In our last post we looked at the Fiction V’s Facts around investing. A huge amount of financial information enters the public domain each day. Without an effective filtering process, you could become so overloaded with data, or deafened by the noise, as to suffer “the paralysis of analysis” and take no effective decisions whatsoever.

Most of this financial information propagates the myth that individual fund managers or fund management companies can out-perform the market by stock selection and/or market timing.

Most of this financial information propagates the myth that individual fund managers or fund management companies can out-perform the market by stock selection and/or market timing. Whilst this can happen over short periods of time, largely as a result of chance rather than skill, consistent long-term out-performance has been achieved by only a handful of fund managers. Extensive, peer-reviewed, academic research has consistently exploded the myth that the market can be beaten, but yet the myth persists.

It is essential therefore to understand that the majority of information entering the investment arena is generated by the active fund management industry (stockbrokers, fund groups and financial advisers) and transmitted by the financial media in its many forms.

The former have a considerable vested interest in propagating the myth, as their primary function is to gather other people’s assets under their management and justify the high fees they charge. As for the latter, their main purpose is not to educate the investor, except in the most superficial way, but to generate advertising revenue from the active fund management industry.

If this were not so, the consumer financial press would publish a consistent message week-on-week: invest in a globally diversified portfolio of index funds and keep charges to the minimum. Were they to do so, it would not take long for their advertising revenue to find its way to the competition, or disappear completely.

The truth is, as much as you may wish to know which funds will be hot, you can’t – and neither can the legions of advisers and publications that claim they can. That’s why building a portfolio around index funds isn’t really settling for average. It’s just refusing to believe in magic.  Beverley McLean, “The Sceptic’s Guide to Mutual Funds,” Fortune

So where can you get reliable, and factual information?

Answer: from the exceptional academics and researchers, some of them Nobel prize-winners, who have transformed our understanding of finance and the theory of investing.

A review of the collective research of Nobel Laureates and other academics shows a sharp contrast between what they and the average active investor understand about investing. After 50 years of scientific research on 70 years of data the results are in and the evidence is overwhelming: active management does not work and is no longer the only game in town.

The conventional wisdom that a stock picker, armed with enough knowledge and research, can consistently beat the market has been completely discredited. The problem is that investors continue to rely on information sources such as consumer financial publications rather than on empirical research – such as that available from the University of Chicago Centre for Research in Security Prices (CRSP) and published in the Journal of Finance.

It is unfortunate that the great majority of investors are unaware of the tremendous amount of academic brain and computer power that has been applied to investing because it is this very lack of awareness makes them more susceptible to the siren calls of active management. Most unfortunate of all is that they are unaware that the overwhelming conclusion arrived at by these academics points to investing in portfolios of index funds.

The Decision Matrix set out below should assist investors in deciding what sources of information are worth paying attention to. In other words: to filter out the white noise and static coming from the active fund management industry on wavelengths 1-3 and tune into the clear signal on channel 4.

Market Matrix