Index Funds (Again)

(Zen Buddha Silence by Marilyn Barbone)

(Image:  Zen Buddha Silence by Marilyn Barbone.)

September 11, 2016

The Elements of Investing: Easy Lessons for Every Investor (Wiley, 2013) is an excellent book by Burton Malkiel and Charles Ellis.

For the vast majority of investors, low-cost broad market index funds are your best long-term investment option.



After four or five decades, low-cost broad market index funds will beat at least 95-98% of all investors, net of expenses.  This is purely a function of costs.  As Malkiel and Ellis note:

This simple investment strategy – indexing – has outperformed all but a handful of the thousands of [funds] that are sold to the public.

Even Buffett has suggested that most people would be far better off simply investing in index funds.  So has David Swensen, the brilliant portfolio manager for the Yale University endowment fund. 

Here is Warren Buffett:

My money, I should add, is where my mouth is:  What I advise here is essentially identical to certain instructions I’ve laid out in my will.  My advice to the trustee could not have been more simple:  Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund (I suggest Vanguard’s).

Buffett is winning a 10-year, $1 million bet against Protégé Partners (the proceeds will go to charity).  Eight years into the bet, Buffett’s investment in the Vanguard 500 Index Fund Admiral Shares is up 65.67%, while Protégé Partners’ investment in five funds of hedge funds is up 21.87%.  See:

After several decades, the very low costs of index funds (the ones with rock-bottom fees) will cause them to deliver better results than nearly all other investors over the same time period.  There are only a handful of funds since 1970 that have beaten the market by any meaningful amount.  Malkiel and Ellis:

Since 1970, you can count on the fingers of one hand the number of managers who have managed to beat the market by any meaningful amount.

Nobody – repeat, nobody – has been able to figure out in advance which funds will do better. (This includes Morningstar.)

Therefore, if your investment time horizon is measured in decades, low-cost index funds are probably your best bet and should make up the core of your portfolio.



If you have a group of at least thirty people, try this experiment.  Fill a transparent jar with pennies, where only you know how many pennies are in the jar.  Then ask everyone in the group to guess how many pennies are in the jar.

Almost invariably, if you take the average of all the guesses in the group, that average will be closer to the true number of pennies than will any individual guess.

This is a very good way to think about the stock market.  The stock market is the aggregate of the best guesses of all investors.  It’s nearly always true that the stock market on the whole is smarter than nearly all investors.  As Malkiel and Ellis write:

It is difficult for most investors to believe that the stock market is actually smarter or better informed than they are. 

The cold truth is that our financial markets, while prone to occasional excesses of either optimism or pessimism, are actually smarter than almost all individuals.

Nobody knows more than the market. 

You can save time, anxiety, and money by ignoring all market forecasts.

 Or as Jason Zweig says:

If you can plug your ears to every attempt (by anyone) to predict what the markets will do, you will outperform nearly every other investor alive over the long run.

Warren Buffett again:

Forming macro opinions or listening to the macro or market predictions of others is a waste of time.  Indeed, it is dangerous because it may blur your vision of the facts that are truly important [i.e., long-term business performance].

Very occasionally there are bubbles and crashes in the stock market.  But virtually no one can time these things.



Many people seem to agree that U.S. stocks are overvalued, but what if U.S. stocks are actually undervalued?

If interest rates stay near zero for a couple of decades, then the S&P 500 Index being over 2100 today may still be undervalued rather than overvalued.  Over one hundred years of history for the U.S. stock market averages (and their predecessors) may not be relevant if rates stay near zero for a couple of decades.

Newfound Research recently did a great blog post about this:

Here is my brief summary:

  • Stocks derive their present value from future dividends relative to interest rates.  As Warren Buffett has remarked, if interest rates were to stay near zero long enough, eventually P/E ratio’s would be 50 or even 100.
  • High debt levels and slow population growth in the developed world could mean slower GDP growth over the next few decades. Reduced GDP growth implies lower interest rates.

An interesting historical note:

Ben Graham, the father of value investing and Warren Buffett’s teacher and mentor, had developed a measure of the fair value of the U.S. stock market.  But based on a more aggressive stance by the U.S. government with regard to corporate earnings, Graham decided he needed to add 50% to his measure of fair value.  See:

If you consider the high debt levels and slow GDP growth in most of the developed world today, it’s quite possible developed world central banks – including the Fed – will keep rates low for a couple of decades.  In this case, like Graham, we need to add at least 50-100% to our estimate of the fair value of the stock market.

On the other hand, if there are economically significant technological breakthroughs in the next decade or so, then GDP growth could jump much higher, in which case interest rates would likely normalize.



In a world of aggressive central banks, including zero or negative interest rates, part of your long-term investment portfolio should be able to do well if inflation occurs.

The best inflation hedge – according to Warren Buffett – is to own productive businesses that can “deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.”  See:

Buffett argues that owning productive businesses like this is better than owning gold.  If you consider the long term (a few decades at least), Buffett is right.  (If you own a low-cost S&P 500 index fund, then you’ll own small slices of many productive businesses.)

Malkiel and Ellis point out that real assets such as timber and oil have usually provided better inflation hedges than ordinary industrial companies whose profit margins get squeezed when raw material prices rise.

Gold and gold-mining companies also tend to do well when currencies are being debased.  Moreover, gold and gold-mining companies are usually negatively correlated with the broad stock market, thus adding true diversification to your portfolio.



In a flat but volatile market, if you dollar-cost average, you’ll do better than you would have if the market went straight up.  This is simply because a volatile but flat market gives you more opportunities to add to your positions at lower prices.  When prices are low, because you’re buying a fixed amount under dollar-cost averaging, you end up buying more shares.

As Warren Buffett has said:

Smile when you read a headline that says, ‘Investors lose as market falls.’  Edit it in your mind to, ‘Disinvestors lose as market falls – but investors gain.’



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are 15-25 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 10-15% (at cost), while the average position is 5-7% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

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