"It will fluctuate."

— J.P. Morgan's reply when asked what the stock market will do.


Harry Markowitz
Harry Markowitz

In this volume Mark Hebner meticulously refutes the idea that individual investors can beat the market by stock selection or market timing. Some readers may react with the thought that "perhaps most investors cannot beat the market, but some can. I merely have to emulate those with superior performance." Examples of investors with sustained superior performance include the legendary Warren Buffett and David Swensen, Yale University's Chief Investment Officer, whose performance over decades has been widely admired and imitated by endowment and retirement plan managers, but with rare success.

If you examine the words and practices of these distinguished investors, you will find their above-market performance is not due to a set of rules which can be followed by individual investors. Rather, it is due to resources and opportunities which individual investors and most institutional investors do not have. Mr. Swensen tells how he does it in his book, "Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment." As noted in the title, Swensen's book explains how an institutional investor (as distinguished from an individual investor) might achieve above-market returns. He observes there is little chance for beating the market with well-followed securities such as large cap and small cap stocks. As to opportunities available to the institutional investor from less conventional sources, Swensen writes: "Populated by unusually gifted, extremely driven individuals, the institutional funds management industry provides a nearly limitless supply of products, a few of which actually serve fiduciary aims. Identifying the handful of gems in the tons of quarry rock provides intellectually stimulating employment for the managers of endowment portfolios."1

Few, if any, individual investors have the time and skill to separate the "gems" from the "quarry rock," even if they were presented with similar opportunities. Any individual investor who believes he or she can achieve above-market performance is almost sure to underperform the market substantially, as Mark Hebner documents.

Hardly any institutional investors are able to outperform their proper benchmarks. Among those who do accomplish this feat, their ranks largely change from year to year, making their discovery a moving target, as Mark Hebner shows in this volume. Swensen affirms the difficulty of identifying skilled fund managers. He states, "I erred in describing my target audiences. In fact, I have come to believe that the most important distinction does not separate individuals and institutions… few institutions and even fewer individuals exhibit the ability and commit the resources to produce risk-adjusted excess returns."2

Indeed, the challenge of ferreting out the gems from among the "tons of quarry rock" is more challenging than it might
first appear. While Warren Buffett has not written a text on the subject, his actions show his success—like Swensen's—is in part due to his being offered opportunities not available to the individual investor. Specifically, he is offered the opportunity to take large positions in established companies at favorable prices. At such times, company information is made available to Mr. Buffett and his staff which is not routinely available to the public. Ultimately, however, it is his and his staff's ability to evaluate such positions—to separate the gems from the quarry rock—that explains their long-run success. As in the case of Swensen's outperformance, few individual investors have the time and skill to evaluate such opportunities, even if they were presented to them.

As to market timing, I know of no one who has consistently outperformed the market by market timing. Since there are always countless "authorities" who say to buy, and countless others who say to sell, there will always be many instances in which someone called correctly the last turn of the market, and even the last two or three turns. As Hebner documents, it is a foolish hope to try to emulate such market timers. It is better to go with J.P. Morgan's advice—that all one knows about the market is that it will fluctuate.

J.P. Morgan's observation has at least three implications. The obvious one is: Don't try to time the market. You will make your broker rich, not yourself. Another implication is you should choose a portfolio you can live with despite market fluctuations. For example, the year 2008 was not an "outlier," nor was it even the worst year on record. Rather it was tied for the second worst year. It was a one-in-forty year event, not a one-in-a-thousand year event. The frightened investor who decided to get out of the market in March of 2009 locked in his or her losses for good. The chief problem with small investors is they buy when the market has gone up and believe it will rise further, and they sell when the market has fallen and believe it will fall more. One of the principal functions of the right financial advisor is to make sure the investor understands the volatility of his or her specific portfolio and is willing to stick with it for the long run.

As Mark Hebner explains, a third implication of the fact that markets fluctuate is the need to rebalance. Suppose an investor is comfortable with a 60-40 mix of stocks versus bonds. If the market rises substantially, the portfolio's equity exposure will greatly exceed sixty percent. The rebalancing process sells off the excess, bringing the portfolio back to a 60-40 mix. If the market falls, then the portfolio will have less invested in stocks than the target 60 percent. The rebalancing process then buys. This process of rebalancing—which sells when the market is up and buys when the market is down—is sometimes referred to as "volatility capture" and leads to what Fernholz and Shay (1979) refer to as "excess growth."3 The rebalanced portfolio will grow faster than the average growth of its individual constituents. It may even grow faster than any one of its constituents due to the rebalancing process. Thus, if handled knowledgeably, market volatility can be the investor's friend.

"Money in the bank" sounds safe, but will do little to outpace inflation. On the average, over the long run, a well-diversified portfolio that includes stocks and bonds will almost surely continue to outpace both inflation and money in the bank. However, as this book documents so well, a foolish attempt to beat the market and get rich quickly will make one's broker rich and oneself much less so.

– Harry Markowitz, Ph.D.
1990 Nobel Prize Recipient

Harry Markowitz, Ph.D. is best known for his pioneering work in Modern Portfolio Theory, for which he was awarded the 1990 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (referred to as the Nobel Prize in this book). In 1952, he developed the simple, yet profound notion that investors must consider the risk associated with their investments, not solely the return. This groundbreaking discovery sparked a financial revolution pertaining to the relationship between risk and return. He is widely known as the father of Modern Portfolio Theory. Dr. Markowitz is also the recipient of the 1989 John von Neumann Prize in Operations Research Theory for his work in the areas of sparse matrix techniques and the SIMSCRIPT programming language, in addition to portfolio theory. He currently serves as an Adjunct Professor of Finance at the Rady School of Management at the University of California, San Diego and an Academic Advisor to Index Fund Advisors, Inc.


About the Author

Mark Hebner
Mark Hebner

Mark T. Hebner is the founder and president of Index Fund Advisors, Inc. (IFA), author of Index Funds: The 12-Step Recovery Program for Active Investors, host of IFA.tv, and creator of ifa.com, ifa401k.com, and ifasustainable.com. His current and previous Index Funds books received praise from financial industry and academic luminaries, including John Bogle, David Booth, Burton Malkiel, and Nobel Laureates Harry Markowitz and Paul Samuelson.

Hebner is considered a leading authority and provider of investment education. His mission is to “change the way the world invests by replacing speculation with education.” He is especially knowledgeable about the research indexes designed by renowned fi nancial economists that provide the building blocks to the passive investment strategy that Hebner recommends.



Americans work hard. On average we log 8.5 hours each working day, with many of us amassing far more hours to secure success. We are dedicated, and we are driven to working and saving for our nest eggs—that little slice of financial security that is our reward for a job well done.

Unfortunately, rarely in the course of this frenetic pace do we stop to learn how to properly invest our earnings so they can best work for us.

I was one of those people. I was fortunate enough to start a successful company right after I graduated from college. I was thirty-two years old when I sold that company, and I walked away with a nice sum of money. Without giving it a second thought, I deposited that money with a big-name brokerage firm. They seemed competent to properly grow my wealth. They had offices in high-rise towers. They had well-dressed analysts and impressive looking reports. Indeed, I was confident they would effectively put my money to work for me.

Twelve years later, I woke up to the ugly truth that my confidence in that brokerage firm was unfounded, and my earnings opportunities up to that point had been largely wasted.

Until that time, I believed the financial success of Wall Street brokerage firms was the result of jobs well done in creating wealth for their clients. Too late, I learned that big brokerages did not get rich by enhancing their clients' wealth, but rather (and ironically) by depleting it, transferring it slowly in the form of commissions and margin interest that were in no way justified by the lackluster returns accompanying them. This steady transfer buys plenty of full-page ads in the Wall Street Journal and ample commercial time on CNBC to lure in even more clients, thus perpetuating the slow and sure transfer of wealth that comes with each buy and sell.

Prior to my revelation, I lived with a nagging suspicion that my investments could do better. I knew there was a better way to invest, but I never really had the motivation to find it. I was busy with my family and my work, and I could never put a finger on what I should have had or could have had relative to what I did have.

My revelation about the investment world came to me through a tragedy. A friend of mine was killed in a car crash. I told his widow I would help her in any way I could. Shortly thereafter, she said what she really needed was help with her investments. I knew she was relying on me to provide some good, solid help, and I also knew I was ill-equipped to give it.

"What do I know about investing?" I asked her. "My portfolio hasn't done well." I knew I had to do some research. I knew I needed to find a better way to invest, and I needed to share it with her. I revisited the finance courses from my MBA program. I went to the library and the bookstore and bought countless books on investing, and I read them all. I dug into Burton Malkiel's Random Walk Down Wall Street and John Bogle's Common Sense on Mutual Funds, among many others. What I discovered in the pages of those books was nothing short of stunning: managers don't beat markets.

At first I asked, "How could this be? We have all these managers in the world who are in business to beat the market, and yet, they're not beating the market. The market is beating them."

It struck me like a bolt of lightning: I didn't just have the wrong advisors, I had the wrong strategy altogether. With all of the time, effort and money spent trying to find the next hot stock or mutual fund manager, I would have been far better off had I simply bought, held and rebalanced a portfolio of index funds. How much better off? When I compared my own actively managed portfolio's performance against the value of a risk-appropriate passively managed portfolio, I was struck with the harsh reality of the price I paid for my lack of investing knowledge. I call this my $30 million lesson.

I paid a very steep price for relying on an industry that profits handsomely when investors are kept in the dark. I wondered just how many others had paid the price for too little knowledge and too much trust. I questioned how many more would suffer before the investment industry would awaken to its very own Howard Beale who would finally muster the courage to step before the CNBC cameras to declare, "I'm mad as hell, and I'm not going to take it anymore."

Awestruck by the glut of misinformation that served as the basis for poor investment decisions, I could not remain silent. I knew I had found my mission in my lesson, and I was determined to change the way the world invests.

Just as in the movie "Network," in which Beale used the airwaves to deliver his message, I leveraged the Internet to deliver mine. In 1999, I launched ifa.com, a free and comprehensive site that contains hundreds of charts, graphs, articles, podcasts, and videocasts to help investors learn about investments that can better enhance their own wealth, rather than the wealth of their brokers. At the same time, I launched Index Fund Advisors, Inc. (IFA), a fee-only financial advisory firm that works with individuals and institutions to invest in risk-appropriate portfolios properly benchmarked for each investor's specific situation and risk capacity. Today, nearly 40 employees and $1.8 billion strong, IFA's mission has taken hold.

This book incorporates the quality research and data that IFA uses to advance the financial futures of its roughly 1,800 clients. It is precisely the information that I incorporate daily to change the way the world invests by replacing speculation with science. Step by step, this book will lead you away from the pitfalls of active investing that threaten your long-term financial success and lead you instead toward a strategy that will efficiently put your money to work for a better financial future.

You work hard enough. You don't need to log any more hours or commissions to fund your broker's retirement instead of your own. Read the following pages well, as they hold the key to your ability to optimally reap the fruits of your labor. Yes, you can finally invest and relax.

– Mark T. Hebner
March 2013

  • 1Quoted by Benjamin Graham in The Intelligent Investor (Collins Business, revised 2003), p. 54; which gives as source: Jean Strouse, Morgan: American Financier (Random House, 1999), pg. 11.
  • 2David Swensen, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment (New York: The Free Press, 2000).
  • 3Ibid., pg. 3.
  • 4Robert Fernholz and Brian Shay, "Toward a Dynamic Theory of Portfolio Behavior and Stock Market Equilibrium," Department of Statistics, Princeton University, Technical Report No. 163. Series 2 (1979).
Forewordharry markowitzmark hebnerwall streetburton malkieljohn bogleindex fundsindex fund advisors

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