This is the nub of Warren Buffett's letter to shareholders in the Berkshire Hathaway annual report, which was published on 28 February. As ever, the document contains a lot of sensible advice for non-professional investors. The 'know your limits' theme dominates Mr Buffett's reflections, eventually leading him to extol the virtues of tracker funds - an unusual position for a portfolio manager. By way of example, the world's most famous investor gives details of his will.
"One bequest provides that cash will be delivered to a trustee for my wife's benefit. My advice to the trustee could not be more simple: put 10 per cent of the cash in short-term government bonds and 90 per cent in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals - who employ high-fee managers."
So why am I quoting this on a week when the companies team at Investors Chronicle has analysed the results of some 100 companies? Should readers forget the whole thorny business of picking individual stocks and pile into passive strategies?
Some may prefer to, others may not. The point is to make a realistic assessment of your skills and decide accordingly. If your sole goal is to beat the market - and hence the returns available on a tracker fund - you need to understand what edge you have over all the other people who are trying to do the same thing. And that edge is unlikely to be simply that you can spot a great company.
This realisation dawned on me some four years ago when I interviewed Alastair Mundy, a fund manager at Investec. Refreshingly, he said he started from the premise that the City was full of highly-educated, well-resourced teams of fund managers and analysts that were very hard to outsmart. The competitive edge he therefore tried to cultivate was not analytical but psychological: to buy stocks that had mentally scarred his peers with terrible performance, but that would one day bounce back.
Mr Mundy is one of the City's few successful contrarians. This is one way to beat the market, though it is much easier said than done. "A climate of fear is your friend when investing; a euphoric world is your enemy," writes Mr Buffett in his latest letter, updating his famous exhortation to "be greedy when others are fearful and fearful when others are greedy". This mantra might lead investors now to emerging markets, mining, BP (BP.) snd Shell (RDSA), RBS (RBS) or Ladbrokes (LAD) - all out-of-favour sectors or stocks. The key is then to ignore all bad news until the story eventually comes right, and to own enough stocks so that the recoveries outweigh any outright disasters.
Playing market psychology is not the only way to beat the market. My colleague Simon Thompson's approach is to pick small companies whose shares trade at a discount to book value. Eugene Fama, one of last year's economics Nobel Prize winners, found that such stocks were among the rare exceptions to the efficient market hypothesis (the notion that stock markets already price in all available information, making stock-picking a vain exercise in futurology). And it makes sense that the market for those stocks too small and illiquid to fit in a City fund manager's portfolio - but not too small for private investors, crucially - would be inefficient and therefore ripe for profitable stock-picking.
Both these strategies depend on a keen awareness of both skills and limits relative to the market. This is surely the essential quality of any investor who wants to outperform a low-cost tracker fund over the long run.
But let's not forget that the hope of beating the market may not be the only reason for stock picking. Some may also derive pleasure from a more direct contact with their investments. If farmers' markets are in vogue because people want to understand what they are eating, is it outlandish to think consumers might also want to invest at source on the stock exchange, rather than relying on shrink-wrapped produce from Fidelity or Vanguard? After all, if the 83-year-old Mr Buffett only invested for the money, he'd have retired decades ago.
