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Warren Buffett versus Modern Portfolio Theory

In this Ask The Expert With Larry Swedroe article, Zapp challenges the legitimacy of Modern Portfolio Theory citing Warren Buffett as a rule breaker.  So which is it, Modern Portfolio Theory or Warren Buffett? Here’s the question from Zapp:

Other than by taking the self-denigrating stance: “I am not an above average investor”, how can a person justify support of modern portfolio theory when there is a Warren Buffett in this world?

Answer From Larry Swedroe

That is an easy question to deal with. First, with thousands or millions of investors we should expect some to outperform the market every year and some to do so for many years, randomly. The question is: Is there any more persistence of performance than would be randomly expected. The evidence from hundreds of academic studies is there is not.

Warren Buffett Is Not Your Typical Investor

Another answer to the question is that Warren Buffett is not the typical investor. He is not like a mutual fund manager. He often buys companies and then manages them. He provides them with economies of scale, lower cost of capital and the benefits of his managerial wisdom. And when he takes large positions in companies he often gets a board seat. So perhaps his great returns are more a result of his managerial skills than his investment skills, or some combination of both.

Berkshire Hathaway Performance Versus General Market

When I got this question a few years ago I went to do a simple check on the performance of Berkshire Hathaway for the prior ten year period and then compared it to the five major U.S. asset classes of large, small, small value, large value and real estate. During that period BRK had underperformed all but the asset class of large stocks (as represented by the S&P 500) and had underperformed an equally weighted (20% each) portfolio of the five that was rebalanced annually by several percent.

So we know that Buffett had delivered great returns in the past but we don’t know that he will in the future. In fact, during that ten year period BRK underperformed. So now what would you forecast regarding the future?

Who Is The Next Warren Buffett?

The issue is this, we know that there will be some investor who produces “Buffett-like” returns in the future. The problem is we cannot identify them today. Unfortunately we can only buy tomorrow’s returns, not yesterday’s. And finally, what I tell investors is this: If you look in the mirror and you see Warren Buffett, go ahead and try to beat the market by picking stocks. But there is only one person who when he looks in the mirror sees Warren Buffett. The rest of us should simply accept market returns. If you do so you are virtually guaranteed, if you have the discipline to stay the course, to outperform the vast majority of investors, both individual and institutional.

By the way, What Wall Street Doesn’t Want You to Know contains a section called “Buffettology or Mythology” which addresses your question. Also, Wise Investing Made Simple contains the tale “When Even The Best Are Not Likely to Win the Game,” which indirectly addresses you question by looking at the results of large institutional investors who have access to the great money managers.

Disclaimer

  • Mr. Swedroe’s opinions and comments expressed are his own, and may not accurately reflect those of the firm, nor Moolanomy and its owner.
  • Not all questions will be answered
  • By submitting a question, you grant us the right to publish your question.
  • The answer is given based on the information provided in your question. Please seek professional assistance for more personalized advice.

28 thoughts on “Warren Buffett versus Modern Portfolio Theory”

    • @Joe – And he’s just one out of millions of investors. The law of probability supports the fact that there will be a few who outperforms the rest. As an average investor, you can’t act like them.

  1. I think if there is anything the recent financial crisis has taught us, it is that modern portfolio theory is hogwash. It’s basically propaganda created by the investment industry to persuade people to give them more money, from which they can take more fees. Just being diversified guarantees nothing except that you will do roughly as well as the market. In the past year, that means would have lost around 50% or your money! You are better off to be small, nimble, and aware of what is happening in the market than to sheepishly behave in portfolio theory.

  2. @ Pinyo – Really? You might want to screen the advice from your ‘experts’ a little better …

    Firstly, Berkshire Hathaway is both an investment company and a management company (taking 100% ownership of 78+ businesses). As an owner of businesses they don’t need to ‘take’ a board seat on any of these companies, they can sit in as many of them as they wish!

    Secondly, studies of BRK’s ownership of common stock (i.e. where they act as a shareholder) shows that they have returned far greater than the market and that cannot be attributed to ‘randomness’ or ‘luck’:

    http://7million7years.com/2009.....or-a-fool/

    Thirdly, Larry is well aware of (a) BRK’s long-term returns (40+ years) and (b) of the perils of looking at relatively short-term (i.e. even 10 years is not a long enough period in the stock market) when comparing investment performance.

    Now, Warren is just one example, but there is no disputing that his performance over many decades runs counter to so-called Modern Portfolio Theory.

    The point that Larry SHOULD be making is that this is not a common result … so, for the average investor, simply plonking all of the funds that you have earmarked for stock investing (e.g. in your 401k) into a simple, low-cost Index Fund – and, waiting 30+ years for Modern Portfolio Theory to run it’s ‘magic’ – will provide the best ‘bang for buck’ performance that you need.

  3. @Joe, @Pinyo – Don’t forget about Walter Schloss, Charles Munger, and Bill Ruane. All studied under B. Graham and all significantly beat the market over extended times. There are 17 “Value Investors” from the group that have produced “better than average” results, but not all have been big winners. I think the point is that this is all they do, it is their day job. They spend more time than the rest of us have picking the right companies to invest in.

  4. @James – I respect your opinion and approach; however, I still personally believe broadly diversified investment is still the best choice for me. This is also true many others who do not have time, or do not have the skill to deal with individual stocks.

    @AJC – I read many of Larry’s book and he is an expert in my opinion.

    However, I do agree with your point about timeframe that could be used to manipulate numbers and support argument one way or another.

    As for your final point, very well said, especially about “not common result”

    @Mark – You can name a few hundred super investors and we will still be in the realm of realistic random distribution. You are comparing a handful of people to millions of average investors. Larry’s answer is aimed to help the masses succeed and I agree with his assessment. And as you point out, these guys dedicated the lives to be where they are so there’s no point to pretend that we (the millions of average investors) could be them.

  5. few thoughts
    First, many people have beaten the market in the past. Some did it simply by buying small and value stocks which have outperformed large and growth stocks over the long term, with the simple and logical explanation that the premiums earned were risk premiums, not free lunches. For example, small value stocks have returned about 14% a year vs about 10% for the market. This is certainly an MPT story of risk and expected return being related

    Second, the criticism of my analysis of BRK is totally off base. I fully acknowledge the long term record of Buffett and BRK and I admit it might be skill or even likely is skill. But it is hard to know for sure. I pointed out this long ten year period of underperformance for a very good and important reason. When Buffett began there was no way to know he would produce such a record, or identify him out of the thousands trying. We know also that he had very little money to manage when he began and even for a very long time. So after say perhaps 15 years people believe that he is really skilled and the money flows in–and then he underperforms for the next ten years. So now what do you do? How do you decide if the first period was skill or just good luck and now bad luck. Or perhaps the large amount of money that came under his management made the game more difficult.

    For those of you who think this is easy, try looking at Bill Miller. 15 years in row beat the market–no one had ever done it before, not even Buffett. Morningstar named him manager of the decade in 2000 and then Fortune in 2006 called him the greatest money manager of all time (forget Buffett). So what does he then do: Underperforms by 10, 12 and 18 percent the next three years. Now was he just lucky and got unlucky again or did he suddenly take a stupid pill three years ago?

    The academic evidence, despite what people want to believe, is very clear, there is no way known to man to identify ahead of time the future winners. Two major studies on the performance of pension plans confirm this. Here is what they found:
    ·Plan sponsors hire investment managers after large positive excess returns up to three years prior to hiring.
    ·The return chasing behavior does not deliver positive excess returns thereafter.
    ·Post-hiring excess returns are indistinguishable from zero.
    ·Plan sponsors terminate investment managers after underperformance, but the excess returns of these managers after being fired are frequently positive.
    ·If plan sponsors had stayed with the fired investment managers, their returns would have been larger than those actually delivered by the newly hired managers.

    And yet if anyone should be able to identify managers who will in the future beat the market it should be them, and they fail. They have access to all the great managers, pay lower fees than we do, hire top consultants to help them with due diligence, never hire managers with bad track records, etc. And yet the evidence shows they persistently fail

    There is absolutely nothing that has happened that shows in any way that MPT is wrong,There is no evidence that markets are inefficient. For example, For the period 2003-08 the Credit Suisse Hedge Fund Index underperformed every single major equity and high quality fixed income asset class, every one. So where is the evidence the markets are inefficient? And as to building portfolios that use low correlating assets to reduce risk, those that make the argument that it did not work simply don’t understand markets. If you are interested in learning more about that subject check out this article I wrote:
    http://www.indexuniverse.com/s.....-flat.html

    It often amuses me that people make the argument about active investing by citing PAST winners. The problem is that, as the evidence on the pension plan-and other studies shows is that that tells you nothing about the future performance. Anyone can use a database to find past winners. But that is exactly what the pension plans and Morningstar does too and they all fail with great persistence to beat the market AFTER we identify them. The past is not prologue when it comes to active management

    If you are interested in learning more on this subject there is an excellent article by Jonathan Berk called The Five Myths Of Active Management.

  6. Interesting discussion. Actually Buffett did write a paper back in 1984 about the SuperInvestors of Graham and Dodd, where he talks about the performance of all of Graham’s students. Even 25 yrs later, I feel as if these value investors have done well, especially Buffett. The thing that he does is that he looks for situations where he has an edge over other investors – picking dollar bills for 40 cents. His recent prefered stock investments in GE,GS, and many others have proven that Buffett knows when to take full advantage of a situation.

  7. few thoughts for you to consider
    First, remember it has been easy to beat the market simply by being a passive buy and hold investor in value stocks. No stock picking skill required at all. Just a faith that markets reward for risk –at least in terms of expected returns.

    Second, as I mentioned Buffett has advantages like people who need cash like him as partner and willing to pay more for his money because his cash comes very quickly and with few strings. If you read his book Snowball he even talks about that.

    The points are really these
    a) there will likely be another Buffett in twenty years. Problem is no way to identify him or her ahead of time. That is what every study done has shown.
    b) If you look in the mirror and see Buffett go ahead and try to pick stocks. But remember that there are thousands of Buffett wannabees who invest the “Buffett” way and do not come close to the same results.

  8. @ Pinyo – Anybody can buy stocks for 50 cents in the dollar … the trick is KNOWING that they are 50c in the dollar at the time 🙂

    @ Larry – You are trying overly hard to make a point that simply cannot be made: that MPT is 100% correct, when I think you SHOULD be saying it’s not wrong often enough for the average (even all but the rare exception, expert) investor to take advantage of.

    The proof: SOME investors beat the market in large cap; small cap; any cap you care to name, because they know how to find the few/rare examples when MPT IS wrong.

    You say that this is attributable to randomness and luck, and in the majority of such cases, I am sure you are right. But, in SOME cases you are wrong … performance cannot be attributed to luck, therefore, barring ‘insider information’ MPT must be SOMETIMES wrong.

    A simple example is WB because his performance CAN be tracked and CAN be attributed to skill rather than luck.

    AJC

  9. @AJC, absolutely agree on the many perils of modern finance theory when applied to the individual investor. And Buffett being the prime example that diversification, M&A and such gems from the last few decades do not end up benefiting most investors.

    But the question is then, given most investors do not have direct access to the management of the businesses they invest in, nor do they have the investment horizon of Buffet, what is the sensible approach? Perhaps that’s when the idea of diversification, and unsystemic risk management comes in. One thing is apparent though, financial advice and planning should never come wholesale, but should vary depending on the particular time-frame and financial situation of the individual. Common sense? But lost on many investment advisors in their uniform recommendation of blah mutual funds, many of which divesting into areas not mandated.

    @Pinyo, @Larry, timing the market is extremely difficult, but it’s interesting to note that WF (or was it BG) that has noted that they do not try to time the market in buying at the lowest point nor selling at the highest point, but instead to buy when a business is under-valued and sell when over-valued. They even stated that they do not wish to cause sharp movements in the BH stock prices, so their investors can have a fair return regardless of their redemption schedule.

    I think it’s interesting that as much as they eschew the herd mentality of the market, they believe in the ultimate efficiency of the system.

    Regardless of your particular take on the pros and cons of modern finance, it’s probably safe to say that an over-reliance on quantitative models is not a smart thing to do. http://www.wired.com/techbiz/i.....ntPage=all

    Cheers, /dana

  10. @ Dane – Warren Buffett said it best:

    “I’d be a bum on the street with a tin cup if the markets were efficient.”

    How about you, Larry, has Modern Portfolio Theory made you one of the world’s richest men? Or, have you merely been unlucky? 😉

  11. AJC
    I fully admit there might be skill that leads to market beating returns. That is not the issue. The issue is that no one can distinguish the skill from the luck–at least until it is too late. The reason is that past performance has proven to be a very poor indicator of future performance–you don’t get persistence beyond the randomly expected. Every study done has found that, at least that I am aware of.

    I did read the study and as I noted, his long term record looks undeniably like skill. But so did Bill Miller’s. And there was a long period when he significantly underperformed. So then the question is how do you know if the skill has “gone away” or perhaps the size of the assets now under management had increased so much that the skill was swamped. Suggest you read Berk’s paper. It is excellent.

    Also note that Buffett’s greatest returns came when markets were less efficient informationally then today. Much of his trading was on things like pink sheet stocks. Also in the early part of his career most of trading was among individuals, today that is far from true. So the competition is much tougher.

    And note that MPT does not say markets are perfectly efficient. That is a “misnomer.” Here is the right way to think about MPT/EMH;The efficient market theory is practically alone among theories in that it becomes more powerful when people discover serious inconsistencies between it and the real world. If a clear efficient market anomaly is discovered, the behavior (or lack of behavior) that gives rise to it will tend to be eliminated by competition among investors for higher returns.— Economics professors Dwight Lee and James Verbrugge of the University of Georgia

    FWIW_I have run large trading rooms and managed various financial risks at some large financial institutions.Not just some “academic.”

    Finally, note I fully admit that Buffett results were likely due to skill. Never said otherwise. But thousands trying to invest the Buffett way using same methodologies have failed miserably

    Again, I repeat show me how you find the next Buffett AHEAD of time.

  12. @ Larry – NOW I understand your argument! Thanks for the clarification …

    Of course, this is a ‘no win’ situation for me: I say that I will back Warren to continue to beat the market because of superior skill and you say that MPT (indirectly, of course) will rush in to fill the ‘gap’ between WB and the rest of the market … if Warren beats the market, it will be because MPT hasn’t quite caught up yet, or randomness, etc. and if WB does NOT beat the market it’s because MPT is correct. Ouch!

    I can’t win … except at the the bank 🙂

  13. AJC

    I think we can agree on two key issues. Buffett’s record is almost certainly the result of skill. But the market’s have become much more efficient over time and the size of his assets under management make the challenge of beating the market now so much greater. Even Buffett himself has made this last point.

    The other point is this. Likely we will see another Buffett 20 years from now, but there is no way to identify that person TODAY, we will only know who that person is ex post. The evidence is overwhelming that you cannot rely on past performance of active managers as a predictor of future performance. Just look at Morningstar’s own Wealth Portfolios if you like and you will see that 2 of the 3 underperform even with false benchmarks that favor Morningstar (their portfolios load higher on risk factors than the benchmarks and thus have higher expected returns). Then you have all the academic studies on mutual funds, hedge funds and pension plans and they all show the exact same thing: Easy to identify past winners, very unlikely to be able to find future winners from that group.

    Thus the prudent strategy is clear, simply accept market returns in the asset classes in which you invest. If you do that, using low cost and tax efficient passive vehicles you are virtually assurred (assume you stay disciplined) to outperform the vast majorty of active investors–and the longer the time frame the higher the percentage will be. Over ten year horizons the odds are probably over 90% after taxes. So why play a game where you have so little chance of winning. That is why Charles Ellis called active management the loser’s game. It is that the odds of winning are so poor it is not prudent to try and win—sort of like the lottery.

    That is the bottom line—what is the strategy MOST LIKELY to give you the highest chance of achieving your goals?

    Best wishes

  14. The big question if MPT is the only way to go is why do we need financial advisors? Basically, all we need is E*Trade or some similar company and Vanguard or some similar company. Or, we could take it one step further and just create a government retirement fund that invests our money in the entire market. This would at least eliminate the need for 90% of the overhead created by financial advisors, traders, etc., as anything that large would just be automated. We wouldn’t be buying houses in the Hamptons with MPT, but at least the people selling us MPT wouldn’t be buying houses in the Hamptons either.

  15. Chad
    The reason one MIGHT need an advisor –or better very likely needs one–is that the education system has done a miserable job of educating investors about the historical evidence on how capital markets work. Unless one gets an MBA in finance it is unlikely that they have even taken a single course in capital markets theory.

    And it is not even enough to know to be passive or active and what funds to use, you have to know how to combine them effectively. And you have to know how to build an investment plan that incorporates ones ability, willingness and need to take risk. Then you need to have the ability and discipline to stay the course–something most investors simply cannot do as greed and envy take over in bull markets and fear and panic in bear markets (the evidence is clear that investors significantly underperform the very funds they invest in as they chase returns). Then you have to know how to write an investment policy statement including rebalancing table. And then you need to know which location to hold the right assets. Then you have to know how to effectively rebalance and tax manage in the most efficient way. And then you need to integrate that well thought out investment plan into a well thought out estate, tax and risk management (all types of insurance) plans.
    And then you need to adopt the plan to changing circumstances (even the passing of time changes the ability and willingness to take risk) and to changes in financial products as newer, better, lower cost and more tax efficient vehicles become available.

    Now if someone can do all those things for themselves, great. But very few can in my experience.

    Having said that here is some advice on how to choose a good advisor–guidelines–an advisory firm should be able to commit to these principles
    It is the set of principles to which Buckingham Asset Management adheres.

    The best interest of the client
    Our guiding principle is that we will provide investment and wealth management advisory services that are in the client’s best interest.

    Fiduciary standard
    We provide a fiduciary standard of care—the highest legal duty that we can have with a client.

    Fee-only
    We are a fee-only advisor—avoiding the conflicts and lack of objectivity that commissioned-based compensation can create.

    Products: They’re not-for-sale here
    We are client-centric—we don’t sell any products, only advice.

    Full disclosure
    All potential conflicts are fully disclosed.

    Use scientific research
    Our advice is based on the latest scientific research, not on our opinions.

    Practice what you preach
    We invest our personal assets, including our profit-sharing plan, based on the same set of investment principles and in the same or comparable securities that we recommend to our clients.

    Advisory team for each client
    Each client is assigned a team of professionals. Our comprehensive wealth management services are provided by individuals who have the CFP, PFS, or other comparable designation.

    Attentive, individualized service
    We provide a high level of personal attention. Developing strong personal relationships is central to our ability to provide appropriate advice and service for each client.

    Customized, integrated planning
    We develop investment and wealth management plans that relate to the whole person—that are integrated into to each individual’s unique strategy and personal situation.

    Strategic advice for long-term success
    Our advice is goal-oriented. We evaluate each recommendation, not in isolation, but in terms of its impact on the likelihood of success of the overall plan.

    As to government running one plan, that makes no sense since everyone has a unique ability, willingness and need to take risk and thus should have a different asset allocation.

  16. Our education system does do a miserable job of educating people financially.

    A planner does bring value to tax and estate planning, and for some people I guess they have to pay someone to organize themselves. However, I don’t see the value after that.

    Essentially you are saying managed funds are worthless…ok, I will go along with that. Now we are down to index funds, which are picked based on cost and sector/country, as there should be minimal differences between indexes in the same sector/country. If the person can read at a high school level they can figure this out on their own in an a few hours, as there are plenty of books and articles advocating index funds, risk, diversification, rebalancing, and dollar-cost averaging. With this basic info available I don’t see how planner/advisor is a justified expense for people only putting $5-10k away per year. The fees, even from legit/upstanding advisors, would be a huge chunk of that.

    Obviously, I have a problem paying someone to implement a strategy as basic as MPT (I know it takes complex math to figure out, but not to implement it). I also have a problem with MPT. It’s too robotic, which can cause problems. A good example is the last 8-10 months. If your porfolio required you to have 5% in financials and you kept rebalancing you lost money…a lot of money. Why when it’s blatantly obvious the financials were going to be in trouble for an extended period of time would anyone do this? Just sticking to a plan doesn’t make it right. MPT should be were you start, but a highly probable human prediction now and then based on hard facts should also be included.

    “As to government running one plan, that makes no sense since everyone has a unique ability, willingness and need to take risk and thus should have a different asset allocation.”

    Why couldn’t a government run or a bare bones operation like Vanguard do MPT for us? You would have 5-10 different risk levels. You pick one and it automatically populates all the appropriate indexes and rebalances on a set time frame. Maybe you meet with and an advisor when you first start and every 5-10 years after that if you aren’t comfortable doing it yourself. (Yes, I know a cheap government run operation is an oxymoron, but it’s just a hypothetical and used to determine if an advisor brings valid skills to MPT.)

  17. One last piece:

    MPT is a system devised by looking at historical results. Thus, there is no reason to assume people using MPT won’t look at their portfolios in 10 years and say, “Damn, this didn’t work.”

    “The issue is this, we know that there will be some investor who produces “Buffett-like” returns in the future. The problem is we cannot identify them today.”

    Just like we can’t say MPT is the correct method for the next 10 years, as the market doesn’t have to perform based on historical data.

    Everyone has their system. MPT is just another system.

  18. Chad
    Unfortunately there are many misconceptions about what MPT is or isn’t. MPT is not a system as you seem to believe. It is a theory about how markets work. It includes the efficient markets hypothesis. And nothing that happened in last year could lead anyone who understands MPT to conclude that it was wrong. Only those that don’t understand what it is make such statements.

    Second your statements about passive funds like index funds is very much the conventional wisdom and is often the case—is often as wrong as the Earth is flat. There can be very significant differences in risks, expected returns, costs, tax efficiency, diversification, revenue generated from securities lending, And there can be big differences in how they can or should be used in constructing portfolios

    You are certainly entitled to your view on the value of a good advisor, but perhaps it is skewed by your experiences with bad advisors or perhaps even understanding how a good advisor can add value.

    Old saying, not what a person doesn’t know that get’s him in trouble as much as what he knows but ain’t so.

  19. just for fun I reran some data I did for an article I wrote 4 years ago on this topic about Buffett

    So here was my hypothesis–want to beat the market, invest in BRK, or invest in DFA small value fund–
    as it has high loading on size and value risk factors. No stock picking, no market timing, etc.
    Both live funds if you will with costs.

    I would argue DFA fund lot less risky since it holds almost 1500 stocks

    Now this I admit is bit of data mining since I choose the start date, but for some people who had to make the choice 13 years ago this was a real decision

    1996-2008 BRK returns 8.84 percent with SD of 21.7
    The DFA fund returned an almost identical 8.83 but had lower SD of 19.3.

    Now I am not arguing that Buffett does not have skill, just now it seems pretty hard to prove that point. We now have 13 years without any evidence that he outperforms a simple passive asset class fund. This of course doesn’t prove anything either way but it does demonstrate how difficult it is to beat the market over the long term

  20. Theory, strategy, system…it makes no difference what it’s called, as it is guidance for investing. The label doesn’t change that.

    I understand MPT fine for someone who hasn’t studied it for years. Highest return at lowest risk by using diversification. Return changes as you change your risk level. Obviously, it gets more complicated than that, but this is the basic premise.

    MPT was created in the 50’s and steadily changed up until today. What makes todays MPT more correct than the 80’s MPT or the 70’s MPT? It’s highly unlikely there won’t be further changes in the future. So why is it good now?

    Basically, this can all come down to one question: Can MPT beat the market consistently? If it can’t, then why spend the money and do the extra work necessary to follow MPT theory? You could just buy a bucket of index funds that come very close to hitting market returns and go on your marry way. I would like to hear the error in my judgement, as I am willing to change my point of view.

  21. Chad
    What has changed about MPT is that more research has been done to make it a stronger theory. For example, CAPM was the leading theory to explain returns at the start–we lived in a one factor world where beta (exposure to the market) explained returns. Along come Fama and French and show that three factors do a much better job of explaining returns for equities–the other factors being exposure to value and size. So now models explain about 95-97% of returns instead of about 67%. And there is also a two factor model for fixed income–default and term risk

    Also we know have hundreds more studies to support the theory and also to explain the nature of the risks.

    And FYI MPT has NOTHING to do about beating market consistently. MPT is about explaining how markets work. In fact MPT would say that the way to achieve higher expected returns is to take more risk–only likely way to beat the market–that risk though can now be in three factors, not just beta.

    Finally as to your last questions, what you are really asking about is the value of a good advisor. I tried to address that above. But I will add this. After developing a well thought out plan it is all about execution-choosing the right funds (which change over time as the “technology” changes), choosing right location, having the right AA, and then disciplined rebalancing and tax management in the most cost effective and tax efficient manner. Based on all the studies done and my own 15 years experience there are very few investors (even those with the knowledge to do it) who can succeed on their own because emotions get in the way of discipline. Most investor simply don’t have the discipline on their own to rebalance when things are toughest–in fact that is when they tend to panic and sell. And the evidence is very clear that this is so. A study on index fund investors (the kind you are referring to) found that they underperformed the very funds they invested in by 2% a year. It was behavior that caused the problem.

    Unfortunately it is simply a very common human trait to be overconfident of ones skills, be it as a driver, lover or investor (there are good studies on this btw). And overconfidence leads to many mistakes including too much risk taking.

    BTW-You might want to read my books –they explain MPT and the EMH and how to build portfolios–I wrote them to help people who want to do it themselves. You can find them on Amazon and check out the reviews. I would suggest starting with Wise Investing Made Simple

    Best wishes

  22. @ Larry – If you’re trying to say that Warren Buffett is now ‘off the boil’ and will never beat the market again (except by luck, etc.) … well, THAT’S speculation 😉

    I think the greater lesson here is that unless you are satisfied with ‘market returns’ (perhaps ‘tweaked’ a little/lot for “risks, expected returns, costs, tax efficiency, diversification, revenue generated from securities lending”) then you should NOT be investing in the stock market: start a business; write a book; build some houses; etc; etc.

    … who knows, you may even end up BECOMING the next Warren Buffett? 🙂

  23. AJC
    You seem to misinterpret what I have been saying. I certainly never said that Buffett will no longer beat the market. And I never said it is impossible to beat the market. What I have said is that no one has found a way yet to identify people who WILL outperform the market with any greater odds than randomness.

    And as Berk points out the more money you have to manage the harder it gets to beat the market because the hurdles get greater.

    The lessons from the scientific evidence on investing is that while you certainly do have a chance to beat the market via stock picking and market timing the likelihood is so low you should not try—unless you place a high value on the ENTERTAINMENT of the effort. But keep in mind that you would never take your retirment account to Las Vegas

  24. @ Larry – No, I understand the point entirely, which I why I am wondering why you keep bringing up the point of Buffett’s performance over short/recent periods: “a few years ago I went to do a simple check on the performance of Berkshire Hathaway for the prior ten year period” and “I reran some data I did for an article I wrote 4 years ago on this topic about Buffett”? How does that possibly enhance or detract from your theory about MPT?

  25. AJC
    I give up.The evidence is important as these are NOT short periods. They are fairly long periods and it shows exactly what the literature shows–that even skilled based performance erodes–and you even have the hindsight of knowing how good his performance has been. We could go back and find many other examples of long success followed by miserable failures. Bill Miller is the perfect example–Fortune declared him greatest money manager after beating market 15 years in a row, something Buffett never did. Over and next three years he underperformed by 10, 12 and 18 %. So was he lucky or did he just take stupid pill three years ago?

    Pension plans and others all try to hire the next Buffett based on long positive records, yet they fail miserably. That is what the evidence shows–the markets are highly efficient.

    And BTW–if Buffett was so good why was he unable to outperform a simple passive asset class fund for the last 13 years?

    Since I have nothing more to say that will be my last comment on this subject anyway.

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