Costs are the best single predictor of the future performance of an investment. Keep costs lower — by tracking an index rather than investing in attempts to beat it — and for any given level of risk your returns should be a little higher.
Why investors need to know about indices.
Research by London’s Cass Business School shows that randomly chosen portfolios — that might as well have been picked by monkeys — are overwhelmingly likely to beat market-cap-weighted indices. But most monkeys failed to match equal-weighted indices, or indices based on most sophisticated measures to limit risk.
So the hierarchy is that simple equal weighting indices beat monkeys, who beat value-weighted indices like the S&P, which beats the average active manager (who nonetheless complains that the S&P benchmark is unfair).
Yet our money is still mostly run by active managers, while none that I am aware of is run by monkeys. For these reasons, and many more, we need to know more about indices.
Mr Markowitz’s comment on this: “One lesson from 2008 is that if it’s very complicated and you don’t understand it, maybe you shouldn’t buy it.”
Anyone with a simple rule that required them to keep 40 per cent in bonds and 60 per cent in stocks would have “rebalanced” — bought stocks — near the market’s nadir five years ago, he points out.