Shockingly Poor

The performance of the typical investor is shockingly poor. This according to Richard Bernstein Advisors (pdf here):

The average investor has underperformed every category except Asian emerging market and Japanese equities. The average investor even underperformed cash (listed here as 3-month t-bills)! The average investor underperformed nearly every asset class. They could have improved performance by simply buying and holding any asset class other than Asian emerging market or Japanese equities. Thus, their underperformance suggests investors”™ timing of asset allocation decisions must have been particularly poor, i.e., investors consistently bought assets that were overvalued and sold assets that were undervalued. They bought high and sold low. When chaos occurred, investors ran away.

Warren Buffett provides an appropriate strategy for the average investor:

Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard”™s.) 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. 

This provides a bit more context for Warren’s comments:

The goal of the non-professional should not be to pick winners ”“ neither he nor his “helpers” can do that ”“ but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.

That”™s the “what” of investing for the non-professional. The “when” is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur… The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long- term results than the knowledgeable professional who is blind to even a single weakness.

If “investors” frenetically bought and sold farmland to each other, neither the yields nor prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties.

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I”™ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife”™s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard”™s.) 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.

Warren’s letter to his shareholders, which includes the above comments from page 20, can be downloaded as a pdf here.