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tony

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Interesting. According to Morningstar's Guide to Mutual Funds, actively managed small cap funds (growth in particular I think) and fixed income funds have been able to outperform their benchmarks over the long term. Peter Bernstein's book "Against the Gods" is a great read. In one of the chapters he tackles the random walk theory and proves that it isn't valid. The markets do not always act in accordance with Malkiel's theory that all current information is factored into the market. He especially disregards the strong form of market behavior. He also illustrates with charts that shows that there isn't a normal distribution of returns around the mean.

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I'm really surprised that the "random walk" theory still has any believers at all. I always laugh when I read people quoting Warren Buffett (out of context, of course) saying that index funds are the best solution for most people. I've done a lot of reading of Buffett's work over the past year, and his body of work (both written and actual examples of his investment) completely contradict the notion that all current information is factored into the market. Indeed, anyone wishing to trouble themselves to read Buffett's annual letter to his investors in Berkshire Hathaway will find an accessible, comprehensible theory of investing that doesn't once say how useful index funds (or any other kind of mutual funds, for that matter) are.

 

In the limited world of 403(b) investing, I can see where index funds can and should play an important role. But for any investments outside of 403(b) or 401(k) accounts, I can't for the life of me understand why an educated investor would turn to mutual funds.

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On the contrary, it is the educated investor who turns to index mutual funds. Just because a market doesn't appear to always be efficient, doesn't mean that you can profit from its inefficiencies after trading costs. In fact almost all evidence points to managers not being able to take advantage of market inefficiencies.

 

Take the 2000 - 2002 market, it appeared that previous to 2000 their was a market bubble - what you might call an inefficient market, yet very few if any mutual fund managers where able to take advantage of this bubble when it popped - they couldn't capitalize on the chaos. Markets don't have to be efficient for index funds to be a viable strategy. The simple fact that most actively managed mutual funds fail to be an accurate benchmark over long periods of time demonstrates that either markets are efficient, or that they aren't, but the inefficiencies aren't taken advantage of - either way, it is the index investor who makes out.

 

The key to a successful portfolio isn't necessarily using index or active managers, it is to keep expenses low, be very diverisified, and behave correctly (the latter being of utmost imortance).

 

ScottyD

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Hi,

Well, here we go again.

The pros and FT reject random theory and the rest of us who knows. Joe M said it best about random theory. He does not know or care. He has his money mostly in VG index funds and that takes care of the theory. Random theory and investing in low cost index funds are two discussions. I agree with Joe. I don't care either, but when somebody rejects it, I know he or she doesn't care about our best interests. In other words, rejecting random theory goes along with commissions, high fees and managed funds. It’s funny how it works like that when the two ideas are not really related.

 

It’s always the same people who argue against the random theory. Its hard to believe that the people still believe they can beat the market benchmarks with managed funds and high fees. Well, its mostly the pros that profit from the managed funds and a few investors who believe in their financial pro.

 

We believe in indexing with its great automatic diversification, tax efficiency and extremely low fees and there is one guarantee; index funds will never underperform the benchmark!!!

 

I did not read the article, but I did see Dan Wiener referenced. For everybody's information, he would be happy to sell you his very expensive newsletter. Sure he uses VG funds, but he is very critical of the indexing. No surprise.

Steve

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Hi,

FT stated: "But for any investments outside of 403(b) or 401(k) accounts, I can't for the life of me understand why an educated investor would turn to mutual funds."

 

I take it FT that you mean someone should invest directly in stocks. Well, I guess I am an uneducated investor because all of my IRA and Roth IRA funds are in mutual funds. All of them are with Vanguard. Not counting my bond funds, I have 9 funds, 6 of them are indexed and 3 are active managed funds.

 

I really don't care if the market is efficient, somewhat efficient, or completely inefficient. I just know I can't predict what the market is going to do. I have a diversifed portfolio that can ride out all of the ups and downs of the market without me having to get excited.

 

Did you know that the market was going to do a roller coaster ride this past month? My portfolio dropped a couple of percentage points than came back. Did you take advantage of that? It would seem to me that traders would like that type of market. They would be able to put their ability to predict the market to a test. As for me I don't need to take that kind of risk. Best Wishes.

 

Joe

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Even if markets are not efficient, how can the average investor, who lacks the intelligence, resources, and experience of someone like Warren Buffett, take advantage of inefficiencies?

 

If the answer is, "By using a 403b salesperson," I'll just pass and be content to earn market returns.

 

In fact, what the heck is wrong about earning market returns?

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Guest Sierra

 

In the limited world of 403(b) investing, I can see where index funds can and should play an important role.

 

FT: So why do you use the NYSUT/ING variable annuity for your 403(b) investing?

 

Joel

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Hi,

Referencing Warren Buffett's investing strategies is like comparing apples to oranges. When he is on the boards of many of the companies he is invested in, that clearly makes him more of a manager of his own stockes so much so that I have wondered whether the SEC has ever investigated him for some type of "insider trading." He has reported in one interview ordinary investors are wise to use index funds.

 

Anybody who suggests that you invest your after tax money in indivudual stocks (or something other than mutual funds) is speculating. I guess the person means osterage farms in Oregan or a partner in a precious metal company, who knows!

 

We like to think we are "all above average" (quoting Garrison Geiler), but in the stock market, we are not. If you try to earn above the averages, you are taking on additonal risk with associated costs, fees and commissions for buying and selling. That my friends is the Wall STreet mania.

 

There is nothing wrong with earning the benchmarks or the averages. Thats the 21st century of investing. If you have a 20 year time horizen or more investors can earn up to 11% in a low cost index fund (Jeremy Segal, "Stocks for the long haul").

 

Steve

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Also, Warren Buffeet doesn't exactly buy stocks any more, he buys companies and for the most part wholly owns them.

 

ScottyD

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Well, I'm glad to have taken my traditional clubbing for having suggested anything but allegiance to the index funds! Happy to play my part.

 

For anyone willing to do a bit of reading, Buffett's methodology isn't that complicated, and can indeed be duplicated. He identifies companies with a record of excellent performance: a return on invested capital of 15-20% annually, and what he refers to as a "wide moat" for the business. These parameters eliminate most businesses right away. The return on invested capital of any company over the last ten years can be looked up online at any number of free sites: yahoo finance, msn, etc. Because these companies represent such good performers, they are most likely to withstand a firestorm like the one we just went through over the last few weeks. And Buffett is adamant that the best time to sell a company, ideally, is "never." So it's hardly a methodology intent on pleasing traders and commission-driven salespeople.

 

Scotty, you are right that Buffett doesn't really take "stakes" in companies any more; he solicits the owners of companies willing to sell him an 80% stake. That way, he controls the companies, but leaves the ownership intact to do the job that they obviously are already good at (else he wouldn't be interested in the company in the first place). That doesn't mean that duplicating his methodology requires the purchase of entire companies. The same traits that drive him to acquire 80% of a given company can clearly make it attractive enough for folks like us to purchase 100 shares, no?

 

Joe, I had no idea what the market was going to do the last couple of weeks, so no, I didn't take advantage of its wild swings. But I hope that having made Buffett's methods a bit clearer, it's not his intent to trade every swing in the market. That would be folly, indeed.

 

Steve, nowhere in my brief message did I say (or even hint) that managed funds or high fees are endorsed by Buffett. That's a straw man argument if ever I saw one.

 

As for the ING question, I trust that that is well-plowed earth by now, and hardly needs any further explanation.

 

 

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PS...here's an interesting article about the Buffett approach that investors in both camps can take heart in!

 

http://www.capmag.com/article.asp?ID=4706

 

Loving index funds? Then you'll love Buffett on index funds: "By periodically investing in an index fund," he says in inimitable Buffett style, "the know-nothing investor can actually outperform most investment professionals." And he very clearly espouses index funds over actively managed funds.

 

On the other hand "...there is a third alternative -- a very different kind of active portfolio strategy that significantly increases the odds of beating the index. That alternative is focus investing." Reduced to its essence, focus investing means this: Choose a few stocks that are likely to produce above-average returns over the long haul, concentrate the bulk of your investments in those stocks, and have the fortitude to hold steady during any short-term market gyrations.

 

The article details the Buffett approach to stock selection: in short, "companies with a long history of superior performance and a stable management, and that stability means they have a high probability of performing in the future as they have in the past."

 

The article is worth a read. At the very least, read it before reloading your muskets and aiming them anew in my general direction.

 

 

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FT and Joe.....Thank you for the articles about investing.

 

From previous posts, I know that Joe investments are similar to the proposed investments by Meriman.

 

FT.......I wonder, do you invest similar to Buffet approach? What is your investment approach?

 

It seems to me that only selecting a small number of certain stocks for investing adds risk to your portfolio, both as a result of greater swings in smaller population, and individual stock risk(which is negligible in a portfolio of index funds that include thousands of stocks.

 

Also using the Buffet approach, how does one pick stock that will perform successfully in the future. How can the small investor without the resources of large institutions outperform these institutions as well as the benchmark.

 

Anyway these are my thoughts.

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IRA,

Just to add on to what you said about the small investor competing with large institutions, the large instituions do a terrible job with picking winning stocks too with all of their "talent," resources and time on their hands. I have never heard of somebody coming here and loving Bear Sterns, Morgan Stanley, etc. But the studies speak for themselves about large brokerage houses, stay the heck away from them.

This site is about 403b and thank god teachers cannot buy individual stocks with tax deferred money.

Steve

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