In a previous post, I said that when it comes to investing, it is better to be lazy and cheap. More specifically, I argued that low cost index funds worked best and that you should have a “hands off” approach, ignoring the daily ups and downs of the stock market. Apparently, I didn’t go far enough and the best investing style is not “lazy and cheap” but “dead and forgetful.” You see, Fidelity did a study of their accounts to determine which investors performed the best. They found that the best performing accounts were from investors who were DEAD! In second place were investors who had FORGOTTEN they had accounts at Fidelity.
Basically, what this study from Fidelity teaches us is that we should keep our hands off investment accounts. The best investors did nothing and were of course not buying and selling. Too often, we think that we can time the market and buy and sell based on our analysis. We’re usually wrong. Not only are we wrong, but buying and selling stocks will often increase transaction costs and is tax inefficient.
Back before I was mainly an index investor, I also tried chasing stock returns. In the spring of 2000 while I was still in college, I remember there being this internet stock craze. Everyone was making money investing in dot-com companies. Everybody thought they were experts because every stock they bought went up. I begged my father to help me open a stock trading account and to help fund a portion of the account. Unfortunately for me, I decided to join this frenzy exactly when the dot-com bubble was about to burst and lost half of the money in that portfolio. My timing was impeccable.
In the mid 2000s, I purchased shares of stock in Starbucks. I mean Starbucks was everywhere, they were expanding quickly and everybody was buying Starbucks coffee. People would joke that you could open a Starbucks store within a Starbucks store and that store would still be profitable. After the 2008 recession, I sold all my shares of that stock at a loss when stocks were tanking and the economy was in the midst of a terrible recession, thinking that most people would shun $5 lattes with money being so tight. A bull market took place not too long after I sold the stock and the price of that stock has more than tripled from the price I sold it at. I could list many more instances where I lost money on buying individual stocks, but this post will run too long! I have also made money on individual stocks, but the losses outweigh my gains.
Maybe you’re just a horrible stock picker. Why don’t I just invest with the pros?
I’m sure many readers may be thinking that, and yes, it is very likely that I am bad at picking stocks. But is entrusting your money to the professionals the best alternative? In 2007, Warren Buffet made a bet of $1,000,000 with a collection of five hedge funds of funds chosen by New York-based Protégé Partners (the winner to donate the money to charity). Buffet bet that a low-fee index fund would beat the expensive hedge fund chosen by Protégé Partners over 10 years. Buffet invested in Vanguard’s 500 index fund which is an index fund that tracks the S&P 500. During the first four years of the bet, Buffet was trailing the hedge fund managers, but has since pulled ahead…WAY AHEAD. At the most recent Berkshire Hathaway shareholding meeting, he revealed that The group of hedge funds are up a cumulative 22 percent, while the S&P 500 has advanced close to 66 percent. He admitted that it wasn’t that the hedge fund managers were bad at picking stocks, it was just that the fees charged by the hedge fund are so high it drastically cuts into the returns. On the other hand, index funds, especially Vanguard’s index funds, have very low fees.
Let me share a few quotes from Buffet which I found fascinating:
“There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities.”
To really drive home his point, he referred to two investment managers employed by Berkshire Hathaway, and said that they each manage $9 billion of the company’s money, and that if they were compensated as much as hedge fund managers usually are, “they’d be getting $180 million each merely for breathing.”
Buffet also said:
“By periodically investing in an index fund… the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”
And one last quote, not from Buffett but from Princeton professor Burton Malkiel, who wrote in his book, A Random Walk Down Wall Street
“A blindfolded monkey throwing darts at a newspaper’s financial pages could beat most experts,”
Resources I recommend if you want to learn more about index investing:
Go to the Bogleheads wikipage which is investing advice inspired by Jack Bogle, creator of index funds. You can also check out the Bogleheads book:
I also recommend reading the Stock Series on Jim Collins’ personal finance blog or get his recently published book:
Are you afraid of investing in the stock market? Do you invest in index funds?
