Teaching People to Trade Stocks Is Like Starting Them on Heroin – Munger
This obsession with index funds is getting a little out of hand. Sure for many people buying an index might be a good idea. I myself recommend that many people buy an S&amp;P 500 index. But to criticize all active managers is a little wrong. For one, Warren Buffet and Charlie Munger are active managers themselves, you do not see them buying an index fund.<p>Lets think about what happens when you buy the S&amp;P 500 index. This is usually the most recommended index, and the one I recommend too. You basically give your money to own stocks of the 500 biggest publicly listed companies in the US. If a company is big enough and it gets their stock listed on the major markets it usually gets included in the S&amp;P 500. (There are some exceptions but generally this is the way it works). Does that make these companies good investments? Not necessarily. There is a way to get big without being especially good at what you do (through mergers). It is possible that certain companies were very good investments before, had their stock appreciate, got into the S&amp;P 500, had a change of management or experienced a change of end markets, and became bad investments. This is what happened to GE, for example.<p>The theory of indexing says that, yes there will be some companies in the S&amp;P 500 that are not very good, but others will be excellent and it will all even itself out and you will make money in general as the economy grows. But that will only work if there are no secondary effects. If putting all money in indexes becomes the usual course of action for institutions as well as individuals then it would be very easy to exploit this. A company just needs to get large enough to get send to the S&amp;P 500 (again this can be done with mergers and without necessarily being very successful or profitable) and then they get a bunch free money send their way by way of indexing. And if you get a bunch of badly run companies merging together to get into the index, indexing will certainly become a rather money losing proposition.<p>The reason why indexing tends to work and it has worked so far, is that indexers are kind of free riding on active investors. Active investors buy and sell stocks and they thus cause the price to move up and down. The price of the most wanted companies moves up and they get put into the top indexes, where the free riding index investors buy their shares. The active investors do not mind because they were first into the shares, and the free riders just increase the value of their holdings. The free riders do not mind because the active investors in a way pick stocks for them.<p>This all works fine but the whole system relies on there being enough active investors to free ride upon. And if this whole buying indexes trend goes out of hand there might not be.<p>Buffet and Munger have some good cause to criticize active managers. Many of them have not been very good at all. Money management is one of those professions where it is not easy to determine ahead of time where someone is good or bad at it. Even excellent money managers can have a couple of bad years and terrible money managers can get lucky once or twice. Thus, you have to wait several years to see whether someone is actually good at managing money and during that time they actually have to have money to manage. So to even test whether someone is a good money manager requires taking on a lot of risk. And because being a money manager can be so very lucrative and glamorous and because it is so hard to distinguish the good ones from the bad ones the whole field attracts a lot of smooth operators that know how to ape the look and talk of a person the public would expect to be a successful money manager but they do not know how to do it.<p>This is a problem with many other professions that are glamorous but where it is hard to initially tell the good from the bad. These include TV&#x2F;Movie director, TV&#x2F;Movie writer, politician, newspaper column writer, artist etc.<p>That being said there are money managers that are undoubtedly very good. Buffet and Munger are themselves a couple of examples. There are many others. Perhaps there aren&#x27;t enough of them. Perhaps we as an economy are having a problem of not being able to train and recognize able money managers. That may be the case, but that does not mean we should abandon the concept of an active investor. The world actually needs active investors, money managers and asset alocators in general. The dream of simple, cheap and easy passive investing cannot work without them.