity strikes us as intelligent behavior.”
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9. “It’s too hard to pick managers. These great mythic figures don’t walk the earth.”
A) Don Phillips, director of Morningstar B) William Bernstein, author of “The Four Pillars of Investing” C) David Booth, chairman and co-CEO of Dimensional Fund Advisors D) Gary Belsky, author of “Why Smart People Make Big Money Mistakes”
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A. Don Phillips made this admission in an interview with The Wall Street Journal.
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10. “Capital gains taxes, when combined with transactions costs and fees, make indexing profoundly advantaged.”
A) John Bogle, founder of the Vanguard Group B) Ted Aronson, founder of AJO Partners C) Charles Ellis, author of “Winning the Loser’s Game” D) John Rekenthaler, Vice President of Research at Morningstar
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B. Ted Aronson admitted this in an interview where he stated: “None of my clients are taxable. Because, once you introduce taxes … active management probably has an insurmountable hurdle. We have been asked to run taxable money—and declined. The costs of our active strategies are high enough without paying Uncle Sam.”
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Count up your correct answers to see how you did. Hopefully each of these quotes will provide some insight into the perils of active management—from leaders in the field no less—and the benefits of accepting market returns in the asset classes, or factors, in which you choose to invest.
This commentary originally appeared March 6, 2015 on EFT.com.
About the Author
Larry Swedroe, Director of Research The BAM ALLIANCE
Previously, Larry was vice chairman of Prudential Home Mortgage. Larry holds an MBA in finance and investment from NYU, and a bachelor’s degree in finance from Baruch College.
To help inform investors about the evidence-based investing approach, he was among the first authors to publish a book that explained evidence-based investing in layman’s terms — The Only Guide to a Winning Investment Strategy You’ll Ever Need. He has authored six more books:
What Wall Street Doesn’t Want You to Know (2001) Rational Investing in Irrational Times (2002) The Successful Investor Today (2003) Wise Investing Made Simple (2007) Wise Investing Made Simpler (2010) The Quest for Alpha (2011)
He also co-authored four books: The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006), The Only Guide to Alternative Investments You’ll Ever Need (2008), The Only Guide You’ll Ever Need for the Right Financial Plan (2010) and Investment Mistakes Even Smart Investors Make and How to Avoid Them (2012). Larry also writes blogs for CBSNews.com, Seeking Alpha, and Index Investor Corner on ETF.com.
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of JDH Wealth Management. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2015, JDH Wealth Management
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