Who are your books written for? My first four books were all directed at the individual investor, though I hope professionals would enjoy reading them and find value in them. My next book, the fifth one, is called Investment Policy, and while it's directed at both groups, [it's meant] particularly for investment advisors, to help them figure out what should be the right investment policy. It will be at a little higher level than my previous books, and anyone who's read the others should have no problem, but if you're reading Mutual Funds for Dummies, you ought to finish that before you read my book.
My fourth book (The Successful Investor: 14 Simple Truths You Must Know When You Invest), is directed right at the individual investor. I wanted this dual audience to benefit from all my books. So I did a tremendous amount of academic research, allowing the advisor or sophisticated investor to get value out of the research and then to show them how to utilize this information. I also had my wife, who is a very bright woman and taught at Stanford but knows nothing about investing and doesn't care, to read my manuscript. If she didn't understand something, I had to rewrite it until she did. So my first book in particular is filled with analogies to cooking and gardening and movies and history to convey these difficult concepts in a way that's easy to understand.
I'm a big believer in using analogies based on experience to help people. I think the books pass that test of being accessible to the average investor who knows at least what stocks and bonds are, but is also worthy of more sophisticated investors who are looking for the academic research and the applications of that research.
This most recent book [is devoted to] 14 basic truths about investing, devoting 20 or 30 pages to each instead on some of the most important issues investors face.
After people find out what I do for a living, the first thing they ask is, "Got any hot stock tips?" And I respond by saying there's only one incontrovertible piece of evidence: Invest in the indexes, and for the longest time. Here's the way I say it very simply. Imagine you belong to a golf club and you've contributed $1,000 to a charitable auction, and as the winner of the auction, you get to play a round of golf with Tiger Woods. On the fifth hole, you hit your usual poor shot, it ends up in the rough near a big tree, and you think, I've got to lay up. Tiger Woods is so unlucky that as he's swinging, a huge gust of wind blows his ball right next to yours. He gets there, notices an opening between two branches, and decides to go for the shot. But it hits a branch, and the ball's right back where he started. He does it nine times in a row, and on the tenth time he makes it and it drops right into the cup. So now you have a decision to make: the very best player in the world can make the shot once in ten attempts: 90% of the time he fails. If you're trying to get the best score, meaning which shot is going to produce the lowest score for you, what should you do? Should you lay up, or try to make the shot that Tiger failed at 90% of the time? You lay up, of course, because if the very best can't do something 90% of the time, you shouldn't try. That doesn't mean the very best can't succeed, only that it's very unlikely that they will succeed, that therefore it's not prudent for you. So what's the analogy?
A study by Future Metrics cited in the book looked at the performance of 224 pension plans over about 14 years versus the performance of a 60% to 40% benchmark of the S&P 500 and the Lehman aggregate index for bonds. Of those 224 plans, 19 beat the benchmark. So what that means is that 90% failed and 10% did better. In other words, 90% of the plans would have been better off laying up.
So ask yourself as an investor, what the hell are you going to do differently than those guys to make you believe that you are better than them and can outperform? Sure, you have the hope of outperformance, just like Tiger had to hope that he could make that shot through the branches. But 90% of the time you fail. So why play the game? When you pose it that way, and already have people realize that it's not rational, they start to think differently.
Here's the other piece of evidence that's also in the book. If you look at the history of after-tax returns for periods of at least 10 years, on an after-tax basis--when you include survivorship bias--the winners are not only grossly outnumbered by the losers by a ratio of about 9 or 10 to 1, but the winners, on average, win by only 1% a year, while the losers lose by about 3% a year. When you risk-adjust those odds, you have a very low chance of winning. Moreover, if you do win you're likely to do so by a small amount--it's not like you're going to hit the lottery.
In other words, it might pay to play and you'd be willing to accept a high likelihood of a loss if when you do lose, you'll only lose a little, while if you win you'll win big. But the evidence shows that this is exactly the opposite. Here you'll have a 90% chance of a loss, and if you do win, you only win by a small amount, while if you lose, your loss is much bigger.
Those two stories tell you all you need to know. Who cares if the markets are efficient are not? Just look at the evidence, and it shows that if the odds of even the very best succeeding are so low, why should you try? That's one of the main messages of all my books. It's not that active management is doomed to failure (though it is in aggregate), it's that everybody thinks they'll do better than average. They all live in Lake Wobegon.
So why don't they realize their error? Two main reasons. First, they're totally uneducated--the educational system has failed Americans. One of my big themes, one of the reasons I write books, is to educate people. Because unless you get an MBA in finance from a good school, where do you learn about investing? From two sources, both of whose goals are totally contrary to yours. You get it from Wall Street, which makes money every time you trade, whether you win or not, so they're very much like what Eddie Murray points out in the movie Trading Places, where he says to [these Wall Streeters] when they tell him they make money whether their clients do or not, "Oh, you mean you're bookies?" And they make money selling actively managed funds which deliver lousy results but they get paid a lot.
The other source of information for investors is the media, and the way they make money is getting you to tune in to the noise, because if they told you to buy and hold and only own index funds, what do they tell you next month?
People have to understand who's giving you this advice, and that those who are have an interest in you playing the loser's game of active management. Not that you can't win, but you have these terrible odds against you. But it's always a winning game for them.