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uh you maintain that in the individual investor can beat the big guys as you put it how can that be well it's pretty interesting that from the research we did in the book um most people know that uh the typical index funds the S P 500 and the Russell 1000 uh if you invest in those uh they beat most managers but roughly about 70 percent of the managers uh and that's pretty powerful it's because of their low fees and that most managers aren't really adding value so one logical thing to do uh would be to say well I know only 30 percent of the managers beat the typical index so how do I find those guys and it turns out if you look back over the last three five and ten years of those managers records there's really no correlation between how they do in the next three five ten which is really what you're trying to figure out uh so that's why you know most uh you know many uh at least advisors have have recommended and and possibly rightly uh that index funds for the individual investor who doesn't know how to pick stocks on their own is maybe a good uh opportunity for most people so we set out to do something a little better and as it turns out the the regular indexes the S P 500 or the Russell 1000 are seriously flawed as it turns out even though they beat the most active managers they're still very seriously flawed and they do something that costs investors about two percent a year uh and that really is is that their market cap weighted indexes which means they put more weight into the larger market caps and so that is the losers right so if you believe like Ben Graham or uh Warren Buffett that the Market's sometimes emotional it's not efficient like so many professors have professed over many years it's not efficient uh that means that if the market does get emotional over the short term uh that some stocks are overpriced and some are underpriced and a market uh a market cap weighted index uh if a stock is overpriced it buys too much of it automatically and if it's underpriced it buys too little of it automatically because it's based in a market cap which is essentially price so it sounds crazy but it actually systematically doing the wrong thing at every Point uh whenever there's an inefficiently priced stock and so there's an easy way to correct that and they're actually equally weighted indexes instead of putting uh putting more in the larger uh market cap companies it actually puts an equally weight so if you have the S P 500 it'll put as much weight in stock number one as it will in stock number 500.
it still makes plenty of errors in other words it's an equally waiting but those errors are now random not systematic like a market cap weighted index so you actually get back the two percent a year uh and a few people have come out with something called fundamentally weighted indexes it's just another way to weight stocks uh without using price and therefore the errors in those indexes are also random and you get back to two percent from those two and since we're value investors and have been done a lot of research on value investing over a long period of time we create an index that we call valuated which just means the cheaper something is the more weight we put into it and it's actually more Diversified than uh you know the S P 500 or Russell 1000 index has the same volatility has the same beta yet uh over the last 20 years you would earn seven percent more a year uh following that strategy and it's it's ridiculously simple just put more weight in the cheaper companies uh before we get to that you uh make the point the reason why there is such opportunity for the individual is that in the investor world you believe it's become more short-term focused which means by high sell low that's a really great Point uh big picture is that uh when you when you look back at what's happened over the last 20 30 years there's been more access to information there's been more computing power there's been more people going onto Wall Street you know it's high paid hedge funds and you know proliferation of mutual funds and and everything else so there's a lot of smart people actually trying to beat the market quote unquote and so you would think that it would be getting tougher and tougher for individual investors to to outperform the market and what it turns out is our simple value factors have actually gotten stronger over the last 20 30 years and the reason for that is that the the world has become much more institutionalized meaning um I'll just tell a quick story I tell in the book which was that uh in the late 80s I had an investor in my partnership uh one of the first fund of funds and these are uh uh funds that actually pick managers and you're asking them to find their expertise to pick the best managers and they put that all together in a fund and so one of the first that was put together in the late 80s or at least the ones I knew about uh asked to invest in our partnership and at the time I was writing quarterly letters and that seemed to be fine for my investors uh but the fun to fund said well we have to report more often so could you give us monthly returns so I said sure I'll tell you the monthly returns as as they come in and uh sure enough after the first month that uh this fund had uh money with us we reported back that we were up 1.1 percent which we thought was pretty good but I got a call from the fund of funds and said well you know we have a lot of other managers that do similar things to you and the average one of those was up 1.2 percent last month to what do you attribute your underperformance and uh I politely told uh the fund of funds to call me back in a year I probably should have told to call me back in four or five years but I don't think they would have stuck around uh so long so I figured I'd settled for one year but the world has become much more institutionalized since then uh people uh look at Daily returns weekly returns monthly returns they get analysis over the month or the quarter it's very hard to keep a long-term Horizon when you're investing in the stock market you know four or five years is more a more reasonable time frame to judge anyone's uh performance and so you get hyperactivity which research shows does not lead to better returns exactly so what happens really is is that uh you know if you underperformed in the last six months year two years uh people chase performance so they take money out of you and and put into someone else and another statistic I wrote In the book which I think is the most telling is if you look at the top performers over the last decade the top 25 percent of managers that have uh outperformed came up with the best record for the last 10 years uh 97 percent okay 97 of those top managers uh spent at least three years in the bottom half of performance 79 spent at least three years in the bottom quartile of performance and uh almost half 47 spent at least three years in the bottom 10 percent of performance so you know all their investors left if they did that but these are the ones who ended up with the best long-term record most people leave them most people don't stick around uh for long enough uh one other thing I write up was the top uh in the decade of the 2000s you know that 10-year period the top performing mutual fund was up 18 a year uh the average investor in that fund lost 11 a year that was the best one uh why is that it's because every time the fund underperformed people left every time the market went down people left every time it outperformed people piled in right after the outperformance right after the market went up people piled in so with all the investors Market decision the average investor you know average dollar weighted investor in that fund over the last decade the best fund ended up losing 11 percent
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