What do Ben Stein, Warren Buffet, Jim Cramer, Kiplinger’s, David F. Swenson, and Charley Ellis all have in common? Who are David F. Swenson and Charley Ellis? David F. Swenson and Charley Ellis manage $22.5 billion dollars for Yale’s endowment fund. Charley is also a director at Vanguard. Everyone mentioned endorse investing in index funds. For an in-depth rational, check out these excerpts from an interview with Charley Ellis at Advisor Perspectives.*
What role, if any, should active management play in the investment strategy of investors with long term horizons? The basic reality is what Warren Buffett has said it true. For almost all investors, index funds are the highest quality, most reliable, best deal going because they are inexpensive. They take away the negative experience, anxiety, and worry associated with active management, especially over the long term.
By indexing, advisors are capturing the cumulative human experience and expertise of many, many investors. Thatâ€™s a real positive reality to remember and reflect upon. When advisors index, they are getting the sum of best judgment of the best investors, especially institutional investors. These investors are doing the hard work for you. Consider this analogy. I fly a lot – perhaps five flights a week for the last 40 years. I have a perfect record. When I fly, I sit in my assigned seat, pull my seat belt tight, and never come anywhere near the pilotâ€™s cabin. The pilots know what they are doing, and I am not going to do be any better at flying the plane. I accept their best judgment.
The same is true in investing. If you believe â€“ as I once did â€“ that you are better at picking stocks, the odds are about 9-to-1 you are wrong. Investing is not unique in this respect. We overrate our abilities in all sorts of pursuits. About 80% of people believe they are above average dancers, conversationalists, and drivers. We are perennial optimists. Be careful when you apply the same logic to investing. If you are really superior, and you are willing to invest the time, you might want to invest actively. But you are probably kidding yourself. If you really are unusually good, you should go in the investment business, which is a great business.
Keep in mind you are playing against the most capable people in the world. The question is not whether you are above average. It is whether your abilities are above the best of those that are investing professionally today. They are, in most cases, way above average so the bar is set very high.
The same logic applies to advisors picking actively managed funds. Very few people have been able to pick funds that will deliver superior performance in the future.
*Charles D. â€œCharleyâ€ Ellis is a consultant to large institutional investors and governments. For thirty years he was managing partner of Greenwich Associates, an international business strategy consulting firm he founded that serves virtually all the leading financial service organizations around the world. Mr. Ellis earned his BA at Yale and his M.B.A. (with distinction) from Harvard and his Ph.D. from New York University. He has taught investment management courses at Harvard and Yale, is the author of 14 books, mostly on investing, and has written nearly 100 articles for business and professional magazines. He currently serves on the investment committees of Yale University and the Robert Wood Johnson Foundation, chairs the Whitehead Institute and is a director of Vanguard. (Source: Advisors Perspecives.com)