Charlie Munger: "Another issue of course that’s happened in the world of stock picking, where all this money and effort goes into trying to be rational, is that we’ve had a really horrible thing happen to the investment counseling class.
And that is these index funds have come along and they basically beat everybody. And not only that, the amount by which they beat everybody is roughly the amount of cost of running the operation and making the changes in investments.
So you have a whole profession that is basically being paid for accomplishing practically nothing. This is very peculiar. This is not the case with bowel surgery or even the criminal defense bar in the law or something. They have a whole profession where the chosen activity they’ve selected they can’t do anything.
Now in the old days the people in the profession always had some of this problem and they rationalized as follows. ‘We are saving our clients from the insurance salesman and the stock broker, the standard stock broker that serves the active trader.’ And they were saving people from the life insurance salesman and the hustling stockbroker who liked active trading. And I suppose in a sense that the investing class is still saving those people from an even worse fate.
But it is very peculiar when a whole profession that works so hard, and is so admirable, and the members of which we are delighted when they marry into our families, and they just can’t do what their profession is really trying to do, which is get better than average results. How is that profession handling this terrible situation, as index investing gets more and more popular and including a lot of fancy places?
Well it’s a very simple answer, they’re handling it with denial. They have a horrible problem they can’t fix, so they just treat it as nonexistent. This is a very stupid way to handle a problem. Now it may be good when you’re thinking about your own death which you can’t fix and it’s just denial all the way to the end. But in all the practical fields of life, this problem thoroughly understood is half solved or better coped with.
So it’s wrong to have all these people in just a state of denial and doing what they always did year after year and hoping that the world would keep paying them for it even though an unmanaged index is virtually certain to do better. It’s a very serious problem.
And think of how much New York say needs a flow of money from finance. Think what would happen to Manhattan if there weren’t any fees for investment management or trading spreads and so on.
So it’s a weird situation and of course it’s unpleasant. Big investment counseling shops, some of them shrink and some go out of business. And the value investors, of course who many of I know because we came from that tradition, the value investors who were honorable are quitting. Boom. Boom. Boom.
And what worked for them for years stopped working and they’re honorable people they just quit. And they’re also rich which makes it easy. But those who aren’t rich have a hell of a problem.
And it costs about fifty thousand dollars in the city of Manhattan to send your kid to pre-school. Non-deductible. And that’s just the start of an endless procession of years of vast expense. So if your game is money management you have a serious problem. And I don’t have any solution for this problem. I do think that index investing, if everybody did it won’t work. But for another considerable period, index investing is going to work better than active stock picking where you try and know a lot."