Interview by Index Funds Staff

"Despite the superior returns generated by passively managed funds, financial publications are dominated by forecasts from so-called gurus and the latest hot fund managers."

Larry Swedroe's second book, a straight-up assessment of the true value and effectiveness of active management, is aptly named. In What Wall Street Doesn't Want You to Know, Swedroe examines many of the commonly-held myths concerning stock-picking and market timing, and questions the true motivations of the financial press. Once Swedroe debunks the perceived benefits of active management, he outlines how investors can assess their financial situation and use low-cost index funds and asset allocation principles to invest smartly.

"This wonderfully iconoclastic book drums home the message that beating the stock market is a loser's game," says John C. Bogle, founder and former Chairman of The Vanguard Group.

Larry Swedroe recently sat down with IndexFunds to discuss his new book, and how the recent market downturn makes long-term passive investing strategies all the more relevant.

Larry Swedroe is a Principal in the firm of Buckingham Asset Management and lives in St. Louis, Missouri. He is also the author of The Only Guide to a Winning Investment Strategy You'll Ever Need. Swedroe has in MBA in finance from New York University, and is a frequent poster to IndexFunds discussion boards, where he tirelessly shares his knowledge with the index investing community.

IndexFunds: The financial media has a stake in getting readers and viewers to tune in every day by giving them a "fix." Are there any media organizations out there, in your opinion, that provide investors with truly helpful information?

Larry Swedroe: I don't think there are any media organizations that aren't a part of the business. You have to remember whose interests they have at heart. The motivation of those companies is to drive profits for shareholders, not necessarily to drive the highest returns for their readers. Therefore, in order for them to make the most money, they must get you to believe that active management - the art of picking stocks and timing the market - is a winner's game. Otherwise, you'd be a passive investor and you'd use low-cost, tax efficient, better-returning index and passive asset class funds that charge between 20 and 50 basis points instead of an average of about 1.5% in operating expenses per annum for the privilege of getting the lousy returns of actively-managed funds, and also their low tax efficiency. You would stop trading individual stocks so they would stop making bid/offer spreads as market makers, and you'd stop them from making their commissions. The magazines would stop selling subscriptions because people would stop paying to peek and find out which are the next ten best stocks to buy or the next ten best mutual funds to buy.

So generally, there really aren't any media organizations that supply investors with helpful information. However, there are several writers who I feel do a great job espousing the winning strategy - two in particular come to mind. One is Jonathan Clements of The Wall Street Journal; the other is Jane Bryant Quinn of Newsweek and author of the book Making the Most of Your Money.

IF: What are the differences between your first two books, and do you plan to write more?

LS: The first book was really an attempt to explain what modern portfolio theory is all about. The book is broken down into three parts. The first part is a look at how investors actually believe markets work. I look at what is considered "conventional wisdom." Things like "Past performance is a predictor of future performance" and the belief that people can successfully time the market. I destroy each one of those myths by methodically presenting the evidence - 50 years of academic research on the subject - and also by using common sense logic. The second part of the book explains how markets really work, or at least how financial economists believe the markets work. The third part of the book attempts to show people what to do with this information. It's not enough to know what the right strategy is, you have to know how to implement it.

My second book focused much more on the evidence that shows that active management doesn't work - hence the title What Wall Street Doesn't Want You to Know. I also focused on ideas that weren't touched on in the first book, things like tax management and the costs of tax inefficiency. There's a whole chapter on behavioral finance and the issues relating to human behavior - what happens when investors let their hearts drive investment decisions and not their heads. Lastly, based on a lot of the feedback I received from the last book, I tried to focus on individual situations for investors. The whole last chapter provides very specific tools to help investors identify their own unique risk tolerance.

I am in the process of putting together another book, and I'm thinking about maybe calling it More of What Wall Street Doesn't Want You to Know.

IF: What do you see as the biggest, and therefore perhaps most dangerous, misconception concerning investing?

LS: That there are smart, hard-working people who can somehow discover stocks that have been underpriced by the market. What this implies is that the market is mispricing securities. The fact of the matter is that there is a tremendous body of evidence that shows that playing that game, while it does give the hope of outperformance, is really the triumph of hope over reason. You have a small chance of outperforming, and even those who do outperform do so by a small margin. The vast majority of active managers, whether they are individuals or professionals, underperform.

A good example is that in the ten-year period between 1980 and 1989, there were 71 large-cap growth funds that survived the period. Two of the 71 outperformed the S&P 500 index after taxes. If the stakes are my retirement money, I don't want to play a game where I have 2 chances to win and 69 chances to lose. You're far better off accepting the market returns. If you want to pick stocks, I recommend setting up an "entertainment account" with 5 or 10 percent of your money. You'll probably end up getting market returns with that money anyway, minus taxes and management expenses of course.

IF: Why should investors read your book?

LS: People can either spend a little bit of money and a little bit of time invested reading my book, or they can play the market. If they read my book, they'll learn how the market works and how to play the winner's game. If they play the market, every once and a while the market will hand them a tuition bill. And in years like 2000, they hand out lots of Ph.D.'s, which we know are very expensive. So quite simply, you can pay now with a little time and money, or pay the market a lot later.

Read our review of What Wall Street Doesn't Want You to Know by Larry E. Swedroe

01/16/2001