It's inefficient. You are statistically going to get a worse return without lower risk, which is a no-no in portfolio design. The only reason to do it is if you have an external reason, e.g. it helps you psychologically, or you just don't have the money up front, etc.
Did you mean Benjamin Graham? Keep in mind that The Intelligent Investor was written in the 40s. Market players are much more sophisticated now, so it's much, much harder to do well.
Yep, there's a bit of a freudian slip, to Buffett's credit.
So with the sophistication of those with money to throw around, the assumption is that the market is much more efficient, and speculating is less likely to offer a good return over the long haul? Basically you're warning against speculating?
How do index funds play into that? I don't know how they work too well yet, but my assumption is that they're like a mutual fund which is so diversified that it removes a lot of the risk involved? So over a long-term period you're more likely to beat less risky products?
Not just speculation. Any piece of information that the average person can find on a company, a quant hedge fund can get too, and their computers react in milliseconds, they don't sleep or get tired, and they (almost) don't make mistakes. They can do all of the standard company valuation calculations and much more besides. People like David Shaw, Jim Simons and others made billions in the 80s because almost none of the investors at the time had heard of eigenvalue analysis, even though they'd all read The Intelligent Investor.
But there's a trade-off... the more people who know about a technique, the more money backing it, the less effective it is. So they needed the next thing, and the next, and the next. To get them, they hire really smart people to figure out what everyone else is missing. I know an ex-Dartmouth professor, a 4-time Putnam fellow from Harvard, physicists, computer scientists, etc that work at these places. At this point in the arms race, they're scrabbling to shave a few miles off the fiber optic lines that carry their news and trade information so they can get them a few milliseconds earlier. Anything for the next edge.
So you have to think - the main possibilities are that they missed what you saw or that they saw it and decided it wasn't worth pursuing over other investments. Have you spotted something that all of those smart people (and AI now) missed? It's possible, but incredibly unlikely, especially if you're just using standard statistics. Much more plausibly, the opportunity you've spotted isn't on the
efficient frontier for them - either it doesn't have as high a return as you thought, or it has more risk.
The other options are almost scarier - that the hedge fund models are all wrong (like in 2007) and/or there is just so much irrational money being thrown around that it causes significant market inefficiencies (like in 2000 and 2007 and probably bitcoin).
Index funds are diversified and stable, and since everyone is trying so hard to wring every last penny out of the markets, they can't be off of the efficient frontier by too much or they'd be arbitraged back on track. So if you invest in them, you pay a small fee and get a pretty much guaranteed optimal risk/return investment. On the other hand, any other investment you could pick would only really be that good in the best case scenario, so on average they'd nearly always be sub-optimal.
Most hedge funds fall into this pit too. It's basically impossible to overemphasize how hard it is to beat an index fund; even experienced professionals fail.
Warren Buffett just won million dollar bet about it. The main question investors face today isn't 'what stock do I buy?' it's 'what percentages should I allocate to each of these index funds?'.
