Thursday, April 07, 2005
The Relentless Rules of Humble Arithmetic
John Bogle, the father of indexing, on that topic at the 60th Anniversary Conference of the Financial Analysts Journal.
That message is simple: Gross return in the financial markets, minus the costs of financial intermediation, equals the net return actually delivered to investors. While truly staggering amounts of investment literature have been devoted to the EMH—the Efficient Market Hypothesis—precious little has devoted to the CMH—the Cost Matters Hypothesis. However, to explain the dire odds that investors face in their quest to beat the market we don't need the EMH. We need only the CMH. Whether markets are efficient or inefficient, investors as a group must fall short of the market return by precisely the amount of the aggregate costs they incur. It is the central fact of investing.
Note that Buffett in the past has acknowledged the usefulness of indexing. From the 1993 Annual...
Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb.