Free Lunches for Everyone

Have you ever heard someone say “and that would be a free lunch” as a proof of an investment argument? I have. Repeatedly.

Yet, those same people advocate low cost index funds, arguably the freest of the free lunches possible. You can come within a fraction of the market average without any effort whatsoever.

How about other free lunches?

These days, the Efficient Market Hypothesis has been thoroughly discredited. The actual evidence showed that it is a rare investor who can beat the market by 5% per year (annualized) for a decade. Guess what? That’s true. But beating the market by a percent or two really adds up after compounding.

There are lots of ways to pick up that percent or two. Value investing is one. Price discipline is another. Timing is another.

Timing? Yes, traditional intermediate term timing based on valuations, the kind of thing that Benjamin Graham did with individual stocks.

The evidence against timing is for the short term, two years at a maximum, and it is designed to maximize stupidity. It is an outrage to make broad claims based on such evidence. Yet, we hear such claims daily.

There are other free lunches out there. Lots of them. Different investors have different needs. Mutual fund managers act in the short term to stay employed, not in the intermediate term to satisfy customer needs. Retirees seek steady income. Young investors favor capital appreciation. A large fraction of participants are not interested in investing at all. They just want to gamble. They have the odds on their side.

Risk does not translate into returns. It translates into excitement. Dividend paying stocks have routinely outperformed the market for those who pay attention to smoothed earnings and payout ratios and other signs of quality. They do so with lower risk. They do so with lower volatility as well.

Have fun.

John Walter Russell
October 6, 2007