This week’s recommended reading comes with an experiment. Find a coin and flip it until it lands on heads three times in a row. Go ahead, we’ll wait.
It’s not easy to do. Everyone will have a different experience, but if we conducted this experiment with a large crowd we’d find that most people would require eight attempts before succeeding. We know this because the probability of flipping a coin and it landing on heads is 50%, and if we repeat that probability three times, we find that there is a 12.5% chance of repeating the same side of the coin three times in a row.
So why the experiment? As Jeffrey Ptak of Morningstar describes in his recent article, “Investing Taxable Money in Active Stock Funds? Bad Idea,” this is roughly the same probability of an actively managed stock fund beating a diversified Vanguard index fund once you account for fees and taxes. This is no coincidence. Companies such as Vanguard and Dimensional Fund Advisors understand the importance of fees and taxes, and build their investment strategies to be low-cost and tax-efficient. As the saying goes, “It’s not what you make, it’s what you keep that counts.”