manager shakes his head and says, “You can’t outrun black bears;
they’ve been known to sprint over 25 miles an hour to capture their
prey!” The second manager responds, “Of course I know that I can’t out-
run the bear. The only thing that’s important is that I can outrun you!”
In the competitive world of money management, performance is
measured not by absolute returns but the returns relative to some bench-
mark. These benchmarks include the S&P 500 Index, the Wilshire 5000,
the Russell indexes, and the latest “style” of indexes popular on Wall
Street. But there is a crucially important difference about investing com-
pared to virtually any other competitive activity: Most of us have no
chance of being as good as the average in a pursuit that others practice
for hours to hone their skills. But anyone can be as good as the averagein-
vestor in the stock market with no practice at all.
The reason for this surprising statement is based on a very simple
fact: since the sum of each investor’s holdings must be equal to the mar-
ket, the performance of the whole market must, by definition, be the av-
erage dollar-weighted performance of each and every investor.
Therefore, for each investor’s dollar that outperforms the market, there
must be another investor’s dollar that underperforms the market. By
just matching the performance of the overall market, you are guaranteed
to do no worse than average.
But how do you match the performance of the whole market? Until
1975, this goal would have been virtually impossible for all but the most
affluent investors. Who can hold shares in each of the thousands of firms
listed on U.S. exchanges?
But since the mid-1970s, index mutual funds and then exchange-
traded funds (ETFs) have been developed to match the performance of
these broad stock indexes. Over the last several decades the average in-
vestor could match the performance of a wide variety of market indexes
with very low costs and a very modest investment. And, over the last sev-
eral years, new indexes have been developed, based on the research dis-
cussed in Chapter 9, that may allow investors to outperform the averages.
THE PERFORMANCE OF EQUITY MUTUAL FUNDS
Many claim that striving for average market performance is not the best
strategy. If there are enough poorly informed traders who consistently
underperform the market, then it might be possible for informed in-
vestors or professionals to outperform the market.
Unfortunately, the past record of the vast majority of such actively
managed funds does not support this contention. There are two ways to
342 PART 5 Building Wealth through Stocks