Am I Smart Enough to Beat the Market Indexes?

I’ve devoted all sorts of time on this site to explaining why buying actively managed mutual funds is a fool’s errand.

After all expenses (most of which are hidden) and after taxes and survivorship bias, the odds of matching the returns of a low cost index fund are far lower than the odds of walking into Las Vegas with $10,000, gambling for a full week, and coming home with more than $10,000.  If you think those odds are even decent, think about why casinos are in business.  Trust me, you’d make more money owning the casino than by gambling in it.

So where do I put my personal money? 

Despite also writing about my investment club, and how we have beaten the market index (S&P 500) for a decade, I still have roughly 70% of my own personal money in indexes.

I own short term Canadian and International government bond indexes (symbols  XSB.TO and IGOV). 

And I own a Vanguard first world international index (symbol VEA).  For reasons describing why I don’t own emerging market stocks or indexes, please check out my post, “Why I don’t invest in India or China”.

With my individual stock picks (which constitute roughly 30% of my invested assets) I own a variety of U.S. stocks.  For ten years, I have beaten the S&P 500 quite handily.

 So why, then, do I not have all of my stock market money in individual stocks instead of indexes? 

The answer is simple:  the odds of me beating the market indexes going forward are slim.  I don’t believe, 100%, that I can beat the markets going forward.  And this is why 70% of my money is indexed.

It’s not that the market road ahead is going to make it harder in the future to replicate my past performance.  I’ve been very lucky in the past, and I’ve avoided doing silly things.  I’ve kept my investment costs extraordinarily low—because I don’t trade stocks, I buy them and hold them.  I also don’t have to pay mutual fund fees, which has helped me as well.

And as much as I’d like to think that I’m a market wizard, the reality of history brings me back to earth.  There have been fund managers who have built God-like reputations for themselves (like Bill Miller, who beat the market for 15 straight years) but ultimately, the market’s odds slap these guys back to reality.

I’m not smarter than Bill Miller.  And I can tell you that despite his extraordinary 15 year streak, an investment in a simple S&P 500 index would have beaten him after all taxes and expenses.   It’s very humbling.

I’ve never bought a lottery ticket in my life, and I haven’t wasted so much as a dime at a casino, yet I have immensely enjoyed giving the indexes a beating over the past decade.  That said, I keep track of every dollar I have invested.  And if the market indexes catch me, I’m going to sell the stocks that I own, and run with an investment portfolio that is 100% indexes.

I may not be a genius, but I’m smart enough to understand odds.

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