No. of Recommendations: 19
The thing that is amazing, even remarkable is that despite the "fund managers" of the S&P500 "classically" buying high and selling low, they STILL outperform 95+% of all other fund managers over the medium term, and STILL outperform 99+% of all other fund managers over the long term. Astounding, isn't it?
Well, to be fair to the active fund managers, the biggest reason for that is fees. Rather surprisingly, the stock picks of most active managers do beat the cap weight index on average before fees and expenses and the drag from cash allocations. Not by much.
That said, it's not at all difficult to beat the S&P 500 if you're not letting taxes determine the outcome. A monkey with a dartboard has about a 99% chance of managing it. (number not picked from thin air, it was a real test)
Commissions and spreads and price slippage are pretty low these days for those of us with portfolios a few orders of magnitude smaller than that of Berkshire, and many portfolios are not taxed as they go. Test a strategy similar to this: pick a number of stocks to buy, N, maybe 40 or 75 or 150. Mainly it's a function of how much you dislike typing. Avoiding days anywhere near index reconstitution dates, put each 1/N of your portfolio value into a randomly selected stock from among the S&P 500 set (or Russell 1000 or S&P 1500 or whatever) that was not added to the index in the last few months. Hold each position for a year (anywhere 6-24 months) then replace it with another random pick. (Do NOT sell something early that is ejected from the index). The stock swap dates can be staggered: for example, you might swap 20 positions every few months. This is extremely likely to beat the S&P 500 over time, before tax, for a variety of empirical and theoretical reasons. Mainly by avoiding having outsized amounts of capital allocated at any given time to whatever is most overvalued at the time, but also avoiding the index-inclusion drag effect. (stocks newly added to an index are statistically extremely bad performers for the next year, causing a drag of at least 0.22%/year in the case of the S&P 500).
There are stretches that only outsized positions in the very largest firms will do well, as in the late 1990s or the last two years, and this strategy will not beat the index at those times. But it will most of the rest of the time, and overall, and will do so with a fraction of the single stock risk.
Interestingly, the "dart board" step is quite important. If you hand pick the stocks to buy, your chances of beating the index will plummet. You're suddenly playing the game everyone else is, with no better information, the exact trap that index investing was designed to avoid.
Jim
