Broker Check

Heads or Tails? Either Way, You Might Beat a Stock Picker

| August 14, 2014

Can Skill Do Better than Luck?

In the ongoing debate between those who feel it is better to "Index" and those who feel it is better to choose specific investments with the goal of outperforming an index, the article referenced is interesting!

“The results were actually very close to what you’d find in a random draw — or a series of coin flips, except they were a little bit worse,” [emphasis mine: ed.] William D. Nordhaus, a Yale economics professor, said in a phone conversation.  However, he went on to say that "the empirical data . . .doesn’t rule out the possibility that some investors excelled for reasons other than dumb luck." [emphasis mine again.]

Many of us used Paul Samuelson's Economics back in our Econ 101 courses.  Separately, Mr. Samuelson wrote.  “The market shows some efficiency in recognizing the occasional genius.”  So, in my own words, there are some people out there with skill that do better than luck would forecast.  Samuelson also thought Warren Buffet to be a genius.  But Samuelson thought even Buffet would have trouble outperforming consistently.  "One reason was that if anyone starts to beat the market in a noticeable way, imitators will eliminate his edge."

Internal Expenses (not advisory expenses)

The referenced New York Times article barely mentioned expenses and did not incorporate the expense argument into the article.  Just for example, suppose an index investment has an internal expense of 0.20% -- and an active investment has an internal expense of -- again just for example -- 1.20%.  My logic says the only reason to pay the higher expense is the expectation (not past performance - we know that is unreliable) that the higher expense investment will outperform the index by at least the extra expense amount!  This logic can be applied by both do-it-yourselfers and those who pay for advice. 





Related Links