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The Warren Buffett Debate, Continued

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Consider me hazed. After my second post as a blogger for Inc.com, the comments ranged from generally supportive to outright disbelief in what I was writing. As a blogger, I sincerely appreciate the feedback from the community and look forward to a continued dialogue on this particular topic -- how to make smart decisions about your money.

For those just tuning in, let me offer a quick re-cap both of what I wrote and of the response I received. I wrote that index fund investing was typically the best way for most people to invest. I used the example of Warren Buffett to suggest that if you happen to be extremely gifted at investing, as he is, then index fund investing wouldn't be the way to go. Rather, choosing stocks that go up faster than the market as a whole would. The majority of the response I got back was along the lines of: If Warren Buffett can do it, so can I.

The lesson I learned is never to underestimate the indomitable can-do spirit of the American entrepreneur. That force burns so bright in each of you, like David against Goliath. In this case, however, Goliath is the data, and the data tell a different story.

Warren Buffett and a few other extremely successful individual investors who beat the market consistently make up a tiny minority of all investors. For an academic analysis of this reality, click here, or read this summary from The New York Times, which describes the percentage of professional investors who outperform the market consistently as "just .6 percent -- statistically indistinguishable from zero." The study, which focuses on money professionally managed in mutual funds, concludes that "index funds are the only rational alternative for almost all mutual fund investors."

Obviously, if professional investors struggle to beat the market, it's going to be even harder for ordinary investors. Why?

Time: Most of us don't have the time to research investments and haven't taken the time to earn Master's degrees in economics or finance as the best investors have.

Access: Most of us don't have access to the avalanche of data, both quantitative and qualitative, that professional investors do.

Scale: Most of us don't have access to the trading systems and the institutional pricing that professional investors have.

These are extremely difficult obstacles to overcome. Even Warren Buffett agrees. Mr. Buffett has espoused the use of index funds for most investors for decades. If you need reminding, here's a comment from him as recently as May 2008:

"When a shareholder asked for the single best specific investment idea Buffett could recommend to an individual in his 30s, Buffett said: 'I would just have it all in a very low-cost index fund from a reputable firm... And I could just go back and get on with my work."

Some of the commenters presented very thoughtful ideas about how Buffett's concentrated portfolio approach works and why it's better than index fund investing. As I said in my previous blog post, if you can do what Buffett does, go for it. But I just don't believe, for all the reasons I've laid out here, that it can be done. And if it could be done, I doubt you'd be telling people about it on a message board. You'd probably be locked up in your castle, defying the odds and keeping it to yourself.

Last point: A few comments suggested I'm selling something by promoting index funds. Not true. I can't sell you an index fund because I'm not licensed to sell any financial product. Nor can I be compensated for referring you to someone who does. The good people at Inc.com made a compelling case about why the readers of the site would benefit from getting good, impartial investing advice from someone who has no axe to grind, no score to settle, and no pocketbook to fill. I agreed.

And by the way, I do walk my talk and proudly have most of my investable assets in index funds. Some are in variations of index funds. I never buy individual stocks -- although I do occasionally receive stock or stock options in companies I work with as a form of payment, and my wife works for a publicly traded company that pays her partly in shares in her company.

Last updated: Jul 28, 2008

LEWIS SCHIFF | Inc. Business Owners Council

Lewis Schiff is the executive director of the Inc. Business Owners Council. His latest book is Business Brilliant: Surprising Lessons From the Greatest Self-Made Business Icons.




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