Retail Investors Aren't Smarter Than Before, and Index Funds May Still Win

Today's individual investors have more tools than ever. They can trade from a phone, pull up company financials in seconds and buy funds built around narrow themes or leveraged strategies. But a former hedge fund manager argues that none of this has made everyday investors more skilled than those of 30 years ago. Access has changed a great deal, the manager suggests, while the results have not.

The core problem, in this view, is the goal itself. Many retail investors are trying to beat the market, either by picking individual stocks or by buying exchange-traded funds that promise exposure to something more sophisticated than the broad market. The former manager's advice is blunt: most people would be better off holding broad market index funds, which track a whole index at low cost and require little trading.

The arithmetic behind that advice is familiar. Index funds charge far lower fees than actively managed funds, and they avoid the timing errors that come with frequent buying and selling. Long-running scorecards, such as the SPIVA reports published by S&P Dow Jones Indices, have repeatedly found that a large share of actively managed funds trail their benchmarks over periods of 10 years or more. Complex products add their own layers of cost and risk, and their structures are not always easy for a typical buyer to understand before purchase.

The argument is not that markets are simple or that skill never matters. Some professional managers beat their benchmarks in certain years, and some individual investors have real expertise. The point concerns the odds facing the average person, and how hard it is to separate skill from luck over short stretches of time.

For anyone weighing their own portfolio, the takeaway is a familiar one. Diversification, low costs and a long time horizon tend to matter more than finding the next winning stock. Investors who still want to pick stocks or use specialized funds can limit those bets to a small share of their savings, so that a bad outcome does not derail their broader financial plans.