A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

HOW THE TOP 20 EQUITY FUNDS OF THE 1990S
PERFORMED DURING THE NAUGHTIES
Average Annual Return
1990–99
2000–09
Top 20 funds of the 1990s +18.0%
-2.2%

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S&P 500-Stock Index
+14.1%
-0.9%
In any activity in which large numbers of people are
engaged, although the average is likely to predominate, the
unexpected is bound to happen. The very small number of
really good performers we find in the investment management
business actually is not at all inconsistent with the laws of
chance. Indeed, as I mentioned earlier, the fact that good past
performance of a mutual fund is generally no help in
predicting future performance only serves to emphasize this
point.
Perhaps the laws of chance should be illustrated. Let’s
engage in a coin-flipping contest. Those who can consistently
flip heads will be declared winners. The contest begins and
1,000 contestants flip coins. Just as would be expected by
chance, 500 of them flip heads and these winners are allowed
to advance to the second stage of the contest and flip again.
As might be expected, 250 flip heads. Operating under the
laws of chance, there will be 125 winners in the third round,
63 in the fourth, 32 in the fifth, 16 in the sixth, and 8 in the
seventh.
By this time, crowds start to gather to witness the

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surprising ability of these expert coin-flippers. The winners
are overwhelmed with adulation. They are celebrated as
geniuses in the art of coin-flipping, their biographies are
written, and people urgently seek their advice. After all, there
were 1,000 contestants and only 8 could consistently flip
heads. The game continues and some contestants eventually
flip heads nine and ten times in a row.
*
The point of this
analogy is not to indicate that investment-fund managers can
or should make their decisions by flipping coins, but that the
laws of chance do operate and that they can explain some
amazing success stories.
It is the nature of an average that some investors will beat
it. With large numbers of players in the money game, chance
will—and does—explain some extraordinary performances.
The very great publicity given occasional success in stock
selection reminds me of the story of the doctor who claimed
he had developed a cure for cancer in chickens. He proudly
announced that in 33 percent of the cases tested remarkable
improvement was noted. In another one-third of the cases, he
admitted, there seemed to be no change in condition. He then
rather sheepishly added, “And I’m afraid the third chicken
ran away.”

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The 
Wall Street Journal
did an interesting story in 2009
showing how fleeting extraordinary investment performance
is likely to be. The paper noted that fourteen mutual funds
had beaten the S&P for nine consecutive years through 2007.
But only one continued that feat in 2008, as is shown in the
table 
It’s Down to One
. It is simply impossible to count on
any fund or any investment manager to consistently beat the
market—even when the past record suggests some unusual
investment skill.