I recently read an article that pointed out supposed advantages of mutual funds and then tore those assumptions to shreds by pointing out that something like 85% of actively managed funds under perform their relevant indices. The article proceeds to point out the incredible evidence of how index funds outperform actively managed funds.
The author finally wraps things up with some notable quotes including a partial one from Warren Buffet’s 1996 shareholder letter:
…the best way to own common stocks is through an index fund… –Warren Buffet, 1996 shareholder letter
If there’s one thing I don’t trust, it’s partial quotes. I decided to find that quote and read it’s entire context. As you see up above, I have linked in the letter so you can find it as well.
Do yourself a favor and read this entire section Waren Buffett wrote:
Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.
To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses – How to Value a Business, and How to Think About Market Prices.
Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.
Though it’s seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders: Our look-through earnings have grown at a good clip over the years, and our stock price has risen correspondingly. Had those gains in earnings not materialized, there would have been little increase in Berkshire’s value.
I highlighted one section in particular, because I’ve read other versions of that in other places. Given all this, does this sound like someone that thinks the true path to wealth involves index funds? Or is he possibly saying IF you are going to buy funds, your best bet will be index funds?
Warren Buffett clearly points out that investment professionals aren’t the ticket to building wealth. He also eschews the complex statistics and fancy theories taught at business school. Instead, he leans on a business’s ability to produce and grow earnings. Balanced against price, he is obviously suggesting buying quality companies when they are on sale. When people panic and sell quality businesses, driving the price down, that is your real opportunity to buy. The price may flutter, but if the company is solid, it will recover and you will succeed.
One last thing. I noticed that further down in the comments a rather strange assumption from one person. They suggest that if you know only 15% of the mutual funds will succeed, why not spend the extra to find them out and invest in THOSE funds. The problem with that advice is the assumption that it’s the SAME funds on top each year, an assumption that can have a dreadful effect on your overall performance as you chase yield.
In summary, I prefer finding quality stocks and real estate that have shown a strong history of earnings and holding onto them long term.