When Warren Buffett speaks, you listen!

And when he says that most investors would do better by simply buying index funds, there must be some wisdom behind it.

He has been saying this repeatedly.

In his recent annual meeting, he said,

“I don’t think most people are in a position to pick single stocks. A few [are], maybe, but on balance, I think people are much better off buying a cross-section of America and just forgetting about it. Most people pay huge amounts of money for the advice that they don’t need”

Ther’s definitely truth in what Mr. Buffett is saying!

Let’s consider the following…

There are 43 AMCs with some 1868 schemes among them.

Which ones do you select to invest in?

This is a big issue for investors!

As per one study, your probability of selecting a winning mutual fund that will last over 15 years is less than 30%. That’s even less than a coin toss!

Have a look at the mutual fund performance table which was published in the Economic Times in November 2019.

There is a vast difference between the top performer and the laggards in the same category.

Now, my question to you is, what is the probability that you would have invested in the top performers and not the bottom performers?

Very less I suppose!

Sad but true!

Now there are always going to be exceptional fund managers who will outperform their benchmarks as we saw in the above table. But your probability of being invested with that fund manager for the whole duration is very less.

The advantages of index funds can be very appealing!

But there’s an issue.

And the issue is of the risk. Now the risk is not what academics would want you to believe. Most economists consider annual volatility as the measure of risk.

But I consider, drawdown as the actual risk! Risk is simply the chance of losing money. when is the chance of losing money the highest? when markets are down. It becomes psychologically difficult to hold on to your investments leave aside adding fresh funds.

The markets have declined more than 50% on many occasions. That’s the actual risk.

So assuming the same level of risk as index funds, investing in mutual funds only makes sense if you can select the right mutual fund scheme which will give more returns than the index fund. Otherwise, what’s the point of going through all the hassle.

The same goes for investing in individual stocks!