Investment pro to individuals: Index or lose

David Swenson is an investment success story. As overseer of Yale University’s endowment fund for the last 20 years, he has helped it grow to $15 billion by beating the stock market with annualized returns of 16% per year. Swenson hires and oversees active money managers who buy and sell based on their outlooks for individual stocks, industries, and the market. Yet Swenson, who just published Unconventional Success: A Fundamental Approach to Successful Investing, says individual investors should not try to copy what he does. Instead, they should stick to indexing their investments through passively managed mutual funds that attempt to mimic market returns. 

Individual investors lack the advantages enjoyed by big, professional investors, he says. For instance, much individual investing is done through active mutual funds. The problem there is the conflict between a mutual fund company’s profit motive and its duty to its investors. “When you put the profit motive up against fiduciary responsibility, that fiduciary responsibility loses every time,” he told The Wall Street Journal. When he deals with the same for-profit money managers, it is a “fair fight,” he says: he has the knowledge and the financial clout to get good service. Individual investors are at the mercy of the fund company, he says. Statistics on the active mutual fund industry that are adjusted for funds that have gone out of business or merged show that the industry has lagged behind the stock market by 4.5% per year over the last 10 years, he says. Many active mutual funds also hurt investors because their tax effects are not managed, meaning investors lose too much money to taxes, he adds. Individuals also hurt themselves by behaving badly: too many investors chase performance, pumping money into active funds that have gone up and pulling it out of those that fall.

Instead of chasing returns and using active funds, investors would do better spreading their money around into a variety of passive funds that invest in different types of assets, he says.

Swenson recommends traditional big stocks and bonds but also suggests inflation-indexed bonds, foreign stocks, emerging market stocks, and real estate securities, he says.