Charlie Munger Once Said You Can’t Beat the S&P 500 Index — Here’s Why
Written by
Caitlyn Moorhead
Edited by
Sean Fisher
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Charlie Munger, who had an estimated net worth of $2.6 billion when he died in 2023, was Warren Buffett‘s friend, right-hand man and vice chairman of Berkshire Hathaway. So, any financial advice he gave in his lifetime is still quite valuable for investors today.
In the world of investing, the S&P 500 Index stands as a benchmark, often hailed as a reliable measure of the stock market’s performance. With that in mind, Munger once claimed that “95% of people have no chance of beating the S&P 500 Index.”
Simply put, an overwhelming majority of investors face an uphill battle in trying to outperform this index. Munger’s insights, gleaned from decades of experience, shed light on the challenges and limitations you may encounter when you try to beat the market. Let’s explore why below.
Liquidity Concerns and Market Discrepancies
As explained in a video from YAPSS, Munger dismissed concerns about liquidity issues impacting index funds during times of crisis. He acknowledged the dominance of index funds like the S&P 500, representing a significant portion of the market.
“The index funds of the S&P, it’s like 75% of the market. But is there a point where index funds theoretically can’t work? Of course. If everybody bought nothing but index funds, the whole world wouldn’t work as people expect,” he explained.
“There’s also the problem … one of the reasons you buy a big index like the S&P is because if you buy a small index and it gets popular, you have a self-defeating situation. When the Nifty 50 were the rage, JP Morgan talked everybody into buying just 50 stocks and they didn’t care what the price was, they just bought those 50 stocks. Of course in due time, their own buying forced those 50 stocks up to 60 times earnings whereupon it broke and everything went down by like two-thirds quite fast.”
The Risks of Excessive Popularity
Drawing parallels to historical market phenomena, Munger warned against the risks of excessive popularity in index investing. He references the Nifty Fifty era, where a narrow focus on a select group of stocks led to unsustainable market conditions and subsequent downturns.
“If you get too much faddishness in one sector or in one narrow index, of course you can get catastrophic changes like they had with the Nifty 50 in that former era,” he said. “I don’t see that happening when the index is three-quarters of the whole market. The problem is the whole thing can’t work perfectly forever, but it will work for a long time.”
The Agony of Beating the Indexes
Munger highlighted the frustration experienced by investment professionals who grapple with the daunting task of outperforming the market. He pointed out that the proliferation of index investing has made it exceedingly difficult for the vast majority of investors to beat the indexes consistently.
“The indexes have caused just absolute agony among the intelligent investment professionals because basically 95% of the people have almost no chance of beating it over time, and yet all the people expect, if they have some money, they can hire somebody who will let them beat the indexes. And of course, the honest, sensible people know we’re selling something they can’t quite deliver and that has to be agony. Most people handle that with denial.”
The Decline of Investment Management Fees
As index investing gained popularity, Munger observed a downward trend in fees for managing large portfolios. He acknowledged the challenges facing investment professionals who must adapt to a changing landscape where fee structures are increasingly competitive.
“What’s happening of course is that the prices for managing really big sums of money are going down, down, down, 20 basis points and so on. The people who rose in investment management didn’t do it by getting paid 20 basis points, but that’s where we’re going I think in terms of people who manage big portfolios of the American Equities in the equivalent of the S&P.”
He added, “It’s a huge, huge, problem. It makes your generation of money managers have way more difficulties and it causes a lot of worry and fretfulness, and I think the people who are worried and fretful are absolutely right.”
Final Take To GO: The Realities of Index Fund Investing
The bottom line is that Munger’s insights underscore the formidable challenges inherent in trying to beat the S&P 500 Index. While index funds offer benefits such as diversification and cost-effectiveness, they also present hurdles for investors seeking to outperform the market.
“I would hate to manage a trillion dollars in the big stocks and try and beat the indexes. I don’t think I could do it. In fact, if you look at Berkshire, take out a hundred decisions, which is like two a year, the success of Berkshire came from two decisions a year over 50 years.”
Munger concluded, “We may have beaten the indexes, but we didn’t do it by having big portfolios of securities and having subdivisions managing the drugs and subdivisions, and so the indexes are a hell of a problem for you people, but you know, why shouldn’t life be hard?”
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