If you're hoping that you'll be the next Warren Buffett, I have some bad news for you.
If you're hoping to pay an investment professional to outperform the market to the same extent that Buffett did, I've got more bad news.
Buffett, CEO of Berkshire Hathaway and one of the greatest investors of all time, was a very rare bird. Active managers — i.e. professional stock pickers — are constantly claiming that they can outperform market benchmarks like the S&P 500, but they almost never do, particularly over periods of time that go beyond three or more years.
That's the conclusion of "The Incredible Shrinking Alpha," a new book by Larry Swedroe, chief research officer for Buckingham Wealth Partners, and Andrew Berkin, head of research at Bridgeway Capital.
How bad is it? S&P Dow Jones Indices has studied active managers for many years. Last year, they noted that after 10 years, 85% of large fund managers underperform their benchmark (usually the S&P 500), and after 15 years, that underperformance reaches 92% of managers.
That is a very bad record!
Why is it so hard to beat the market? Swedroe cites several reasons:
More from Invest in You:
No money? No expertise? Ditch your excuses and start investing anyway
Here's a scientific way to make better investment decisions
Millennials look to make a social impact with their investing dollar, study finds
But what about the Warren Buffetts and Peter Lynch's (the famed Fidelity Magellan Fund manager) of the world? Don't they outperform the markets?
Swedroe acknowledges that a small (very small) group of legendary investors do outperform, but he points out several factors that should discourage others from thinking that performance can be replicated:
So what's an average investor to do? Swedroe says the first thing to do is to decide what your risk tolerance is — the higher the risk, the higher a percentage of stocks to bonds you can own. For example, many fund managers recommend the traditional 60/40 split — 60% in stocks, 40% in bonds. But if you can tolerate higher risk, there's no reason you couldn't own a higher percentage of stocks, particularly if you are younger.
After that, Swedroe says that most investors are better served owning low-cost index funds, like those that track the S&P 500 and the Russell 2000, and not bothering to pay an active manager a higher fee to pick stocks or funds.
And keep it simple: Swedroe says you don't need to own 50 mutual funds or ETFs to have a broad portfolio.
How many would it take? He says a broad portfolio can be constructed with as few as three funds:
Whatever you do, Swedroe says, keep a consistent investment plan, and don't panic when the market goes down.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.