Among the most brilliant and successful political tactics I’ve ever witnessed was the Republicans’ decision, decades ago, to use the words “tax-and-spend liberal” to repetitively and pejoratively label Democrats.
The phrase was so resonant with individual voters that it led to a Republican resurgence that continues to this day. But it also prevented what could have been an important national conversation over the ultimate role and size of government. Labels are powerful because of their simplicity. But used too often or too long, their simplistic message can result in one-dimensional thinking—with predictably terrible results.
“The goal of active investing is to outperform the market.”
I cannot count how often I have seen variations on the theme of this apparently sensible observation. There certainly doesn’t appear to be much, if any, argument with its conclusion. It is so ingrained in our thinking and so seemingly obvious that I’ve never come across anyone who was willing to claim that the goal of active investing has nothing to do with outperforming the market.
So I’ll do it: “The goal of active investing has nothing to do with outperforming the market.” Admittedly, it looks like I’m just trying to be provocative with a foolishly illogical statement. But one of the most valuable lessons I ever learned was the importance of knowing the difference between something that appears foolish and something that actually is foolish. For investors that distinction can mean everything.
Before we can evaluate the goal of active investing, we first need to step back a bit and understand the activity we know simply as investing. The purpose of investing is obviously different for each investor—but the fundamental reason that leads us to take money out of the bank and sink it into an enterprise is that we believe that our opportunity for profit is worth the risk. Whether the investment is a four-unit apartment, our own business, a few shares of Berkshire Hathaway or an index fund—the basic calculus is always the same.
In terms of stocks and bonds, the common denominator among successful strategies of all varieties (both legal and illegal) is that they are able to identify something that can be exploited profitably. For example: Inside information exploits non-public secrets; a Ponzi scheme exploits investor greed; value investing exploits investor impatience and short-termism; highspeed trading exploits inefficiencies in the market mechanism; micro-cap investing exploits opportunities created by a lack of Wall Street research; and indexing exploits the efficient market hypothesis. There is no end to it. The number of potential investment options is limited only by the creativity and insight of market participants.
The hard truth, the inviolable law of human affairs, is that in whatever activities we engage, whether in school, sports, arts, community, government, work or investing—the bell curve applies. A few of us will be truly outstanding, and a few of us will be completely inept. But most of us will be end up being somewhere above or somewhere below average. There’s not much we can do about this. I will never swim like Michael Phelps or write anything as compellingly interesting as Michael Lewis. But my body is energized by swimming, and my thoughts are clarified by writing. The pleasure and satisfaction I get from my competence in these activities has nothing to do with where I am on the bell curve, even if it could be known. The activity is its own reward.