There are three types of investors: smart, dumb and dumber. Eugene Fama, best known for his Efficient Market Hypothesis, helped millions of "dumber" investors to switch to dumb investing, by having them use passive investing, where you invest in low-cost passive portfolios that mimic the performance of the S&P 500 index or some other broader index. Academic studies have shown that retail investors, on average, significantly underperform the market after accounting for transaction costs. Switching to passive investing is a big improvement for these investors. However, this doesn't change the fact that they are still leaving money on the table.
Smart investors don't imitate the S&P 500 index. There are better ways of investing. Warren Buffett has been claiming publicly for the past 30 years that he can outperform the market. Our research has shown that imitating Warren Buffett 's top-five large-cap stock picks outperformed the market by 30 basis points per month between 1999 and 2012. These stocks also outperformed the market by 37 basis points per month between 2008 and 2012.
Imitating Buffett's top-five large-cap picks in an IRA account has been a superior alternative to dumb investing. The list of Buffett's top-five large-cap picks didn't change dramatically from quarter to quarter, yet it managed to outperform the market by four percentage points per year over the past decade or so.
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| Warren Buffett |
