Warren Buffett took a bet 10 years ago with a hedge fund that simply investing in a low cost S&P 500 index fund would out-perform other strategies that the hedge fund may employ. In his latest shareholder letter pages 9 - 12, Buffett details the results of his win - the S&P 500 handily out-performed the hedge fund.
But why does index investing work? For a detailed look at this, read "Do Stocks Outperform Treasury Bills?" by Prof. Hendrik Bessembinder at the Arizona State University. Prof. Bessembinder analyzes all stocks publicly listed in the US markets (approx. 25300) since 1926 through 2016. Just 1000 or so companies (4%) account for 100% of the wealth created by the stock market. The remaining 96% tread water with Treasuries (hence the title), and, scarily, 4 out of 7 companies destroy wealth. The key insight from Bessembinder's paper (that dovetails in with Buffett's call to invest in S&P 500 index fund) is that diversification is NOT just a loss-minimization strategy but rather a gain-maximization strategy. Omit key stocks from your portfolio and your results are likely to be pretty bad.
Prof. Bessembinder's paper is a must read. It's filled with mathematics - though its understandable even if you skip the math.
I have written a blog post tying the two papers together. To make it easier to read I have written this as a fable in 2 parts. I have just published On Successful Investing: A Fable (Part 1). I thought that interested readers may read Part 1, delve deeply into the papers themselves and make their own judgments, and then review Part 2 which I plan to publish in a few days.
Good luck!
Submitted March 05, 2018 at 07:41PM by arnexa http://ift.tt/2FWnnFp
