Money Master

By Daniel Kadlec

David Swensen is easily the best money manager in higher education. He may be the best, period. In 20 years of running Yale University's endowment, which has $15 billion, he has delivered average annual returns of 16.1%--blowing away the typical college endowment's return of 11.6%. Swensen, 51, author of Unconventional Success (Free Press), spoke with TIME's DANIEL KADLEC on how mutual funds fail the average Joe, why Peter Lynch is misguided and how you should invest.

TIME Your book trashes the fund industry for its high fees and misleading ads and advises folks to stick with index funds. Didn't John Bogle at Vanguard beat you to this drum by, oh, a couple of decades?

Swensen If you want to distill my book into two pages, yes, it's about indexing being the best way for individuals to invest. The costs are low, and you can get true diversification. But it's not just about that. It's also about investor behavior. Most people buy a fund after it's gone up and sell after it's gone down. You can't make money that way. My hope is that people will understand how to do the right thing--and stick with it.

TIME What is the right thing? What is the key to your success at Yale?

Swensen A truly diversified portfolio and strong orientation toward equity or equity-like investments. That part translates very well to individuals, who can buy a broad range of funds, including real estate. The other part, though, is getting strong active-management results. The individual just cannot do that. They don't have access to the same managers that institutions use, and they don't have the resources to properly evaluate what is available to them.

TIME Peter Lynch, the legendary market-beating fund manager at Fidelity, says anyone can beat the pros by paying attention at the mall and asking a few simple questions.

Swensen He is so wrong, and I'd be happy to tell him that. It's really, really hard to beat the market. You can't do it by spending a few evenings each week and a few hours on weekends putting together a portfolio. The few people who can beat the market tend to be obsessed.

TIME What assets should be in every investor's bag?

Swensen Domestic, foreign developed and emerging-market stocks, REITs, government bonds and inflation-indexed bonds--all through low-cost index funds. Regardless of what happens to interest rates and currencies, you ought to get a decent result.

TIME On average, how much do investors in actively managed funds lose from fees?

Swensen We found that the after-tax shortfall of actively managed funds compared to an index was 2.8% per year over 20 years. Put another way: your chance of picking a managed fund that will beat an index is less than 1 in 7--and that doesn't factor in sales commissions.

TIME Some might say you underestimate the individual investor.

Swensen Individuals absolutely cannot get it right. Most of us feed our winners and kill our losers. But with investments, if something is going well, we need to think about paring back. If it's going poorly, we need to think about nurturing it. The evidence that people chase winners is overwhelming. It's not all their fault. Mutual funds advertise funds that have done well--just before they start to lag.

TIME You could make $100 million a year running a hedge fund. Why not jump?

Swensen I love it here. There's more to life than accumulating a pile of money.

TIME Good thing. If you're right about mutual funds, most of us have no shot.

Swensen If individuals follow a simple recipe and stay diversified with index funds, they've got a fighting chance. You won't talk about it at cocktail parties, but you should have success.