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.
Interpretation
Active managers often take risks that lead to varying outcomes, which can be misinterpreted as skill.
Eugene Fama emphasizes that active managers in finance must concentrate their bets, leading to high variability in performance. This concentration is a defining characteristic of active management, and the wide range of outcomes can often be attributed to luck rather than skill, highlighting the inherent uncertainties in investment strategies.
In practice
A financial advisor might quote this when explaining the risks of active investment strategies at a seminar.
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.
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.
Never, ever invest money that you will need prior to three to five years - minimum.
Eliminate emotion from your investment program.
But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?
A stock certificate is not a tool, like a shovel, or a commodity, like a pound of cheese. What we sell a customer is not a share in a business, but a view of the Elysian Fields. A financier is a creative artist. Our function is to stimulate the imagination. We are poets!
We are all powerless as children, and money looms so powerfully... we don't grow up to claim our financial power until we look money directly in the eye, face our fears, and claim that power back.
The Vanguard Experiment was designed to prove that mutual funds could operate independently, and do so in a manner that would directly benefit their shareholders.
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