Plain Money ideas

How to out-perform the hotshots

Outside a university finance lab

This is a new finance lab at the university where I teach. The students who study at this lab get advanced training in using Bloomberg information systems. Such labs are becoming increasingly common, and not just at the graduate (MBA) level. Most of the students using this lab are undergraduates. They’ll go out ready to work in the financial sector.

If you are an individual investor with a job and other obligations, you can’t beat these students-turning-finance whizzes in short-term trading. They can jump in and out of hot stocks while you’re still doing your morning’s work. And yet your portfolio can outperform theirs — if you’ll buy and hold index funds. Why? All those hotshots, competing with other hotshots who trained in similar labs, will get the average return to the market. They can’t all beat the market. But they’ll be doing it at higher costs than you, if you buy and hold for the long run.

Why am I so confident these hotshots won’t beat the market? Because the smartest hotshots of all get to run mutual funds — and mutual fund managers don’t systematically beat the market. Here’s the evidence. The number you are looking for is the percentage of mutual fund managers who did not beat the appropriate index. That number is usually over 50 percent. So don’t worry about the young hotshots training in the finance lab, or what they’ll do when they enter the world of finance. You’ll outperform the majority of them by buying and holding index funds. (Yes, there are lots of complications. Read my book to find out more. But even after all the qualifiers and footnotes, the basic conclusion holds.)