Imagine sitting in a bar in which you are introduced to someone said to have an uncanny ability to predict whether the Yankees will win or lose their next game. Further suppose that you know for a fact that for the previous six games he has walked into this bar the day before each game and had been correct every single time.

Would you be impressed? More importantly, suppose this soothsayer then asked you how much you would pay him to provide you with his next prediction. Would you be intrigued?

Suppose, however, that you learned that six games ago this expert had visited 32 bars in New York and loudly claimed he would be able to successfully predict the outcome of the next game, claiming in 16 bars that the Yankees would win while claiming in the other 16 that they would lose. Then, the day before the next game he went into the 16 bars where he had predicted correctly, and followed the same scheme. He repeated this process five times, each time visiting only those bars in which he made a correct prediction.

So, of all 32 bars, you happened to end up in the one in which he was correct all six times. Armed with the true secret of his success, would you be willing to pay for his next prediction? We certainly hope not.

Yet, this is essentially the trap into which so many investors fall when they invest in mutual funds or other investment vehicles that have outperformed the market. There are over 6,000 mutual funds attempting to pick winning stocks or time the market. At any point in time there will be several that have outperformed the market, but only as a result of chance.

In his most recent letter to Berkshire Hathaway shareholders, legendary investor Warren Buffett stated “The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

We diversify even further by recommending that investors hold not just the S&P 500 index but an index that captures the entire stock market (funds for doing so appear on the back page). Small and mid-cap stocks, which the S&P 500 excludes, have provided substantial returns over time and provide additional diversification. We suspect Mr. Buffett recommends the S&P 500 (he specifically recommends the Vanguard 500 fund) because it is a widely recognized proxy for the market, or for the slightly lower expense ratio this particular fund provides.

Also in This Issue:

How Much Should I Save for Retirement?
Fixed Income Investing: Bonds versus Bond Funds
88 Years of Real U.S. Stock Market Returns
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles