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My Interview with

I recently did an interview with discussing passive investing and whether skill exists in choosing individual investments. You can read the full interview in their post, "Larry Swedroe on Passive Investing and Skill." Below is an excerpt from the interview.

Portfolioist: You quote loads of research that supports your position that investors lose out when betting on actively-managed mutual funds. And the Bogleheads is a discussion forum with a strong bias toward Vanguard-style, low-cost, index investing. So why do you think, even there, readers argue this point?

Swedroe: People want to believe there's somebody who can predict where things are going. Despite all the evidence that there are no seers, people will still pay a lot of money to believe there are seers ... Philip Tetlock is an expert in political judgment, where it's much more important to get the forecast right. Does Saddam Hussein have weapons of mass destruction, for example. In his book Expert Political Judgment: How Good Is It? How Can We Know?, he writes about the people who advise the CIA, etc., and their forecasts are lousy. There are no good forecasters.

Tetlock describes the hedge hogs and the foxes. Hedge hogs look through a prism. You can tell them something is black and they'd say it's white. You can't convince them. Hedge hogs know a lot about a little. Foxes know a little about a lot. If you're a fox and I try to convince you your position is wrong, I might get you pulled into the middle. It's the hedge hogs who are more sure they're right. Neither are good predictors, but hedge hogs are worse. They're like Nouriel Roubini [who's negative predictions have made him famous in the last few years]. On occasion they'll be right, like a broken clock is right twice a day. The foxes pick moderate outcomes, they get it more right, but the hedge hogs get more famous. They're on CNBC for the next few months.

There's an old saying about forecasters, from John Kenneth Galbraith, "There are two classes of forecasters: Those who don't know and those who don't know they don't know." I say there's a third type: Those who know they don't know, but get paid a lot of money to pretend they do.

Portfolioist: Your argument isn't that there's no chance an investor can be skilled.

Swedroe: [Academics Kenneth R.] French and [Eugene F.] Fama wrote the paper on skill versus luck. They say what we do know is there are so few funds that outperform, we can't differentiate skill from luck. An investor might [pick the] right [fund], but the odds are so low that they're right, it's not prudent to take that risk.

You only hear about (Yale Endowment's chief) David Swensen, but how many others failed trying to do exactly the same thing? I'm not saying Swensen doesn't have skill and Warren Buffett doesn't have skill. I'm saying I can't find the future Buffett today. The very few who outperform, especially in taxable accounts, outperform by very little on average.

Portfolioist: So just buy the market and go away?

Swedroe: Don't confuse index investing with just buying an S&P 500 fund. In The Only Guide You'll Ever Need for the Right Financial Plan, I describe how much small company stock, emerging markets, real estate you want to have, and having the right amount of high quality fixed income. You need to decide on a geographic division too. I tell people 50% international, 50% US is logical, but 30% international is better than 0 and it's better than 10% which is what the average investor has.

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