After costs, only the top 3% of managers produce a return that indicates they have sufficient skill to just cover their costs, which means that going forward, and despite extraordinary past returns, even the top performers are expected to be only as good as a low-cost passive index fund. The other 97% can be expected to do worse.
Interpretation
Most managers fail to outperform a simple index fund after fees are taken into account.
Eugene Fama's quote highlights the reality of investment management, emphasizing that only a small percentage of managers have the skill to deliver returns that surpass the costs associated with their management. Despite some managers showing impressive past performance, this quote suggests that most will struggle to meet or exceed the returns of low-cost index funds, illustrating a significant challenge in active investing.
In practice
This quote can be used in a financial seminar to illustrate the challenges of active management.
The problem that people don't understand is that active managers, almost by definition, have to be poorly diversified. Otherwise, they're not really active. They have to make bets. What that means is there's a huge dispersion of outcomes that are totally consistent with just chance. There's no skill involved it. It's just good luck or bad luck.
Market timing doesn't work. If all the bubbles and all this mispricing really exist, how come so few people see it before it turns out that way?
There's quite a bit of evidence that even professionals don't show any ability to pick stocks or to predict market rollbacks. Most of the people we identify as skilled based on returns have probably just been lucky.
I cannot invest the way I want the world to be; I have to invest the way the world is.
If the fluctuations in your investment portfolio are reduced, the impact of emotions and behavior on your account is also reduced.
Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.
It isn't as important to buy as cheap as possible as it is to buy at the right time.
Ben's Mr. Market allegory may seem out-of-date in today's investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising 'Take two aspirins'?
The basic story remains simple and never-ending. Stocks aren't lottery tickets. There's a company attached to every share.
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