How to Beat the Returns of the World’s Greatest Investors

This simple strategy will help you earn better returns than professional money managers.

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A recent article in SmartMoney extolled the virtues of the world’s greatest investors. These four money managers who “trounced the market during the crash and recovery” offered tips on what stocks they are buying now. The clear message for readers is they should consider following this advice and loading up on these stocks. Unfortunately, many investors will follow this advice and will probably suffer as a consequence.

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There is little data indicating anyone has stock picking skill. Of course, amateurs and professionals can pick stocks that do well, but rarely more frequently than you would expect from random chance. The financial media encourages the false belief that there are investment gurus who are exceptions to this rule. An examination of the four greatest investors debunks this myth. The best that can be stated about their purported skill is that sometimes they are right and sometimes they are wrong, which is exactly what you would expect.

The first example is Bill Nygren who runs the Oakmark Fund. If Nygren had the secret recipe to stock picking success, he must have lost it in 2007 when Oakmark lost 4 percent and in 2008 when it dropped 36 percent. Nygren also placed a huge bet on Washington Mutual and took a 40 percent loss.

Next up is Thyra Zerhusen, who runs the Aston/Fairpointe Mid Cap Fund. In 2002, she bought Unisys at $65. The stock has dropped 27 percent. In 2008, her fund was down 42.86 percent. That’s a huge hit for a manager who is supposed to be able to time the markets and pick stock winners. If she really had this skill, how did she miss the biggest market crash since the Great Depression?

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The third anointed greatest investor is Bruce Berkowitz, who runs the Fairholme Fund. Last summer, he sold off health care stocks which took off after the sale. His year-to-date return is -9.42 percent. In 2008, his fund lost almost 30 percent of its value.

Finally, there is Will Danoff, who manages the giant Fidelity Contrafund. His fund has $81 billion in assets. Danoff concedes his worst mistake was not getting back into the market when it bottomed out in early 2009. His fund lost 37 percent in 2008.

All of these managers outpaced the S&P 500 index in the past three years, which is why they were designated as great stock pickers. But a three year run is hardly proof they have stock picking or market timing skill. If they did, they would have used their crystal ball to avoid losses in 2008 and jumped in just in time to benefit from the subsequent recovery which started in 2009.

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Skill persists and is demonstrable. Luck doesn’t. The expertise of Wall Street is not in stock picking or market timing. It is in confusing luck with skill and convincing you to pay for a faux expertise. Over the long term, you are likely to beat the return of these greatest investors by purchasing a globally diversified portfolio of low-cost index funds in an asset allocation suitable for you.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.