Berkshire Hathaway, efficient markets and Charlie Munger

The efficient market hypothesis [EMH] basically says that you can't beat the market except by chance. The practical implication of EMH is that you shouldn't spend money hiring investment advisers or mutual fund managers to pick stocks for you, rather you should invest in a low fee index fund.

Megan McArdle, a firm believer in EMH, says that she keeps "being assailed by people pointing out that Berkshire Hathaway has done spectacularly, and therefore this EMH stuff is a bunch of hooey." Berkshire Hathaway has indeed consistently outperformed the market.

But even Berkshire Hathaway's Vice-Chairman Charlie Munger believes that at least large charitable foundations should use indexing. In The Little Book of Common Sense Investing Munger is quoted as saying:

"At large charitable foundations in recent years there has been a drift toward more complexity. In some endowment funds, there are not few but many investment counselors...There is one thing sure about all this complexity, the total cost of all the investment management, plus the frictional costs of fairly often getting in and out of many large investment positions, can easily reach 3 percent of foundation net worth per annum. All the equity investors, in total, will surely bear a performance disadvantage per annum equal to the total croupiers' costs they have jointly elected to bear...And it is unescapable that exactly half of the investors will get a result below median result after the croupier's take, a median result that may well be somewhere between unexciting and lousy. The wiser choice is to dispense with the consultants...by changing to indexed investment in equities."


And if financially sophisticated charitable foundations should use indexing, then so should you!