While it happens less often than it used to, some people still roll their eyes when you suggest they simply start investing [1] via a mix of index funds and cash.
- Why aren’t you telling them about the special snazzy funds?
- Don’t you think they’re smart enough to pick up some hot stocks?
- Why are you telling them to buy a poor man’s fund?
Are you saying they’ve failed in life, and that they should start buying Value branded canned tomatoes and scavenging for the Financial Times out of the wastepaper bins?
Yes, I’ve had that when I’ve tried to explain the virtues of cheap passive investing [2].
Perhaps it’s my fault for talking about investing at parties.
Index funds: The experts’ choice
While newcomers still tend to believe they should invest their money with clever fund managers – and why wouldn’t they, given all the hype and the fact that index investing seems so wrong [3] – I’ve noticed more and more seasoned private investors are switching to index funds.
You might call it throwing in the towel, except that sounds so defeatist.
When you consider that active investing is a zero sum game [4] at best – and that high fees [5] make it a losing game for the vast majority of funds and their investors – switching to a passive approach is a smart and proactive decision, not a sign of retreat.
And plenty of investing experts feel the same way.
In fact, I’ve decided to start a roll call of the more surprising fans of index investing [6], which we will update as more are outed!
Warren Buffett
The greatest investor of all-time and one of history’s best stock pickers made waves in 2014 when Buffett revealed [7] he didn’t trust anyone to pick winning stocks after he was gone.
Instead, he said that on his passing, 90% of his wife’s estate would be put into a very low cost S&P 500 index tracker, and the rest held in cash.
Buffett said:
“I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers.”
It’s easy to create a similar passive Buffett portfolio [8] with off-the-shelf index funds in the UK.
David Swensen
As the manager of the prestigious Yale endowment fund, David Swensen beat the market by investing some of its billions into hedge funds, private equity, and real estate.
The best-selling books he wrote on the back of his market-beating returns – of which Unconventional Success [9]
Yet in that book and elsewhere, Swensen has repeatedly said most people (and most institutions) should stick to index funds [10].
Here’s an extract from a Bloomberg report [11] on a conference where Swensen spoke about the virtues of indexing:
David Swensen […] said investors who don’t have access to top managers are best off using index products.
“There are two sensible approaches to investing — either 100 percent active or 100 percent passive,” [he said].
Unless an investor has access to “incredibly high-qualified professionals,” they “should be 100 percent passive — that includes almost all individual investors and most institutional investors.”
Most active mutual funds are more interested in collecting fees than in boosting returns for investor, Swensen said.
You can get a passive approximation of Yale’s asset allocation via a similarly-weighted Ivy League ETF portfolio [12].
Just don’t expect it to achieve exactly what Swensen achieves [13].
Paul Wilmot
Oxford graduate Paul Wilmot is one of the leading experts in quantitative finance, a field which typically seeks to use applied mathematics to discover and profit from the financial markets, often through discovering pricing anomalies or other inefficiencies.
Wikipedia [14] tells me Wilmot also founded a hedge fund.
So I’m grateful to a Monevator reader, Robert, for highlighting the following quote from page 116 of Paul Wilmott Introduces Quantitative Finance [15]
“[The] vast majority of funds can’t even keep up with the market.
And statistically speaking, there are bound to be a few that beat the market, but only by chance.
Maybe one should invest in a fund that does the opposite of all other funds. Great idea except that the management fee and transaction costs probably mean that that would be a poor investment too.
This doesn’t prove that markets are random, but it’s sufficiently suggestive that most of my personal share exposure is via an index-tracker fund”.
I admire Wilmot’s candour here.
And as our reader Robert says: “Nice to get (yet more) vindication from someone who knows all about the most esoteric financial wizardry…”
Harry Markowitz
The Nobel prize winning economist Harry Markowitz is one of the father’s of modern portfolio theory, so it’s no surprise he likes index funds.
What is surprising though is that the the inventor of the Markowitz Efficient Frontier [16] of portfolio construction took a far simpler approach to creating his own simple portfolio [17], with Markowitz admitting [18]:
“I should have computed the historical co-variances of the asset classes and drawn an efficient frontier.
But I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it.
So I split my contributions 50/50 between stocks and bonds.”
Keeping things simple. That is a sign of real genius at work.
Lars Kroijer
While he’s hardly a household name, Lars Kroijer came to UK investors’ attention when he published Confessions of a Hedge Fund Manager [19]
It was a down-to-earth explanation of how he made a fortune in the active fund industry, with an inspiring ‘almost anyone can’ back story that has no doubt encouraged a few wannabes to try running a hedge fund [20] for themselves.
It was surprising then when just a couple of years later, Lars came out with Investing Demystified [21]
Lars writes:
“A one-time hedge fund manager writing about investments without edge may seem like a priest writing the guide to atheism.
In my view, however, it is not at all inconsistent.
The fact that some investors have an edge on the market does not mean that most people have it. Far from it.
‘Edge’ is confined to a very small minority of investors who typically have access to the best analysis, information, data, and other resources.
Most other investors simply can’t compete, and would be worse of trying.”
For more of Lars’ wisdom, read his articles on passive investing [22] on Monevator.
The dumb money isn’t so dumb
As you can see, deciding to go for index funds is not like shopping for tat in the pound stores.
Some of the smartest and/or richest brains in finance have looked at the evidence and decided passive index investing is the best way forward.
No wonder 98 cents in ever dollar that went into US mutual funds in 2013 went to Vanguard, which dominates the index investing space.
That momentum continued last year, too, with data showing US investors pulled $12.7 billion out of actively managed funds in 2014, while putting $244 billion into passive index funds.
In the UK too, the amount of money put into tracker funds hit a new high [23] in 2014.
Of course I expect the trendiness of index funds will hit a bump some day – most likely at the next bear market.
When that happens, different experts will come to the fore to say they told us so.
But remember while they laud the virtues of active management in the fearful aftermath of a crash that it’s impossible for actively invested money to on average outperform.
Unlike investing [24] in a broad stock market index, active investing is a zero sum game [4] – and that’s before high fees [25] make things worse.
For that reason, I expect this roll call of tracker fund-loving experts to grow over the long-term.
Got an idea for a surprising investing expert we should add to this list? Let us know in the comments below.