Week 7 Day 4: You Do Not Need to Pick Stocks

Over any 15-year period, roughly 90% of professional stock pickers fail to beat the S&P 500. These are people with teams of analysts, million-dollar research budgets, and decades of experience. If they cannot beat the index consistently, what chance do we have? The answer: buy the index.

The SPIVA Scorecard, published annually by S&P Global, measures this rigorously. Over 15 years ending 2023, approximately 88% of U.S. large-cap actively managed funds underperformed the S&P 500. Over 20 years, it is above 90%. The reasons are structural: (1) Fees. Active funds charge 0.5-1.5% in management fees versus 0.03% for an S&P 500 index fund. Even if the manager matches the market, the fees drag the net return below it. (2) Tax inefficiency. Active trading generates capital gains taxes that index funds avoid through low turnover. (3) The market IS the collective wisdom of all professionals. It is very hard to consistently outsmart the aggregate. Jack Bogle, founder of Vanguard, made this case for decades and was eventually proven right by mountains of data.

Eugene Fama's Efficient Market Hypothesis (EMH) provides the theoretical framework for why index investing works. The semi-strong form of EMH suggests that all publicly available information is already reflected in stock prices, making consistent outperformance through stock analysis extremely difficult. While pure market efficiency is debated, the practical implication is robust: after costs, the average investor's return equals the market return minus fees. William Sharpe formalized this in his 1991 paper 'The Arithmetic of Active Management,' proving mathematically that the average actively managed dollar must underperform the average passively managed dollar by precisely the amount of fees charged. It is not an empirical claim -- it is arithmetic tautology. This is why Buffett's famous bet (2007) that an S&P 500 index fund would beat a selection of hedge funds over 10 years was won handily. The index returned 125.8%. The hedge fund selection returned 36%.