When an average person goes to an accountant, they expect, and usually receive, value in exchange for payment. Likewise, when hiring a plumber, electrician, attorney or any number of other specialists, the average layperson receives reasonable value in the exchange.
When it comes to money managers, though, this may not be the case. There is a lot of data that shows that, as a group, money managers’ performance equals that of the general market minus the frictional costs they incur in the form of fees, commissions, slippage, and taxes. How could it be otherwise? Many savvy investors such Bogel, Buffett and Greenblatt advise that average investors simply invest in an index fund and pocket these frictional costs. This is certainly a rational approach, and, as long as expectations are kept in check, it is likely to generate a reasonable return over the long term. Also, it has the added benefit of minimizing, if not eliminating, self inflicted wounds.
What about going it alone as an active investor? I think Buffett is correct that a person who spends an hour or two a week on investing has the potential to get a significantly worse result than simply buying and holding an index fund, particularly if he is doing focused value investing. Being able to value a company is sine qua non for successful value investing and this requires time and experience. Without good valuations grounded in independent work, you will lack the necessary conviction to buy meaningful positions and hold them through the inevitable ups and downs of the market. You could also get seriously burned if you buy something that looks “cheap” that really is a lousy, deteriorating business.
So why do many investors – even those who call themselves value investors – continue to dabble?
First, speculating can be very exciting and enticing. People can go to great lengths to speculate, even if it means dressing it up as value investing. Second, because investing outcomes are a result of both luck and skill, it is easy to draw the wrong lessons from one time successes or bull markets that generate good results for everyone, even know-nothings. These misguided lessons can lead to the conclusion that it is easy to make money in the markets. This is closely related to over-confidence bias which continues to draw patsies into the markets even when they bring nothing to the table and can offer no sound reason why they should generate a sound return when trading against well informed, sophisticated counter-parties.
Therefore, if you want to beat the market, don’t dabble. Dedicate yourself to it in a serious fashion or find a professional with the right investing framework and psychological makeup who will. Short of that, you’re better off investing in an index fund.