The best investment advice you’ll never get

I  stumbled across a fascinating history of indexing in San Francisco magazine.

It begins with an amazing discussion of how Google — pre IPO — prepared the soon to be wealthy troops with a crash course in investment theory (from Bill Sharpe, Burton Malkiel, and John Bogle) before the Wall Street sales crew came tromping thru Mountain View.

One by one, some of the most revered names in investment theory were brought in to school a class of brilliant engineers, programmers, and cybergeeks on the fine art of personal investing, something few of them had thought much about. First to arrive was Stanford University’s William (Bill) Sharpe, 1990 Nobel Laureate economist and professor emeritus of finance at the Graduate School of Business. Sharpe drew a large and enthusiastic audience, which he could have wowed with a PowerPoint presentation on his “gradient method for asset allocation optimization” or his “returns-based style analysis for evaluating the performance of investment funds.” But he spared the young geniuses all that complexity and offered a simple formula instead. “Don’t try to beat the market,” he said. Put your savings into some indexed mutual funds, which will make you just as much money (if not more) at much less cost by following the market’s natural ebb and flow, and get on with building Google.

The following week it was Burton Malkiel, formerly dean of the Yale School of Management and now a professor of economics at Princeton and author of the classic A Random Walk Down Wall Street. The book, which you’d be unlikely to find on any broker’s bookshelf, suggests that a “blindfolded monkey” will, in the long run, have as much luck picking a winning investment portfolio as a professional money manager. Malkiel’s advice to the Google folks was in lockstep with Sharpe’s. Don’t try to beat the market, he said, and don’t believe anyone who tells you they can—not a stock broker, a friend with a hot stock tip, or a financial magazine article touting the latest mutual fund. Seasoned investment professionals have been hearing this anti-industry advice, and the praises of indexing, for years. But to a class of 20-something quants who’d grown up listening to stories of tech stocks going through the roof and were eager to test their own ability to outpace the averages, the discouraging message came as a surprise. Still, they listened and pondered as they waited for the following week’s lesson from John Bogle.

“Saint Jack” is the living scourge of Wall Street. Though a self-described archcapitalist and lifelong Republican, on the subject of brokers and financial advisers he sounds more like a seasoned Marxist. “The modern American financial system,” Bogle says in his book The Battle for the Soul of Capitalism, “is undermining our highest social ideals, damaging investors’ trust in the markets, and robbing them of trillions.” But most of his animus in Mountain View was reserved for mutual funds, his own field of business, which he described as an industry organized around “salesmanship rather than stewardship,” which “places the interests of managers ahead of the interests of shareholders,” and is “the consummate example of capitalism gone awry.”

As you can imagine, after that brief education, things did not go as planned when Wall Street’s sharpest were paraded through. (heh heh)

The rest of the article is all about the quantitative underpinnings of indexing, and how the entire process came about.

As I’ve written here before, for many people, indexing is the way to go.

Indexing’s largest "flaw" (if you could call it that) comes about during bubble purchases and the ensuing long periods of flat performance. Think about the 1895-1905, the post-1929 crash era, or 1966-82 period. It seems that about every 3 decades or so, markets go thru these underperforming periods. Eventually, they mean revert, but during these decadelong lulls, Indexing requires extreme amounts of patience.   

Regardless, is a fascinating article well worth checking out . . .


The best investment advice you’ll never get   
Mark Dowie
San Francisco magazine, December 2006
(One Page Print Version)

Portfolio Theory and Capital Markets (Capital Asset Pricing Model)
William Sharpe

Investments (6th Edition)
William Sharpe

Investors and Markets: Portfolio Choices, Asset Prices, and Investment Advice
William Sharpe
Princeton Lectures in Finance

A Random Walk Down Wall Street
The Time-Tested Strategy for Successful Investing, (Ninth Edition)
Burton G. Malkiel

Investing: The First 50 Years (Hardcover)
John C. Bogle

Common Sense on Mutual Funds
New Imperatives for the Intelligent Investor (Paperback)
John C. Bogle

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What's been said:

Discussions found on the web:
  1. post pc commented on Dec 17

    Weights and measures
    A squabble erupts over how best to create a stockmarket index

    “…market-value indices will tend to overweight expensive stocks and underweight cheap ones.

    “That is where fundamental indices can have an advantage. If stocks are weighted by objective measures, enthusiasts argue, then the irrationality introduced by the price mechanism is eliminated. And the process does seem to generate better performance. A study* by Robert Arnott and John West of Research Affiliates, an investment-management firm, found that a fundamental-weighted index beat the S&P 500 by an average of two percentage points a year over the period 1962-2005. The results were similar with smaller American stocks and international ones…”

  2. wcw commented on Dec 17

    For almost all investors, I love indexing, even though I do not believe markets are efficient. The reason is simple: the labor market is a lot more inefficient. The likelihood of a 10% raise is pretty high if you work at it. The chances of 100 bps of alpha are a lot lower, and for most investors, worth a lot less than that raise.

    If you live off investments, that’s different, but most of us are not the Walton heirs.

  3. wcw commented on Dec 17

    Oh, and an aside: “fundamental indexing” is not indexing. It is a simple, mechanical value strategy. The value effect has been known forever, certainly since Fama and French (1992). Nothing wrong with a value strategy, but to call its product an “index” is an insult, and to pretend the value effect is news is ignorant.

    I like Arnott and Siegel (this strategy’s other big proponent) in general. They’re smart guys with good ideas. On this one, however, they’re the basest of self-interested marketers.

  4. Hans van Deun commented on Dec 17

    “Think about the 1895-1905, the post-1929 crash era, or 1966-82 period. It seems that about every 3 decades or so, markets go thru these underperforming periods.”

    2016: Dow 12,000?

    (then after the robot bubble of 2030, dow 100,000 for another 15 years)

  5. My1 commented on Dec 17

    I was actually thinking, will it be in 2030? After all, Bottoms in 1920, 50 and 80. Seems like a bottom will likely be in 2010-2015. That makes a top more predictable around 2035. Just having fun with the numbers.

  6. Roger Nusbaum commented on Dec 17

    Robot bubble? Great comment but also important. We know bubbles have happened in the past so it makes sense they will happen in the future. But as alluded to they don’t happen every few years. Bubbles are bubbles and the things in between might be better thought of as manias.

  7. Hans van Deun commented on Dec 17

    It could also be a space bubble. In any case, having lived through the previous one, we’ll know it when we see it (hopefully). And we’ll be ridiculed by a bunch of youngsters who believe this time’ll be different. Some boy geniuses will racket up 200% annual returns with their funds, while our time-tested investment strategies are out of favor.

    I can’t wait to say “told you so” after the bubble bursts, however.

  8. Gunther commented on Dec 17

    Can anyone who favours indexing please explain why very few people are over very long periods of time better than an index? Take Warren Buffet or George Soros for example. Both are in business long enough and have a track record of beating the market.
    For someone working all day this type of investing is for sure impossible because it takes by far too much time, so the indexing advice makes a lot of sense.
    If an investment professional sees indexing as the best way to invest, that sounds to me like an insider saying that his profession is unnecessary.

  9. dn commented on Dec 17

    I just don’t think this is such grand investment advice. The index investing being pitched by these people has two implications:

    1. entry point valuations don’t matter
    2. most people are not good at active investing; therefore you shouldn’t even try

    Well, valuations do matter very much to long term returns; see Grantham’s latest quarterly newsletter at for a great study that illustrates this (if you need a study to illustrate something so self-evident). And just because most people are bad at a given discipline doesn’t mean that everyone is destined to be bad at it.

    I agree there are plenty of ripoff artists in the financial industry, and I suppose index investing may be the least bad option for some people. But it doesn’t seem like great advice to make a blanket statement that people shouldn’t worry their pretty little heads about things like valuation.

    BTW I agree with wcw’s great observation about fundamental indexing. This is not what “index investing” means to the public at large, and it’s not what people like Malkiel have been pimping for decades…

  10. brion commented on Dec 17

    “One of the company’s founders, Patrick Geddes, aged 48, is a renegade from the top echelons of his field. For several years he served, first as director of quantitative research, then as CFO, at Morningstar, the nation’s leading company for researching and appraising mutual funds. But when he left, not only was he disenchanted with his own company’s corporate environment, he was also becoming uneasy with the moral underpinning of the entire industry. “Let’s be straight,” says Geddes in his soft-spoken but zealous way….

    (money quote) “Being unethical is a good precondition for success in the financial business.

    Exactly right. But then most people drawn to the industries of “Mammon” are intrinsically drawn are they not?
    (thou shalt have no other gods before Me)

  11. trader75 commented on Dec 17

    Investment Theory? Sounds more like Investment Nihilism.

    The index touts refuse to admit a basic truth, born out by statistical and historical evidence: there are investing and trading strategies that beat indexing like a red-headed stepchild. The problem is, these strategies will never be available to the masses… because you have to someone on the other side of the trade.

    The problem is the utopian / egalitarian fallacy that a methodology must work for everyone, regardless of how little knowledge they have or effort they put in.

    It is amusing to see how investment returns are implicitly treated as a fundamental right — something the common man deserves with no effort or interest required. Imagine if we had that attitude in other areas. No wonder the quality of passive investment strategies is on par with the public school system. It’s all founded on bullshit egalitarian fantasy.

  12. David commented on Dec 17

    I wrote a post yesterday on my site on MPT and cencentrated portfolios. MPT is misunderstood from the standpoint, Markowitz’s study was talking about diversification in a portfolio as it applies to risk and not securities. The minority of investors that understand this still concentrate investments in securities that tend to have lower downside volatility. These individuals tend to be our more wealthy investor. Additionally, due to compounding, ones returns are harmed the most when negative returns are incurred. I include six examples of portfolios that all have the same average return, but compounded returns vary. The portfolio that ourperforms is the one that had no negative returns during the performance measurement period.

  13. blam commented on Dec 17

    Passive index investing is a great way to go. However, there are times when investing in the stock market is not a good bet.

    Short term, the market can be a zero sum game and losses of 25 pct or more are pretty difficult to overcome, index investing or otherwise.

    The current market run up may or may not have staying power. I personally have so little confidence in the current market regulation, the Federal reserve, or the reported economic data, I hesitate to put a dime into this market.

  14. trader75 commented on Dec 17

    Also — think of how it would sound if the indexers’ logic were applied to the business world. Maybe something like this:

    – More than 90% of small businesses fail, therefore the few successes must be wholly based on luck.

    – If you think you’ve got a window of opportunity for starting a great business, forget it. Someone has already closed it. In fact, it was closed before you even spotted it. You must have been hallucinating.

    – Since even the most excellent and profitable companies typically don’t last more than a few decades, their success must be based on random chance.

    – Though a few serial entrepreneurs demonstrate a knack for business success over and over again… and even though many successful entrepreneurs demonstrate similar profiles and characteristics… none of that matters. They are all just lucky coin flippers. And by the way, a blind monkey could have built Microsoft.

    – It’s been said that things like knowledge, experience, perseverance and talent explain the ability for some to succeed in business while others fail. But since academic studies can’t measure those factors, it’s only rational to assume they don’t exist.

    – If the common man has no viable chance of starting his own business, there’s no reason to think YOU have a chance either. If Joe Blow from Kokomo has no shot, neither do you. (After all, it’s only fair.)

    – We may live in a Darwinian world, and you may have learned young that you can’t get something for nothing. But Darwin has nothing on wishful thinking, and by golly, if we want an egalitarian solution bad enough, we can wish it into existence. So what all you entrepreneurs need to do is stop trying to succeed on your own hook. Put your money into a blind pool instead, so it can be doled out among the existing businesses of the community. Really, you’ll be much better off that way. All the academic research says so. (And you’re a fool if you disagree.)

  15. fiat lux commented on Dec 17

    trader75 is missing the point. Of course some people can beat the market, just as some entrepreneurs can form successful businesses. The real issue is that, as with entrepreneurship, the number of people who think they can beat the market is much larger than the number of people who actually can beat the market. And your average Google employee may or may not have the financial chops needed to sniff out who’s really going to be able to handle their money well and who isn’t.

    Advising someone to play it safe with their newfound riches is hardly bad advice to give a newly-minted millionaire. It’s not like they can’t get more aggressive with their money later on, after they’ve adjusted to being rich and made the time to learn more about money management.

  16. Eclectic commented on Dec 17

    BR, it’s one of the most thought-provoking pieces you’ve posted. I read the whole thing and picked out this part to comment on:

    Here’s the author, Dowdie, quoting one of his subjects, Sharpe:

    Begin quoting…

    [“If you’d told me 35 years ago that indexing would one day represent 40 and 15 percent of investments, I would have asked you what you were smoking,” says the personable Sharpe with his characteristic chuckle. If everyone invested in index funds, he points out, the market itself would die a natural death. “We need active managers,” he says. “It’s buyers and sellers who keep prices moving, which is what drives the market. Index funds simply reflect what the market is doing.” He believes we’d even start to see a decline in market efficiency if index funds rose to 50 percent of total investments.]

    end quoting…

    Back to Eclectic:

    In one sense the buyers of indexed funds are no different than the buyers of managed funds; that is, during periods when both types of buyers have no reason to believe that (here I really mean no capacity to c-o-n-c-e-p-t-u-a-l-i-z-e) great harm could ever come to them during an unexpected market event, the buyers of the managed funds are content to remain as perpetual equity ‘holders’ via active management which they assume to be beneficial, and indexed fund buyers are even more determined to remain as perpetual ‘holders’ as well, just without active management. I mean here by using the term ‘holders’ that they are perpetual ‘buyers and holders’ but never sellers of equities.

    The two types of buyers would likely argue with each other that their own particular strategies are the most effective, but both types are determined holders nonetheless. They are brothers in the blood, only just cousins of a sort in that particular difference that is the core thesis of this article.

    The author makes a good case that the indexed fund buyers either have outperformed managed fund buyers outright, or received returns at least equal to managed fund returns without the expenses of the active management. I’m not writing this to argue the point.

    However, Sharpe seems to imply, with a smugness and a chuckle that’s in my opinion well deserved, that what has happened [my interpretation of what he’s saying] historically is that since the same terminal stock values over time have been recognized by managed funds and indexed funds alike — but that, in hindsight, since the indexed funds have realized the same values without additonal management expenses — that the holders of these funds realized a great advantage of lower costs and therefore higher net returns.

    I think his chuckle owes largely to his recognition that a considerable increase in the relative percentage of indexed fund investors, over what it’s historically been to now, would give us an even larger percentage of equity holders today that would have no conceptualizions of the need for ever selling an equity investment.

    For, after all, are stocks only made for buying?… Is there no selling, ever?… What is the fundamental motivation for buying stock?… Is it to line one’s coffin with the certificates and go smugly into the afterlife, impervious to any thoughts that one’s strategy could ever fail?

    I will say this much which I don’t think any reasonable person could very well argue against.

    If we ever have a significant enough downturn in the market (which is at least reasonably argued by many to be possible today), any active manager who assisted his investors in avoiding much or all of the downturn would be well worth his fees.

    And, when, and if, such an event were to occur, indexed fund holders would have no protection from the very thing that had made them the more successful over time; they’d have no protection from themselves, because they’d have an attitude that crossing every economic and market risk bridge, regardless of any warnings given them about the status of the bridges, would reward them in the same way they’d been rewarded historically.

    That is, they’d then just as likely view risks and warnings about the overall economy and markets with the same smug dismissive attitudes with which they currently view management fees.

    If the smugness about fees translates into a smugness about market risk, they are far more likely to ride markets to their ultimate lows, because their managers are not managers but merely custodians that are structurally even more destined to ride the market to the ground than their investors are. The investors could at least decide to get out of the indexed funds, but the non-managers are destined to ride them, whatever may come. These non-managers have designed a strategy that can only succeed in one way, and they’ve developed their confidence in this strategy from having promoted it during a period when, possibly by chance, the strategy has never really been tested.

    Indexed fund investors in effect have an autopilot as an investment manager, and that autopilot has been flying them at an assumed safe altitude for some 50-plus years across a wide expanse of mountainless flat plain and clear blue sky. Where are the mountains and the storms?… Would ignoring a mountain or a storm change the eventual outcome of remaining on autopilot?… Is willfulness always enough to protect an indexed investor?

    Part of the smugness of indexed fund investors comes from making the apparent assumption that there are n-e-v-e-r any mountains or storms to worry about. If you apply logic to what I’ve written, you’ll know that is a true statement.

    I can also say that, were I to be the CEO of a very large and successful company that traded its stock on the exchanges, and I’d enjoyed years and years of back-dating options to dilute the shareholders equity and put large amounts in my own pocket, and also benefited from hocus pocus pro-forma EBITDA accounting which had contributed to my company’s stock price rise, I’d look to the large positions of my stock held by various index funds and smile rather smugly myself at their perpetual votes of confidence in my management, safe in the assumption they’d never call me to task in any more meaningful way than by exercising a toothless and public tongue lashing, but certainly not by liquidating their holdings of my stock or recommending, wholescale, to their investors that they liquidate their shares in their own funds.

    Smugness has another face sometimes.

  17. Max commented on Dec 17

    “Also — think of how it would sound if the indexers’ logic were applied to the business world. Maybe something like this:”

    Maybe nothing like that.

  18. donna commented on Dec 17

    Money is like manure, it’s no good unless it’s spread around encouraging young things to grow”.

    The purpose of the stock market is to provide money for new businesses and growing businesses. The problem is, everyone forgets that, and thinks it is there to make a profit on.
    Ideally, one makes money by investing in a company and then reaping the rewards of its growth. The fact that Americans have forgotten this certainly explains a great deal of our problems. The fact that the Google kids did well is the reward of their hard work. The advice given them was to make sure they could hang on to those rewards, rather than being fooled into believing they could become even richer by squandering their wealth on bad investments.

  19. trader75 commented on Dec 17

    trader75 is missing the point. Of course some people can beat the market, just as some entrepreneurs can form successful businesses.

    Eh, but that’s not what they say. What they say, or at least strongly insinuate, is that all money managers are blind monkeys, i.e. that no one can win. That is worse than a blind faith statement; it is obstinate arrogance in the face of crushing evidence to the contrary.

    There is a populist argument that argues it’s okay to fudge the truth, in the interest of telling the average joe what’s best for him to hear. This is paternalizing and disingenuous, kind of like those anti-drug ads suggesting that marijuana leads straight to crack. Lying to people for their own good is the road to Orwell’s 1984.

    The dirty secret is that there are far better strategies than indexing out there–and talented managers worth giving money to–but as a rule of thumb, neither are available to the general public and never will be.

    Rather than admit this fact–that things aren’t always fair in this world, that you can’t always get what you want, that certain advantages and disadvantages are a fact of life–the subtle goal of the index touts is to foster a politically correct, egalitarian mythology in which all have the same access to market returns. This myth can only be sustained by pretending that gradations of talent and skill do not exist, while turning the market itself into an abstract, self-contradictory dreamworld.

    I’d have a lot more respect for these academic types if they made a reasonable case instead of acting like fundamentalist zealots. It’s one thing to warn amateurs against foolish mistakes, to underline the pitfalls and dangers with a bright red marker. It’s another to act like a preacher sharing the one and only gospel truth. And the worst part of their pot-banging is, obvious evidence disconfirms their views.

    Say you’re a newly minted millionaire at Google, with little to no knowledge of the financial world. After hearing that no one can beat the market, you do a little research on your own and uncover the track records of guys like George Soros, Paul Tudor Jones, Jim Simons. Guys who have gone decades without a losing year and crushed average returns beyond all statistical reason.

    What will your natural reaction be? It’d be that those well-meaning academic guys “lied to you for your own good,” just like the after school specials lied about how smoking pot would kill you.

    I don’t have much respect for BS. Paternalistic BS, designed to protect investors from themselves by distorting the facts and removing excellence from the bell curve, certainly doesn’t smell any better.

    This topic is an old dead horse that has been beaten into the ground many times. Don’t know why I bothered getting worked up over it. Maybe the mental image of Malkiel wagging his finger triggered ancient memories of throwing “Random Walk” across the room. At any rate, I’m done now.

  20. brion commented on Dec 17

    Trader75. The story is about sharks, cads and cheaters (the unethical) and the value of their investment “advice” vs. the returns based on passive investing.

    What’s with all the “Atlas Shrugged” Ayn Randian chest-thumping? What’s it have to do with that story?

    “…the utopian / egalitarian fallacy that a methodology must work for everyone, regardless of how little knowledge they have or effort they put in.
    It is amusing to see how investment returns are implicitly treated as a fundamental right — something the common man deserves with no effort or interest required.”

    I’ve NEVER heard of this “fallacy” of yours T75. (Has anyone else?) Or is this some Randian straw-man thrown out there by those same said “cheaters”?

  21. trader75 commented on Dec 17

    I’ve NEVER heard of this “fallacy” of yours T75. (Has anyone else?) Or is this some Randian straw-man thrown out there by those same said “cheaters”?

    Umm, yeah, that’s it. A Randian straw man, constructed to do battle with Dr. Pangloss. I’m not an objectivist (the word you seem to be grasping for)… just someone who calls ’em like they see ’em.

    Really, just ignore me. I have Blogger’s Tourettes. Fortunately it’s only triggered by rare and exotic words like ‘Malkiel.’

  22. LK commented on Dec 17

    trader75, you state:
    “The dirty secret is that there are far better strategies than indexing out there–and talented managers worth giving money to–but as a rule of thumb, neither are available to the general public and never will be.”

    Thanks for clearly making the indexer’s argument in one sentence.

  23. Mark commented on Dec 17

    maybe Bogle, the indexer pioneer, should spend a little more face time with his son Bogle Jr., the hedge fund manager

  24. Fazal Majid commented on Dec 18

    Index funds are clearly preferable to actively managed funds run by professional money men (as opposed to investors like Buffett and co). Unfortunately, they also have the side-effect of neutering corporate governance.

    If an index fund is required to buy X percent of Enron because Enron constitutes X% of whatever index, they will keep their holdings no matter how corrupt Enron’s management is, and only sell when the looting at Enron becomes so obvious it is booted off the index, by which time it is far too late.

    Few if any funds (whether actively managed or indexed) seriously follow their fiduciary responsibility towards their fund holders by holding management to account on issues like corporate governance, executive compensation, benchmarking against other companies in the same industry, and so on.

    If stocks were representative of random fluctuations in en efficient market, indexing would be an optimal strategy. Unfortunately, there are agents, managers being just one group, who have interests opposed to those of shareholders, and who can adapt to game any simplistic absentee owner investment strategy.

    That is probably where the Buffetts of this world make their biggest contribution. Actively managing funds is useless. Actively managing companies is where value can be created. Of course, Wall Streeters utterly lack any qualifications to manage companies, which is why they fall back to what they understand, much like the proverbial drunkard looks for his keys under the streetlight because it’s easier to see there.

  25. Steve C commented on Dec 18

    I subscribe to a financial newsletter that has beaten the market (SP500) by several % pts. a year for over 25 yrs. – NoLoad FundX (check with Hulbert’s for confirmation). They are always rated no. 1 through 3 compared to all newsletters for all rolling 5, 10, 15, and 20 year periods. They will never be no. 1 on a yearly basis – but would you want to select one of those newsletters anyway?

    They use a simple momentum algorithm. For example, in 2000 it switched generally into small cap value funds and substantially sidestepped the big-cap growth carnage during 2000-2. Currently, European funds are at the top of their list.

    I generally don’t use their fund recommendations…I use the equivalent exchange traded fund (i.e., EWZ for European equities). Less turnover that way.

    Of course their system works best in a non-taxable account, but I’ve yet to find a better system for above average long-term returns on a CONSISTENT basis.

  26. thegirl commented on Dec 20

    it’s too bad more companies don’t bring in investing and personal finance experts to talk to their employees. although, if they did, the employees might get their financial acts together and not need to work any longer.

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