It was Richard Thaler's Misbehaving: The Making of Behavioral Economics book that finally broke through my thick, anxiety ridden skull and convinced me to stop reading economic news everyday and just forget the the retirement accounts existed. If I'd read that book earlier, I'd be up 3X on my positions.
I haven't touched my 401(K) in over 30 years. It's done 9-20% per year. It's not super aggressive, but will take a hit, on really bad markets (the only year it actually lost money, was 2020 -and it has completely made up for that. It even made some money in 2008).
I ignore the Fidelity calls. Every time a new broker rotates in, they try to get me to move my money around.
Most people just look at the balance and forget (in the self-preservation, "I want to be right" kind of forgetting) that they contribution $20k+ that year so unless you've got a multi-million dollar 401(k) or the market was down 10%+ across the board you're very likely to see more on December 31st than was there January 1st regardless.
I'm not sure that's quite fair. Unless it were 2001 or 2008 people look at their balances and see they're generally up unless they made some big gamble and at least unconsciously conclude they probably did as well as they reasonably could. But that may be what you're saying. Worrying about a percent here or there probably isn't worth it for most people.
We're saying the same things, I just meant you could actually lose a lot of money but see your balance go up, especially with smaller portfolios. As your portfolio gets bigger it's less likely to happen because eventually a single-digit loss over the course of a year might be enough to wipe out more than the max contribution.
Yes. Even if your overall balance is going up, it makes sense to keep your eye on doggy investments. I really cleaned shop a couple years ago and I'm glad I did.
I don't work for Interactive Brokers, but I do periodically shill for them here on HN! Their market access diversity and rock bottom fees are very hard to beat. It should be possible to transfer a 401k in-whole with zero tax consequences nor booked trades.
Yeah... At times I just take funds I like, read what they re actually made of, and replicate their holdings in IBKR. This way I dodge the fund's 0.5% annual fees and performance fees.
39 cents per transaction is hard to beat.
The lump sum of cash on the sideline gets you 4.83% on IBKR (as long you have $100K+ on he sidelines). Cash secured puts you sell bring you yield on the USDs securing the put.
Financial reports they make are top Noth and entirely configurable.
Bond funds are weird to me because you cannot hold to maturity to realize yield-to-maturity. The only point to them is to get coupon payments. Is your bond fund total return or, if not, what do you do with the coupon payments? To me, it just seems better to buy outright mix of 2yr and 10yr US treasuries and always hold to maturity.
which is fine, but you're just adding administrative burden on yourself.
The bond fund is doing exactly what you're trying to achieve, except that they reinvest the bond capital back into new bonds when they mature. You get the coupon payment as income, and you sell the bond fund when you want capital back.
The price of the bond fund is a reflection of the value of the bond at market prices - exactly as if you would yourself, if you held the bond directly, and wanted to sell before maturity.
You might eek out a tiny bit of efficiency due to lack of fund fees you pay, if you held bonds yourself - but then the administrative burden you have to do yourself is going to cost just the same imho (via time taken for example).
Everything you mention is correct, I just wanted to add that holding bonds directly makes sense in the case when you have a date in mind for when you will need the invested money. So for instance if you plan to buy a car in 2 years buying bonds that mature in 2 years has the nice property of being worth a guaranteed amount of money exactly at the point you need those savings. There are etf equivalents known as “bullet shares” but these have an expense ratio that isn’t incurred with owning bonds directly.
It's silly to quibble with your great results (good job!) but its a good idea to re balance your portfolio between stocks and bonds every quarter or every year at a fixed percentage. (60/ 40, 70 / 30, 80/ 20 ratio is risk)
Portfolio re balancing, like ETFs is one of those things that has been shown to work over time in many studies. ETFs re balance. The stock / bond ratio was an early form of "automatic" investing.
> I contributed 50% to a bond fund, as well, but that is like, 10% of the total, nowadays.
That's one of the ridiculous aspects of fixed-percentage allocations: by constructions those allocations tell you that you should get rid of the things that are making you the most money, and put it into the things which are underperforming instead. (I get that you didn't do that, I'm just got reminded of it.)
You are thinking about it backwards. Humans have a tendency to buy high and sell low. It seems to be a psychological benefit of some sort that holds us back in abstract market scenarios.
By having a fixed percentage portfolio you are forcing yourself to sell high and buy low.
This was also the only basic strategy that mathematically beats the market based on papers I read during undergraduate (there may be others now). Basically, by splitting investments among higher and lower investments that are out of phase you can make sure that you are moving money out of an investment before it falls and into it before it rises.
What I find interesting is that the advantage only works with discrete periods of rebalancing. Instantaneous rebalancing doesn’t provide any advantage. I do not understand why but I saw a paper that showed that being able to take advantage of phase shifts in nearly correlated signals goes to zero as delta t goes to zero.
> By having a fixed percentage portfolio you are forcing yourself to sell high and buy low.
Yes, and the things you sell high are the ones that performed well in the past, so you'll have less of those in the future, which is what I said. I'm not thinking about anything backwards.
If you can time the market, then by all means, do that. The reason periodic rebalancing works, is because stocks and bonds don’t exclusively go up (or down). By rebalancing you can take advantage of a racheting effects as a result of signal variance. By rebalancing at set times, you can overcome the psychological effects of waiting just one more day to get gains that then evaporate while you watch.
I’m having a hard time finding the paper around instantaneous rebalancing eroding the effects (or any good papers atm). But you can model this very easily. You can take 2 signals that randomly walk up or down. One at a “high apr” and one with a “low apr”. I’m not sure if it matters, but typically I’d expect the lower apr to have lower variance of the 2. Most of the literature around rebalancing assumes lower volatility of at least one asset class, but I’m not convinced it’s necessary from some of the math I’ve seen. You may need to add an assumption of correlation between the 2. Be sure to include code that if a signal reaches 0 it stays there. Be sure to backtest as well. Few strategies work in a bear market, but rebalancing is expected to still outperform when markets go down.
Kelly criterion is another thing to look up. It’s a mathematical look at betting stategies and what’s the biggest bet you can afford to make in the long term given that no bet is 100% gauranteed.
You're making this sound more complicated that it is. Correlations, random walks, backtesting, strategies, rebalancing, kelly criterion, have nothing to do with this.
Bonds give you cash later. Cash loses value over time.
Stocks give you a participation in the best companies in the world.
Bonds versus S&P I know which one I'm holding. Good luck with your thing.
The question is whether "thing that did well in the past" is more or less likely to do well in the future than "thing that did less well in the past." This seems to vary somewhat by "thing."
The tradeoff is you lock some of those gains down in safer assets. Probably the wrong choice for retirement earlier on, but if you need money during an economic crisis, say you got laid off, then that might change how it's viewed.
That’s very true, but he’s had the account for 30 years and assuming that means he started it young, 50% in bonds is borderline insane. It’s a lot more likely to cost you a large amount in retirement than bail you out in your 30’s.
Applying optimal portfolio theory to the long history of market returns suggests that the most risk-efficient allocation is something like 60% stocks and 40% bonds. The diversification reduces volatility faster than it reduces the overall return, so equity-like returns can be regained by using leverage on the portfolio.
Following this advice today is tricky thanks to the persistent yield inversion: you obviously can't improve returns by using short-term borrowing at 5% to invest in long-term bonds at 4%.
Wouldn’t the most risk-efficient strategy both depend on a large number of factors and also, in any case, start off with a higher allocation of equities and move over time to a higher allocation of bonds?
The stock market has never not outperformed bonds over a 45 year period, maybe even half that, so if you’re 20 and putting 40% of your savings in an account you can’t touch until your 65, you’re kind of just chucking money down a well right?
> Wouldn’t the most risk-efficient strategy both depend on a large number of factors and also, in any case, start off with a higher allocation of equities and move over time to a higher allocation of bonds?
Not really. The most risk-efficient strategy optimizes the ratio between expected return (less the risk-free rate) and volatility (standard deviation), regardless of the absolute value of those parameters.
If that optimal allocation has too much risk, such as for the near-retiree, then the investor can keep a fraction of their portfolio in the mix and the other half in cash (money market, paying the risk-free rate). If the allocation has too little risk, then the inverse applies: borrow on margin (at approximately the risk-free rate) to invest more than 100% of net assets into the mix.
Right but a 25 yr old’s retirement account has practically zero risk. If you functionally can’t withdraw the money for decades anyway, there’s approximately zero chance a dollar invested in bonds will outperform a dollar invested in equities.
Ending up at 60/40 might be a good plan, but starting there seems a waste of money.
That's where leverage comes in. Under more ordinary conditions, the 22 year-old would have something like 80% in equities and 50% in bonds, using leverage to have a net 130% invested.
Under current conditions, that allocation is more questionable. The yield inversion means that the expected value of a leveraged bond investment is about zero (borrowing at a higher short-term rate to lend at a lower long-term rate), so any portfolio gains come from anti-correlation of bond and stock prices. However, the current market worry is more about stagflation than a traditional recession, such that inflation leads to both higher interest rates and lower equity returns (through equity de-leverage).
Where do you get the leverage and what does it cost? To be clear: Leverage isn't free. It is borrowed money -- financing -- for your positions. For most retail people, they will struggle to pay less than 5% per year, and usually much more. Here is a list of margin rates from Interactive Brokers: https://www.interactivebrokers.com/en/trading/margin-rates.p...
A never once, did I am read any sensible long-term retail strategy that recommended the use of leverage, let alone persistent leverage. This is a strange post.
Isn't the point to change as you get closer to retirement? When your investments have a decade plus to recover, leave them in aggressive investments. There is a risk that a decade+ recession might mean delaying retirement, but in that situation delaying retirement is likely the best option even if your money was in s safe investment.
Once you are close to needing some amount of money, say X a year, then you don't have time for that X to recover, so the idea is to move X into a safer investment so it won't go up or down. Any money you don't need is still in aggressive options that have time to recover. Now you need X money every year, so you decide how many years you want to sacrifice growth for safety. Maybe 5 years, maybe 10 years. Call it Y years. Simulations show the historic optimal Y, though I don't recall the exact number and some people might want to gamble depending upon how much freedom they have to change X if needed. So X*Y is roughly the amount of money that needs to be in safer investments.
This all ends up being too complicated a math equation to optimize for the average person, so percentages are given that are much easier to follow which roughly work as a solution to this equation.
Individuals should be able to come up with their own plans based on what they want. For example, if I'm heading towards an early retirement, I might leave all my money in aggressive investments because if a market downturn hits, I'm okay with working a few more years before retiring. I'm also aiming for a retirement with big X spend a year, but have plans on how to live life if I have to move down to medium X or small X. Others might be aiming for a retirement of X and won't be able to make finances work with les than X, so they have to take a much safer approach to guarantee a retirement that doesn't lead to running out of money.
It really depends upon your age, your financial situation, what you want to do in terms of passing down money--and, as you suggest--if retirement means opening the money funnel on extravagant vacations... If you're comfortable with your ongoing situation with very conservative investments, that's probably what you should do. If you want to play the typical equity numbers over a reasonable timeframe, that may be a better bet. I've certainly been ratcheting down my equity, especially individual stocks, over time even if the expected value is probably lower.
I think that this holding stocks and bonds and then re-balancing every year or so is advice from back in the 1980's when historically bonds got under valued when stocks boomed and vice versa, so this made sense. I don't think that works so well now, especially when we had zero or negative interest rates for such a long time. If you can tolerate the risk (have a large amount of assets relative to your spending), investing in close to 100% stocks for retirement makes more sense.
Interest rates haven't been near zero for a while. I am not sure the logic of being 100% in stocks still makes sense right now, especially since you can get 4-5% interest in cash accounts and bonds are also starting to pay higher rates. Stocks are high right now too, and it's hard to see that stocks will deliver high returns from this point. Looking ahead, there are plenty of risks of inflation returning, especially in the US, and so I suspect rates are unlikely to fall back as fast as a lot of people are assuming.
The volatility of stocks is much higher than that of bonds or some other asset classes. If your time horizon is shorter than, say, five years, or if you are the sort of person who checks your portfolio daily, keeping a portion of your portfolio in bonds will drastically reduce your personal volatility.
I have an inherited IRA that I am required to take mandatory withdrawals from; I keep part of it in bonds so that I don't have to sell my stock funds when they're down.
Not underperforming but with less risk. If something goes to the moon there is high chances it will drop back to the ground. So you want to put some of that growth into something that will keep on flying.
Not sure, it was supposed to grow until I turned 67, at which point it was to be converted to a fixed annuity until my death. But I liquidated it early.
What about the book made the difference? I'm 100% convinced that it's better to do as you say, and forget about the accounts, and also unable to resist the temptation to check them every day. I'm constantly tempted to make changes.
The full analysis is too long to go on here, but on the chapter "Narrow Framing on the Upper East Side has this conclusion: "The implication of our analysis is that the equity premium - or the required rate of return on stocks - is so high because investors look at their portfolios too often. Whenever anyone asks me for investment advice, I tell them to buy a diversified portfolio heavily tilted toward stocks, especially if they are young, and then scrupulously avoid reading anything in the newspaper aside from the sports section. Crossword puzzles are acceptable, but watching cable financial news networks is strictly forbidden."
Of course there's the usual caveat about rebalancing as you approach retirement, basically the target date strategy. Really, the book gives great context into just how irrational we humans are. It has lots of studies, examples and anecdotes on behavioral economics. It was the book that actually helped me make sense of sunken cost fallacy.
I've done well (39% annual returns) investing in 2-3 individual stocks in addition to index funds for the rest of my investments. More than that would be IMO too much to pay attention to.
Admittedly my choices for stocks are a bit on the high-risk side, but it's worked out well so far. Picking up lots of AMD in 2017, and Rivian 6 weeks ago, seems to have been decent calls.
Sorry but I never believe these online claims given with no evidence about ridiculously high returns. It’s not to say you are lying but it’s easy to miscalculate these things.
Anecdotally I can confirm there's been a few 40% years in the past decade, but it really is a gamble, and because of survivorship bias it's easy to only hear about the ones that gained and not the ones that lost.
I started my investing journey about 5 years ago, started with stock picking, and my average yearly return is... 4.5% p.a.
I would've 100% been better of investing in a low fee index fund, like S&P500 (VOO), or even just a world ETF like VT.
I picked some winners, like Microsoft / Google, both up 150%, but they're tiny fraction of my total portfolio, so hardly returned anything all counted up. I did 170% at one point with Tesla too, but didn't sell at the peak. So ended up with 4.4%p.a. over 5 years.
Save to say I don't stock pick anymore and just buy VTI (kinda like VOO) and some VT.
Lore has it that SP500 doubles your money every 7 years. If someone is 60 and just started, well, it's not going too high.
But for someone who is 20something and begins placing $€200 per month in SP500 (preferably somewhere with the lowest possible fees), and does so every month for all the years he/she works, then there is a very nice surprise waiting for them (and their kids) later in life.
Keep in mind, investment funds don't die like our pensions, they are transferred 'down'. So even if someone has e.g. 200k when they have kids, by the time those kids turn 21, that 200k would have turned to 0-7yo 200k->400k, 7-14yo 400k->800k, 14-21yo 800k->1600k. It needs discipline and consistency though.
Can’t argue with the math but there are still risks (inflation, the government that issues your currency, etc). I’ve seen people sell all investments to buy all the supplies they need to live out their lives, and I used to think it was insane. But it is just a different sort of hedge.
I hope you don't think that type of return is normal. Anything, sustained, over 1% should make use suspicious. Really, that would be 12% per year. That is excellent return over the long run. We are in a mini-bubble, thanks to the Magical Six.
Oh yeah, I'm well aware these are very high returns, and chances are high that we'll soon get a year of -30% or the like, as the average p.a. return over 25 years is usually ~7-10%, depending what timeframe you mesure. (ex fees and tax)
I'm under no illusion that this will continue going forward.
I bought into AMD stock when it was $10 per share, it's now $180, yes it's a bit lucky but I'm not bullshitting.
It seemed quite logical to me at the time that they would do well. This was right as Intel was being savaged by Meltdown and the performance hits of the mitigations and Zen 1 was successful.
But will you sell in time for all that growth to not be eroded away?
Tech has been doing really well last few years, but it won't last forever looking at history. So when do you sell, and what do you buy when you sell.
This is why people opt for low fee index funds, like a total stock market fund. It'll always be in the right companies.
As noted in my original comment, a large portion of my savings / retirement IS in index funds. My individual stock investments represent such a large percentage of my account only because they've done very well, not because I dumped all my money into them.
I did something similar albeit more recently - I saw Nvidia was doing _extremely_ well, and figured it would pull AMD up as one of the few genuine competitors. I was right.
So I use the Freetrade app for my "fun" investments. I've got about £2k in there, and I've had it for about 4 years now.
There's a section where you can check the "Time-weighted rate of return", basically removing the effects of deposits and withdrawals. Their wiki says this is usually the best figure to compare portfolio performance.
Over that time, my performance has been 337%. The performance of the FTSE All-World Acc has been 67%.
Apparently I'm _massively_ outperforming the world market, which I'm a little suspicous of. I'm mostly invested in tech since I'm a software engineer - I got real lucky with both ARM and AMD, investing days before they skyrocketed, but also got good returns from TSMC (took ages though), Coinbase, and Games Workshop.
I only bought about a month ago, and I'm up 10% already, plus a round of dividends. I'm not trying to time the market, I just think GW is a great company with a lucrative future.
You could have doubled your money on Nvidia since January?? Look at the charts for all the evidence you need. There's survivorship bias in all the claims but it's easily done for the survivors.
Anecdotally, the prior decade had a few years that returned >40% for many people that weren’t indexing, and averaged well above the S&P500 over that period. The market conditions were nearly ideal for making those kinds of bets in the 2010s. We are no longer in that market and ZIRP is a fading memory. Part of being a more active investor is recognizing periods of years when certain strategies are likely to be profitable and robust and when they are not, and adjusting your investments appropriately.
Yeah, I've done quite well with a few specific (tech) stocks that were reasonable picks (and some modest bets that were simply wrong). (Which I mostly funneled into a charitable trust that pays an annuity.) But I certainly wouldn't put all my money or even most of it on such a bet. Even if I think I have a better insight than John Q. Public into something, there are so many variables.
In general avoiding fees is definitely a good thing. Its one of those things that hindsight finds the best strategy and they were kinda lucky about the crazy bull market in the USA in this time.
If you were a Pension fund in France, Australia, UK, Japan, China etc and put all your money in the local passive index tracker you'd maybe double your money in the last 20 years but way under perform S&P which is like 6x in that period.
This is true. Of course, when you have many indices, with random returns, some of them will perform well, but past performance doesn't guarantee future results.
Except the performance of S&P 500 isn't random. Over a long horizon, it is explained by economic policy and resulting economic conditions. There is a reason that most EU and LatAm nation indexes have done so much worse in the last 25 years: Worse economic policy. I still have high hopes for China equities.
Is this a controversial opinion? The most I could say without feeling like a total liar is: It is probably random around some signal, and that signal is indirectly affected by economic policy in ways that are itself not perfectly deterministic. Is it I who is out of touch?
Whenever I'm tempted to buy individual high performing tickers (e.g. NVDA, TSLA, AMD), I restrict the purchase to no more than 2% of my portfolio and I only allow myself to bet on 2-3 "race horses" at a time. I think this fulfills the desire to gamble a little and see 100-200% YoY returns. NVDA cracked 300% cost basis when I finally sold, which is wild.
The reason I can do this is because the rest of my portfolio is a boring mix of low-fee ETFs that track major US and international indices. As a retail investor, it's good to remind myself that if I actually had the skills to invest professionally, someone would probably be paying me to do it for them.
> As a retail investor, it's good to remind myself that if I actually had the skills to invest professionally, someone would probably be paying me to do it for them.
Don't discount the knowledge you have from being deep into an industry. The higher quality of the CUDA toolkit compared to other SIMD languages, combined with it's increasing relevance in compute (gaming, followed by blockchain, followed by ML, followed by GPT) would have made this an NVDA an easy pick for anyone (of the increasing number of people) that worked in parallel computing from 2006-2023.
Sometimes you can see a company is positioning itself for a great long term position before the entire wallstreet herd takes notice. That's when you add a single stock as part of your diverse portfolio. I keep up to 5% of my stock portfolio as these single stock picks, judged entirely on the product the company sells.
> Don't discount the knowledge you have from being deep into an industry. [...] diverse portfolio
It's worth emphasizing that investing in the same sector that you are employed-in is actually a kind of anti-diversification, and it won't usually show up using "rate my portfolio" tools.
The archetypal example that comes to mind--unusually extreme but illustrative--would be all those Enron employees who invested their 401(k) funds straight into their own employer.
Consider these three scenarios:
1. If your investments plummet but you keep getting wages from you job, you can try riding it out until they recover.
2. If you become long-term unemployed but your investments stay normal, you can sell a little to cover the gap.
3. But if you can't work and your investments plummet, you may be forced to "sell low" quite a lot to cover immediate expenses, and the long-term outcome is much worse.
> investing in the same sector that you are employed-in is actually a kind of anti-diversification
You can reduce your microeconomic risks by making investments in and around your sector of occupation. Especially when betting against yourself.
For example, someone who works in the electric vehicle space could reduce their risk by making personal investments in ICE companies, just in case EV adoption is slower than expected. A person who works in a payment processor could invest in visa/mastercard, to protect from the risk of fee rises. A privacy tech investor could put money into adtech, so they can make money whoever wins.
> For example, someone who works in the electric vehicle space could reduce their risk by making personal investments in ICE companies, just in case EV adoption is slower than expected.
This works well if the EV industry slows and ICEs are poised to dominate the future. This works very very badly if the vehicle industry as a whole slows and the entire sector tanks.
It may work in the actual case: EVs are the future, but the longer term future, and the market irrationally decides a company that makes 1% of the cars is worth 50% of the industry because they greatly overestimate how fast the transition will occur and the legacy auto makers (whose stocks have underperformed due to the same bad prediction) have plenty of time to use their substantial advantages to compete.
Yeah it only works well for narrowly defined microeconomic risks.
However, in sectors like vehicles there's a relatively low risk people will stop car purchases altogether but a very very high risk they'll buy from another manufacturer instead of yours.
> You can reduce your microeconomic risks by making investments in and around your sector of occupation. Especially when betting against yourself.
Or I can just put my money in something like VTI (total US stock market) or VT (total world stock). Effectively does the same thing with almost zero effort. One thing I don't really like about the comments here is how insistent people are in doing something specific as opposed to picking the simplest thing and then sticking to it. Most of the power of investing comes from time.
Admittedly, though, I have been putting new money into a leveraged ETF, RSSB, which is a 2x leveraged 50/50 global stocks and bonds fund (so 100/100). Existing money is still in VT. The only reason why I'm pursuing this is because of Cliff Asness's great article [1], which argues against going 100% stocks (which I used to do) and instead prefers using something like leverage on a 60/40 portfolio.
1. It's normal in the tech industry to own a lot of stock in the company you work for. Investing in a vendor (in Nvidia's case) or another adjacent company is lower risk. You cannot avoid risk in investing, it's a natural part of the situation.
2. You can avoid the sell low situation by having 3-6 months of expenses saved in an emergency savings account. With all the layoffs in the last few years everyone should have gotten the message to do this. Even in a large downturn six months of expenses in a savings account is enough for you to re-skill and find new employment.
> It's normal in the tech industry to own a lot of stock in the company you work for.
For certain companies, but misleading: Most of that is stock which their employer structured into compensation, and sometimes they only kinda-maybe-potentially own it because it's an unvested RSU or un-exercised stock-option etc.
That's not the same as taking your paycheck and then choosing to spend part of it on shares from the open market.
Just because everybody is doing it, doesn’t mean it’s rational.
The people who held onto their RSUs from being hired at Zoom during the height of the pandemic might not be so happy they chose to double down on their employment risk with investor risk.
> Just because everybody is doing it, doesn’t mean it’s rational.
Also, an agenda that is rational for one party may be irrational for the other.
Many employers would be overjoyed if their workers agreed to be paid 100% in deferred-vesting RSUs and converted all their private savings into pure company stock. It would both drive the price up and shackle workers to certain company interests.
But if an employee sought the same outcome, we'd question their sanity.
> You can avoid the sell low situation by having 3-6 months of expenses saved in an emergency savings account.
Maybe. You can also just be trying to catch a falling knife. Sometimes it's sensible to cut your losses but, of course, it's often not clear when (or if) that's the case.
> You can avoid the sell low situation by having 3-6 months of expenses saved in an emergency savings account.
I see this (3-6 mos savings) constantly quoted in basic personal mgmt blog posts, but it seems unrealistic for most. Seriously, what percentage of people in OECD can do this? Surely, less than 5%. I am not sure it is great advice because it is discouragingly unrealistic for most. The average person has out of control expenses and 632 reasons why they cannot change anything. If you read any personal finance Q&A, they all eventually descend into this pattern. It gets boring. And most people who do save a lot have a much higher income than is average in their area.
Most people can without much trouble. Income follows a statistical distribution. It follows that most people could choose to live the lifestyle of someone earning 10% less than them and save 10% of their income per month, building a buffer that grows by about one month per year.
You are right in that they have 632 reasons they couldn't possibly do that, but they are clearly wrong since other people are. The correct thing to do is to realise that having a little bit of financial stability is a higher priority than those reasons in the majority of cases.
Or option B, which is figure out a way to earn more and keep lifestyle inflation in check. In theory, everyone should be able to take that path.
> And most people who do save a lot have a much higher income than is average in their area.
Cause or effect? Because if you save consistently you are going to automatically have a higher income than your more average peers. You all have the same average income but savers supplement that with passive income.
> I see this (3-6 mos savings) constantly quoted in basic personal mgmt blog posts, but it seems unrealistic for most. Seriously, what percentage of people in OECD can do this
Also worth noting that in most of the OECD, 3+ and even maybe 3 months depending on the situation is quite high, bordering on the wasteful. Americans have to worry about healthcare and crappy if present unemployment payments if they lose their jobs; in most other developed countries (of course your mileage will vary), you cannot be fired on the spot with no notice without compensation. And if you do, you don't lose your healthcare. Also, you can't be fired for being sick/unavailable to work for medical reasons, and at least some countries have medical provisions for burnout too (you get months of paid sick leave to recuperate, while your job is being kept).
Therefore, in most of the OECD (at the very least the EEA + UK + Australia and NZ), there are very few, if any, situations which can leave you with zero income with no notice. Therefore the safety cushion you need is much lower than an American that might lose their job tomorrow and then need to pay tens of thousands in medical bills.
Why is this being downvoted? There are lots of great points in this post. I never considered that most of the advice that I am reading is aimed toward US people, where the labour laws and social safety net for working people is awful, compared to the rest of OECD.
Probably because of the narrative that people are routinely fired out of the blue and that there is no recourse to also suddenly having tens of thousands of dollars in medical expenses also out of the blue.
It doesn't really matter how regularly it happens, only that it does happen and that there is zero recourse in that case. So people need to build their own safety nets in the US.
I know it happens less frequently in tech, where people get compensation, but what % of workers are in tech? The median worker has no such luck.
As discussed, there is much less of a chance that you'll suddently find yourself with no income when you live in most of the EU+UK+Aus+NZ.
And if you do, you're still less uncomfortable because your healthcare is not tied to your employer. Unemployment and other related aids/insurances/benefits will vary wildly between countries, but I'd still bet the majority do it easier than in most US states.
Possibly. As you say there's a lot of variance. I don't generally assume that you can get quality healthcare, housing, and food in Europe with no source of income outside of government programs.
And certainly many countries have lower salaries and higher unemployment that the US does in general.
> I don't generally assume that you can get quality healthcare, housing, and food in Europe with no source of income outside of government programs.
And what's the issue with government programs? If someone without employment or revenues can get healthcare or food, that's good.
> And certainly many countries have lower salaries and higher unemployment that the US does in general
Higher unemployment yes, absolutely. Lower salaries you can't really compare because you need to adjust for a lot of things (quality of life, cost of living, things like the safety cushion one needs, etc.)
Coming from a family that has a frugal culture, it’s always been easy for me to save a substantial part of my income, even when I had to downsize my lifestyle after losing a relatively high paying job. Looking at how people around me spend their money, it can feel they’re actively trying to get rid of their entire salary.
> it can feel they’re actively trying to get rid of their entire salary.
They probably are, in a literal sense. Most people play status games and identify that money is a resource that can be used to buy higher status. They then work out how to spend all their money on status-boosting activities because they don't want money. They want status. And they want it ASAP because their instincts are confident that status now is more important than later.
It is a bit sad because it means they are less comfortable and prosperous later on, but there is not much that can be done. Human nature is a real obstacle; it isn't calibrated to understand exponential returns or capital investment.
More than currently do. Rates are low in higher income countries.
We never really teach these things, which is a shame because I think they have such value over time.
I've spent a lot of time helping people with budgets and I've found a few things to be common. To make this easier I'll just say "people" as a general thing of those coming for help.
1. People don't get why they're running out of money
2. They don't know what they're spending
3. They've not connected the idea that knowing what they're spending money on is important to figuring out where their money is going
This isn't a slight, it's just interesting to see that this connection has never really been made. Money is treated as an emotional thing rather than a mathematical thing.
And this is those who get to the point of seeking help - they're actively asking for help and have never tried just tracking their spending. It's an entirely new concept.
The next big thing is that people talk about unexpected costs coming up and have never stepped back to look at the issue more broadly.
Some find birthdays an "unexpected cost" but they're not actually a surprise if you are able to look ahead more.
More unexpected are repairs and replacements. But stepping back although your tires were a surprise this year and your brakes a surprise last year, the idea that something would need dealing with on your car isn't.
The 3-6 mo savings is really a goal before suggesting moving on to riskier investments rather than "oh just have this". One day of spending is better than none. A week is better, a month better and 3-6 is better still. Beyond that the benefit drops massively, so you can start putting away money for much further in the future.
It's boring but that's imo because there's not much to basic personal finance.
If you spend more than you earn you are screwed.
If you earn more than you spend, you can build up savings.
If you are right on the line, you're either statistically shocking or your spending should move one way or the other.
It's unrealistic for people who have no money to invest.
But the top 5% in the US make 300k+. If you can't save anything making 300k you have a spending problem. Honestly I'd you're making 100k can can't save you have a spending problem.
It is interesting that you cofounded two points from my point to assume that I meant the top 5% of earners in the US. No, I have see personal finance Q&A from all income levels where people have out of control spending. I think this is the norm in the US.
It may be unrealistic for many people, but it should not be unrealistic for the subset of people who have available funds to invest in the stock market, which is who the GP's advice is for. Putting money into stocks before you have an emergency fund is bad prioritisation.
Worth noting that they're not saying you don't need that kind of value on assets available to you. They are simply advocating for keeping that money invested rather than as cash and they have access to immediate fairly large loans (via credit cards and something about their mortgage).
> It's normal in the tech industry to own a lot of stock in the company you work for.
It's actually not. The tech industry is much bigger than startups and the like, and outside of that environment it's not normal to own a lot of stock in your employer.
I would have said it's larger tech companies where it's fairly common to own (some) stock that's actually worth something. (So maybe not a lot in the scheme of things.)
So you've been invested in NVDA for 15 years? Because that's how long AMD's been trying unsuccessfully to crack CUDA's secret (OpenCL was initially released in 2009 when it was already clear that nobody wanted to use AMD cards for HPC).
Or how about 5-10 years, when it was clear that everyone was using Nvidia for crypto-related purposes? Heck, even start-of-pandemic when high-end graphics cards were nigh impossible to buy without a 3x markup? (A cool 1500% ROI to date)
This is the sort of thing that's obvious to everyone in hindsight, but it's not always clear in the moment, nor is it clear when the stock has peaked (how many people sold in Nov 2021 as the GPU shortage was starting to ease?).
If you bought NVDA on Jan 1 2006 and held it for 10 years, then you'd have about +100% ROI, or about 7% per year. Not terrible (S&P 500 was closer to +50% ROI over that timeframe), but not amazing (compare this to GOOGL which had a +250% ROI, or AMZN which grew 10x over the same timeframe). Amazon was also an obvious winner in that timeframe due to AWS, right? What about Google / Alphabet? What was unique about its circumstances that warranted it growing twice as fast as Nvidia in that timeframe? Google Plus? Android (it didn't grow 10x like Apple did)? YouTube?
It wasn't clear then that NVDA would have been the winner that it is today, and it's similarly not clear today if NVDA has another 10x gains ahead of it, or if it's already peaked. Or, for that matter, what the next big tech winner will be. (I bet it already exists. It might even already be publicly traded.)
edit: also, if I had perfect predictive knowledge of the financial markets, I'd have put $1000 on BTC back in 2011 when it was about $2 a pop, and sold at any of the recent peaks for $3+ million. There is literally no technical justification for those returns other than market speculation.
They mentioned the timeframe as 2006-2016. I think they were purposely omitting the recent gains to highlight their point about the unexpectedness of NVDA's stock jump.
Exactly. NVDA wasn't clearly a winner until the past 2 years or so. From Jan 1 2016 to Jan 1 2020, it grew by 8x -- certainly impressive (70% year-over-year growth). From there until the ChatGPT announcement in Nov 2022, it maybe doubled once more (peaked from the crypto-induced GPU shortage, then was falling). But from there on out, in the course of 20 months, it's skyrocketed 8x (an absurd 250% year-over-year growth).
So sure, if you correctly guessed that ChatGPT was going to spur a ton of interest in Nvidia hardware, then you could have made lots of money in not very much time. Meanwhile, to me at the time, this seemed like an incremental release on top of OpenAI's prior GPT models, none of which were earth-shattering paradigm shifts. I certainly did not anticipate the surge of all these AI startups that wanted to build on top of it, or the industry shift to try to use GenAI to solve all of the world's problems.
--
If I got the math wrong anywhere, it was the magnitude of investing that $1k in BTC back in 2011 -- I'd have $30-35 million to my name, minus taxes for long term capital gains. Even then, it wouldn't have been clear to me at what point I should sell -- mid 2017, when that investment would have grown to $1 million? After it peaked in December 2017 at $20k, it lost 80% of its value -- what reason would I have to expect that it'd grow to more than 3x its previous peak, just a couple years later?
The bet I described was that GPUs would be more and more relevant in modern computation, and that Nvidia sells the best GPUs and the best toolkit for writing general purpose code on GPUs. GPT is just the latest on a large chain of applications.
> Sometimes you can see a company is positioning itself for a great long term position before the entire wallstreet herd takes notice.
Well, the investment landscape is littered with the rotting husks of companies with great products. Wonderful, amazing products. They had incompetent management. Or the market for their amazing product never took off. Or there was a general downturn in the economy and they couldn't get cash when they needed it.
If the company has demonstrated itself a good investment, you can rest assured the wolves of Wall Street have already picked the carcass clean before you as a retail investor even get a whiff. They run analyses on factors you don't even know about to make their picks, and they do it in large number like you're never likely to see.
Even if you make the right picks, it's often the wrong pick. Consider if you had invested in Oxycodone a few years ago. It was a great product, brought simple, accessible, effective pain relief to the masses. Prescriptions were flying off the shelves like no other drug before it that wasn't a statin. I'm sure a handful of retail investors are smugly crying "inb4" but most of them are left holding the bag on that one. Hindsight investing is mostly a bitter strategy.
This sounds a lot like hindsight bias. Nvidia is a great company but they lucked out on two unpredictable hypes, crypto and AI, that happened in close sequence to each other.
We tend to underestimate the fortune component of success when we succeed. And other aspects, like ruthlessness. Also, having a self satisfaction in the wise (but cautious, or even silent) past forecasting of success for those that coincidentally succeeded eventually (forgetting the others we were wrong about).
We seen good and promising products targetting growing markets fail while competing half crap craps sell wild with the broad public and win, go large.
Without predicting the future of the AI cycle, the crypto bubble basically burst and the high end gamer market is a pimple on a pimple. And, certainly, the fact that the AI hype came along when it did was hardly ordained--though the availability of GPU hardware had something to do with it.
Nvidia's recent success was in no way pre-ordained to anyone who had two brain cells to rub against each other as various people here seem to think.
An extended family member is a software engineer who has worked in wireless networking for decades and decades, including being personally involved in the development of key parts of 5g.
In the 00s there was some company that had great tech. Surely useful for the future. He put a shitload of money in there. On each paycheck he put in more and more. But although the company had great tech, it didn't end up being the market winner for whatever reason. As the stock dropped and dropped he bought more and more. After all, it was the best tech.
He lost a fortune.
It is probably easy to look back and say "well, I knew that CUDA was easier to use than OpenMPI ages ago, it was obvious that nvidia would blow up."
Of course. But it is still relevant when discussing why one should not discount the knowledge you have by being deep in an industry.
Yes, he would have lost less money if he hadn't gone so deep here. But he still would have lost his investment had he put 5% in or whatever. The point is that even deep knowledge about an industry isn't going to ensure winning picks.
I clearly said "up to 5%". If I lose 5% of my stock portfolio on a single stock in a year, but the rest of my portfolio goes up the expected annual return of 8%, I still made money that year.
1000% but when it is the right time (per fundamental analysis). For example around the subprime crisis companies such as Microsoft had a low PE ratio and the average person thought that Microsoft was a loser vs. Apple and Google. Microsoft has a resilience track record that would be the envy of most companies and .NET was a real thing.
I also remember other companies such as Globant that has a lower PE price vs. similar companies after their IPO. It is incredible that some investors try to build very complex models instead of waiting for the right opportunity.
Not against speculation but you should know when you are doing it or fundamental investing.
I might argue that financial analysts are too focused on their models and this quarter's numbers but most of the better ones are actually pretty savvy about the trends and other happenings in the industry that they follow. They're as susceptible to the hype du jour as most people are but they're not actually stupid for the most part.
Yes, but remember there are multiple layers to that. I have worked as a buy side analyst in a small team (in my former career) and did much less detailed modelling.
There is an incentive structure that pushes fund managers to look at their rankings this year: there is no point in aiming at outperforming over a decade if you got fired two years in for underperforming. It has happened to people who have not bought into booms.
I actually think avoiding the "hype de jour" is one place where small investors have a chance to do well. Avoid the overhyped, pick up the neglected and you can outperform.
No argument. Incentives matter. There's one company I looked at for a modest investment and I was like "This is the only company in the world that can do something that is obviously needed in semiconductors but has long cycles" and it stagnated for a year or two. (And then went up considerably.)
As a financial analyst I might very well have logically held off for a bit.
>The higher quality of the CUDA toolkit compared to other SIMD languages, combined with it's increasing relevance in compute (gaming, followed by blockchain, followed by ML, followed by GPT) would have made this an NVDA an easy pick for anyone (of the increasing number of people) that worked in parallel computing from 2006-2023.
Hindsight is 20/20. I highly doubt people in parallel computing, unless they already worked at Nvidia, have done better than anyone else with their portfolios. Other than the standard delta you'd assume since those people are probably savvier investors in general.
Every share of an S&P 500 index fund you hold is already 6-7% NVDA, so a lot of investors already have substantial bets on some of these "race horses".
Whenever I kick myself a little about not owning any/enough of the "race horses" I content myself that there's probably a lot scattered around my portfolio. So you missed out a bit but your index funds actually benefited.
Yeah, if you have an itch to individually invest, set a budget and play without doing anything too stupid. I've actually done pretty well with that approach especially when I've avoided capital gain with a charitable trust with a few relative home runs I have hit.
It’s not just a matter of skill but of time. Value investing a la Warren Buffet works extremely well, but choosing a single stock with the deep research required for that method is so much work it is a full time job. It’s not worth it unless it is in fact your full time job.
This is great advice. You follow the best rule of thumb for individuals, ETF w/ dca and set it and forget it, but allow a bit of fun to scratch the itch.
I do something similar but honestly allow too much to go towards the latter. I need to pair back. I am thankful and lucky that my returns have been similar to index funds and not far below (thanks NVDA and NET)
> As a retail investor, it's good to remind myself that if I actually had the skills to invest professionally, someone would probably be paying me to do it for them.
The majority of supposed "experts" are not beating the market. Its probable that the only difference between them and you is the belief/confidence in their skillset.
I like this approach too. My primary investments in index funds continue to grow and I get just enough of a dopamine hit from smaller bets on Nvidia and Crypto that I don't get crushed by fomo and end up betting my mortgage on some far otm call options or some shitcoin.
> NVDA cracked 300% cost basis when I finally sold, which is wild.
It's not if you consider the volatility of the stock. It appreciated x10 in less than 2 years and 20-30 times since the pandemic. Volatile stocks have high returns because they have high risks for losses.
This is totally reasonable and I support it. When (usually young) people are bored with my advice about index funds, I tell them that it ok to "gamble" with a tiny fraction of their portfolio, but be prepared to lose what you bet!
I also think that if you look at the regulatory environment in the last 20 years and the lack of monopoly oversight from the SEC and FTC, you can just ride the regulatory capture. I can't see anything beating S&P500 + N100 over any 5 year period unless new laws are passed.
The original idea behind passive investing was to use the pooled intelligence of many traders guessing the value of cr I think we’re beyond that. Most traders are just trying to get a timing edge over the indices. This introduces the modern concept of passive investing as a positive feedback loop force-fed by monetary supply. The market seems to hate dividends and buybacks, preferring expansion or acquisition, but then what gives it value? It has to be its memetic ability to attract investment, and this can easily eclipse anything on the earnings statement. I’m not sure this can go on forever.
>The market seems to hate dividends and buybacks, preferring expansion or acquisition, but then what gives it value?
I've always thought of a stock as a claim on future dividends, but for most of a company's lifecycle they should have a better idea how to invest funds than returning them to shareholders. So ideally only mature large cap companies should pay dividends.
As far as valuations go, international stocks are far more attractive than US stocks right now.
Total US stock fund (VTI): 1.33% dividend yield, 25.1 P/E
Total international stock (VXUS): 2.94% dividend yield, 15.4 P/E
It's been my experience discussing with many US investors that they are loathe to hold any international stocks for a variety of reasons. Personally I think they will have their decade soon. The US market cannot continue eating the world market capitalization without commensurate outsized earnings growth to back it.
Yeah. Some are saying passive investment is the biggest bubble of all times. The P/E of so many companies, not just tech ones, makes zero sense.
Mandatory pension funds are a ponzi. And btw the EU is hard at work working on one atm: they re currently thinking hard as to how to capture the wealth of EU citizens and the latest iteration would be a mandatory fund to invest in... State sponsored companies. They ll oc course not be presenting it that way but that s what it is. Then they ll kick the can down the road for years or decades by forcing mandatory contribution from new taxpayers.
Ponzi / pyramidal / state-mandated shenanigans never end well.
FWIW that mandatory fund in the EU shall be used to finance the army, digital transition (supposedly to counter the US but actually to siphon taxpayers money into friends of politicians creating companies that ll never compete with SV) and... Ecology.
I'm not thrilled that in a few months I ll be forced to invest in that.
I agree and Michael Burry has warned about it. There's no real price discovery on these index funds. Money comes in - buy all in the fund regardless of any fundamental. And many of those stocks aren't that liquid so in an exit and a dump, they will get destroyed.
This is incredible from a stakeholder management perspective.
Normally non finance people in the organisation get hoodwinked by investment sales people. Then they pressure the finance guys into perusing a complex high fee strategy.
>Normally non finance people in the organisation get hoodwinked by investment sales people.
Some benefits salesman came to my blue collar office and tried to hoodwink [great wordchoice] our boss into buying employee insurance policies (health, whole life)... but would not allow employees to read the contractual terms until after bossman signed-up.
It was left to employee vote, and I was grateful when my peers listened to my concerns [slick sales guy was out-voted, left frustrated with me about his lack of commission]. Why not just let us see the terms & conditions.?. are you really offering that shitty of a product?! †
†: insurance company's mascot was some waterfowl with a loud two-syllable mouth...
See: calpers, where everyone in the organization is both non-finance and getting hoodwinked, often by their coworkers, often by their board! Notable for many things, including selling out of their hedge fund positions shortly before the pandemic, as well as becoming an extremely large owner of timber companies across the US for absolutely no good reason.
I'm curious if this is demonstrably an optimal strategy for individual investment too... I haven't had much success getting any clear data about whether active management demonstrably produces better results.
Short answer re: investing in active managers (based on my many years listening to rationalreminder.ca) is that, if you eliminate some of the worst active managers, the average returns net of fees are the same. However, eliminating the worst managers is challenging (but not impossible) to do ex-ante. Even then, you’re only getting the same average returns as indexing, not better. Plus, you will experience a higher dispersion with active managers (greater chance of extreme negative or positive outcome), which is not desirable. Because of these two issues, It’s definitely better to pick an index fund.
Re: picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Active managers can only beat the market gross of fees because they employ large teams of people to do a lot of work to gain a small edge (stuff like predicting retail sales numbers from satellite images of store parking lots).
This is my attempt at summarizing a whole field of research in a few sentences. There are many more nuisances. I highly recommend listening to the Rational Reminder podcast if you’re curious about this sort of thing. They interview a lot of academics.
There's more dimensions to an investment than average returns.
Volatility adjusted returns (or Sharpe ratio) for instance, will tell you how much returns you have per unit of risk you take. This is important because getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility. You can only compare investments at equal amount of risk.
An other factor to take into account is diversification. If you have an alternative investment to compare to your base, and it's average returns is lower than your base, but it is un correlated, then you actually get an increased volatility adjusted average returns by investing in both.
That's just two dimensions to take into account, there are many others, but overall:
- Don't compare investments based on annualized returns alone, it really doesn't make any sense.
- Don't compare investments one against an other, instead look at the addivity of one on top of another.
> getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility.
Doesn't this depend on how long you're planning on investing for, and what your criteria for selling your investments are?
If you're planning on investing for at least 10 years, and you're willing to give yourself a 2-3 year window for selling your investments once they reach a threshhold you decide on ahead of time, isn't the 10%/10% investment better?
(e.g. if retirement is 20 years away, you might consider putting your funds in that sort of investment for 10 years, with a view to moving them to something less volatile in the 5 years after that, as soon as they cross a 10% annualised return threshhold during that window.)
If you consider that "you don't know any better" and returns are normally distributed (i.e. you don't have some secret sauce nobody else knows about), then there is no dimension in which the 10/10 is better.
You can convince yourself intuitively by imagining how you would maximize each strategy. The amount of money you have is a factor of the risk you take, because if you want to do something risky you will not be able to borrow much, whereas if you want to do something safe you can easily borrow.
That is, you objective is to maximize your expected return, under the constraint of not breaking your risk limit.
Suppose you have a 10% annualized volatility risk tolerance. That's your budget.
If you invest it all in a 10% average return / 10% annual vol strategy, that's it.
Now if I propose you a 5% average return / 1% volatility strategy, you just have to go to the bank and borrow 10x your capital. You will have the same risk exposure (in dollar), but 5x the expected returns.
Is 10x borrowing even an option if we are talking retirement savings?
I don't know much about finance. I guess that at that point (you borrowed 10 times your net worth). This is no longer your investment, it's your lender's investment. They will adjust interest rate to match the riskiness of whatever you are doing, leaving you with net zero.
> Is 10x borrowing even an option if we are talking retirement savings?
Of course it is, though not exactly by "borrowing money" in a "mortgage" sense. Margin trading is a way to take leverage, derivatives is another. The former is simpler but costly, the latter is cheaper and allows you much more than 10x leverage, though it requires some high school mathematical thinking.
What you're saying sounds right. But in practice, no one is going to lend me, a nobody, 5x my money. At least outside real estate, that's it's own crazy alternate reality.
> - Don't compare investments based on annualized returns alone, it really doesn't make any sense.
>- Don't compare investments one against an other, instead look at the addivity of one on top of another.
I don’t think either of these matter to 90% of investors whose goal is to build up a nest egg for retirement which means not spending for decades in the future.
Sharpe ratios and all those “risk” adjusted calculations all involve assumptions that may or may not be true.
Comparisons of just annualized returns over long periods of time seems fine for broad market index funds, especially if you are assuming the federal US government will provide a backstop.
> Sharpe ratios and all those “risk” adjusted calculations all involve assumptions that may or may not be true.
On the contrary, these risk adjusted measures assume nothing more than a normally distributed random variable.
If you just look at annualized returns, then go ahead and invest in CDOs ETFs.
More seriously, the S&P for instance has around 20% annualized vol, which IMHO is way above what you would want for a retirement fund. I would target something closer to 10%.
> Comparisons of just annualized returns over long periods of time seems fine for broad market index funds
Do you have any sort of reasoning or is it just a gut feeling?
>However, financial assets are often not normally distributed, so that standard deviation does not capture all aspects of risk. Ponzi schemes, for example, will have a high empirical Sharpe ratio until they fail. Similarly, a fund that sells low-strike put options will have a high empirical Sharpe ratio until one of those puts is exercised, creating a large loss. In both cases, the empirical standard deviation before failure gives no real indication of the size of the risk being run.
>Do you have any sort of reasoning or is it just a gut feeling?
The reasoning is that their volatility is negligible over the long term due to political forces. Of course, it is also an assumption that could be wrong, but the mechanisms for government policy (democracy, aging demographics, and voter participation trends) seem to favor reducing purchasing power of currency rather than letting broad market equity prices stall or slide down.
> >However, financial assets are often not normally distributed, so that standard deviation does not capture all aspects of risk
Volatility not being a full measure of risk obviously does not imply that volatility should be ignored.
The former statement about returns not being normally distributed is a, trivially verifiable, factual mistake. Daily stock returns are normally distributed with a slight positive kurtosis. This remains true on any period over the last 30 years.
I am bot arguing either that the Sharpe is an all encompassing measure, some strategies have a returns distribution that is not well explained by Sharpe. I don't think it matters in this argument though.
I think when stating your opinion against 40 years of econometrical research, including multiple Nobel prizes in economy, you should feel enticed to explain your opinion a bit more than "no I don't think so"...
Please quote a Nobel prize (well, there's no Nobel prize in economy, but surely we understand each other) winner explaining that stock prices are, in actual reality, random variables.
As for the quotes, I encourage you to strongly think about the meaning of the work of Sharpe, Black & Scholes and Markowitz applied to non normal distributions (both Nobel prizes, we understand each other).
In particular, try to articulate the relevancy of sharpe ratios between two non normally distributed portfolios.
If one is a random variable, so is the other. It's a simple change of variables. What's your point?
> As for the quotes, I encourage you to strongly think about the meaning of the work of Sharpe, Black & Scholes and Markowitz applied to non normal distributions (both Nobel prizes, we understand each other).
Could you quote the part where they say that actual, real-world stock prices (or returns, whatever) are random?
> If one is a random variable, so is the other. It's a simple change of variables. What's your point?
Not sure I follow your reasoning. Prices are positive only, and non stationary. That is very much not the same for returns. Usually prices are log normal, leading to normal (log) returns.
> Could you quote the part where they say that actual, real-world stock prices (or returns, whatever) are random?
It is not said, but rather implied. Take the Sharpe ratio for instance, it is a measure that:
1) is used to compare different assets / portfolio returns
2) rely on the 2nd moment of the returns.
The standard deviation is less relevant the further away from the normal distribution you go, so since this is a comparison metric, it can only be reasonably applied to compare normally distributed returns.
If you believe the returns are not generally normal, then you reject the use of the Sharpe ratio as a relevant measure of comparison.
I don't have a B&S reference at hand, and I did not read it since 15 years, but I'm pretty sure it assumes lognormals prices as well.
> Not sure I follow your reasoning. Prices are positive only, and non stationary. That is very much not the same for returns. Usually prices are log normal, leading to normal (log) returns.
Perhaps we should take it back to the beginning. What do you believe "random variable" means...?
This is absolutely absurd. Economists including Nobel prize winners, including even Eugene Fama who proposed the Efficient Market Hypothesis, does not think the stock market is normally distributed.
At best, using a normal distribution is something that undergrads use as a tool to learn about the stock market and make some simplifying assumptions for pedagogical purposes, but it most certainly is not something that actual professionals or researchers in the field genuinely believe.
Come on, don't create a trial of nitpicking. I am not saying returns are a law of nature meant to teach us normality.
My point is that, for all intent and purposes, you should assume normal distribution of returns.
If you don't, you're obviously on either end of the spectrum: not knowing the subject at all, or nitpicking expertise on the internet.
The subject of the matter here is convincing someone that risk adjusted measures should be considered when comparing portfolios. This is the basic underlying modelisation that 99.99% of the finance world makes, "compare sharpes", "compare volatility adjusted returns".
I'm stating 1+1=2 and you're arguing it doesn't hold in Z/2.
> At best, using a normal distribution is something that undergrads use as a tool to learn about the stock market and make some simplifying assumptions for pedagogical purposes
Implicit normality assumptions are everywhere. I encourage you to think hardly about your model and question whether anything you do would work on non normal distributions, you will most likely find that you have millions of these assumptions in your linear combinations, sample renormalization, regressions, sharpe weighters and optimizations.
Now of course you could refine that with students, lognormals, and whatever, but this is more _refinement_ than anything.
>assume nothing more than a normally distributed random variable
But look at something like systemic risk: it’s not necessarily normally distributed. The S&P returns skew left. I’m sure there are other risk metrics that break this assumption as well.
Right, risk is often fat tailed, but unless we enter an expert discussion, for which HN is hardly a good medium, it is safe to assume 99% of strategies out there yield normally distributed returns. Non normally returned strategies are rarer and sophisticated.
The level of discussion that HN is a good medium for has absolutely no bearing or causal relationship with whether or not the actual stock market is normally distributed.
Imagine really thinking that the nature of a discussion forum can somehow influence the distribution of stock prices, as if stock prices examine comments on the Internet to determine their behavior.
I dont have a dog in this hunt but that seems like a strangely aggressive response. Perhaps the comment meant nothing more than that plaintext HN is a difficult place to start having a discussion that really requires some mathematical machinery, and therefore, since we cant throw around sigmas and integral signs here, we will make some assumptions.
Attacking the comment with sarcasm isn't in the spirit of HN even if you think that is a dumb idea.
>I dont have a dog in this hunt but that seems like a strangely aggressive response.
Well I do and as someone who has seen his other posts on this subject as well, he has a tendency to try to dismiss differing points of views on the basis that he has 20 years of experience and knows better than everyone else but can't be bothered to explain it.
Someone who has experience and wants to flaunt that experience should do so by coming up with good arguments, pointing people to good resources, and making a good effort to inform rather than pulling rank as a way to dismiss the conversation under the guise of sophistication and pretention.
I too have decades of experience working at a quant firm, and guess what... many people who post on HN have subject matter expertise and frankly I don't think many of us would agree with the idea that the stock market is normally distributed, or that you need a great deal of mathematical machinery and sophistication in order to demonstrate that fact.
Math models reality, reality does not model math. Whether or not stock prices or portfolios, even the portfolios of those on Hacker News, follow a normal distribution has nothing to do with the nature of the discussion of those portfolios.
Also, policing people's tone is also against the spirit of HN as well, but here we are. If you want to police how I speak, flag my comment and/or downvote it.
The meaning of quantitative changes a bit with time and context.
I would say the more "bayesian / sell side / derivative pricing" kind of meaning exists since the late 70s, the more "frequentist / buy side / let's hire 100 physics PhDs" meaning came prominent in the early 2000s. (as a general feeling).
> he has a tendency to try to dismiss differing points of views on the basis that he has 20 years of experience
I surely will concede I have this tendency, now you have to keep the context in mind. You are on an internet forum focused on CS, and emerges a comment thread on personal investments. The very subject of this thread is whether it makes sense to consider risk adjusted returns or just any kind of returns for your investments.
My argument is based on the fact that risk adjusted returns should be used, and you should assume normal distribution. I am not saying this is a law of nature, but rather that this is a fine and widely used assumption for both practitioners and academics, which allows the argument and explanation to go further without entering an experts debate (like you are trying to start).
So I stand by what I said: for all intents of this discussion, assuming normal distribution should be a given. If you want to dance around it and demonstrate that a students distribution or whatnot is a better fit, go ahead. I think this is more armful than helpful here.
> try to dismiss differing points of views on the basis that he has 20 years of experience
I think this is important on the contrary. What is lost on a forum like HN is the context of people answering comments. When someone comments "I don't think risk adjusted returns are important", it makes a hell lot of a difference if it's just the opinion of a random guy, or someone with actual experience.
Now while it takes 1 sentence to wrongfully dismiss a scientific fact, it can take 100 pages of an expert to prove that it's true. Look at a proof that 1+1=2.
That is where credentials are important IMHO. Some debate tengents are not interesting in a discussion, and will only lead to an expert explanation serving no purpose other than confusing a reader, and making the expert proud of himself. In these situations, just stopping the tengent is the best reaction IMHO.
So I apologize if you take my comments as dismissing, but try to assume good intent. When someone asks why you should use risk adjusted returns to compare investments, I think the saner thing to do is to tell him to assume normal distribution, because that's the far more likely scenario, most of the research do take this overall assumption, and you can proceed to the demonstration that makes sense, which I showcased in my previous comment about 10% returns on 10% annual vol versus 5% returns on 1% annual vol.
To re take the example I posted above, when the discussion is about 1+1=2, I don't think you're doing any good contradicting that it doesn't hold on Z/2.
Assuming normal distribution of returns is a pretty standard base for comparing investments. It is a base shared by many models and metrics. Sharpes don't make a lot of sense on non normal distributions, mean variance optimization either.
Modeling (and possibly economics, especially) is rife with simplifying assumptions that break down in practice. You can find many economists who think modeling individuals as rational agents is a "fine and widely used assumption" while also finding many economists and psychologists showing where this assumption can get you into trouble. There is a big difference between "this assumption is made because it reflects reality" and "this assumption is made because it makes my life as an economic modeler not suck." The latter is still fine, but only if you're upfront about its limitations.
>it is safe to assume 99% of strategies out there yield normally distributed returns.
I don’t know that I agree. If the market as a whole doesn’t have normally distributed risk, it implies even the simplest strategy of buying SPY and holding will also not have normally distributed risk.
Except this is a myth. You will not win the lottery without taking crazy amounts of risk. The active managers who do beat a major index for a long, long time almost do not exist in retail space, and they beat the market by a tiny amount (~1%). In my era Legg Mason was the most famous, but even they fell too.
Buffet isn’t a passive investor. Berkshire Hathaway have often taken a very active role in the running of their acquisitions - appointing managers, setting strategy, merging/splitting off subsidiaries, etc. This is as much managing as investing. If Buffet was a pure stock picker, then he would be an interesting case in the active vs passive investment debate.
When you own one billionth of a company you are just along for the ride. When you buy a 10% or more stake you can influence the running of the company. Another aspect is he has offered liquidity to distressed companies like GE and got richly rewarded for it with favorable terms.
Yeah, I have tried to simulate this several times under different conditions. Given zero sum game and random odds, there is always going to be small percentage who have a lot and most will have below what they started with. It is easy to explain as well, if you for example start with $1000 and you have 50% odds of winning 10% every time. If you win and lose 50% you are going to be below what you started.
If you always win after lose and lose after win, then it would go like this:
1. $1000
2. $1100
3. $990
4. $1089
And so on... After 100 turns you would have only around 600 - 700.
But it's a zero sum right. Where does the 300 - 400 go? It goes exponentially to select few who by random chance have more wins than losses.
In fact the longer it goes on, the higher odds of there being outlier with a lot - you might expect that everyone would converge around $1000, but that is not the case.
I did an example run with 10 000 investors, each doing 1000 trades, each trade they bet 10% of their portfolio, with 50% odds of winning.
First investor had 562 wins and 438 losses, with $1,666,061.
Median investor had only $7 left with 500 wins and 500 losses.
Top 10th percentile investor had $364 with 520 wins and 480 losses.
So interestingly even an investor that had 40 wins more than losses, lost 2/3 of portfolio.
> How does that explain Warren Buffet’s spectacular success?
Buffett buys “cheap, safe, high-quality stocks” with leveraged “financed partly using insurance float with a low financing rate” [1]. TL; DR He’s doing private equity with discipline.
For most people who are saving for retirement between the ages of (say) 30 to 65, that's most of their investing lifetime, and such underperform could radically effect the life they can live once they start working. Do you want risk your proverbial Golden Years simply because you chose not to take the market average returns?
2. While Buffett is a better-than-average investor (and certainly better than me), the main reason why we know him is because he's so rich, but as Morgan Housel notes, the vast majority of that wealth has come from compounding:
> As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s. Warren Buffett is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation.[16] What if he was a more normal person, spending his teens and 20s exploring the world and finding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $84.5 billion. $11.9 million. 99.9% less than his actual net worth. Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time. That’s how compounding works. Think of this another way. Buffett is the richest investor of all time. But he’s not actually the greatest—at least not when measured by average annual returns.
The key is that for every Apple, there are a ton of companies we don’t even remember the names of that went out of business or otherwise did not beat the SP500.
Put another way - if you can reliably pick the next Apple before anyone else, you should go work in finance and make tons of money.
> Put another way - if you can reliably pick the next Apple before anyone else
Problem is that it might take years to verify that.
> The key is that
That doesn't change the fact that there are plenty (in absolute numbers) of individual investors who consistently beat the market. Whether that's because of luck or something else is rather hard to tell.
> That doesn't change the fact that there are plenty (in absolute numbers) of individual investors who consistently beat the market. Whether that's because of luck or something else is rather hard to tell.
It's actually not very hard to tell; if it was because of something other than luck, you'd expect that beating the market in the past would have some predictive value of their ability to beat the market in the future.
Individual traders beat the market all the time, it’s not impossible. But you can’t expect to do it reliably, because in practice it’s essentially gambling, unless you’re Warren Buffett, or those firms that utilize sophisticated quantitative or algorithmic trading.
So for all intents and purposes, the takeaway for regular investors should be that they cannot expect to beat the market (but they can gamble on it if they like).
Lots of people "play the market" as a mostly total game of chance. They might just as well join a giant pool that tries to guess the ratio of alphabetic characters within each morning's top headline of their favorite newspaper.
Warren Buffet buys the newspaper and has significant control of the editor. That's not the same game at all.
There's a lot of talk here about active fund management. Active ownership is playing on a completely different level.
You do know there are thousands of stocks right. how many people dump their entire savings into one stock. 20 years ago you wouldn't have known apple was going on to do so well. If people did know it would have been bid up in price at the time
And a lot of the Apple run-up happened relatively late in the game. Don't get me wrong. Apple--and what I was able to do with the money--was good to me. But so was a late 2010s Microsoft purchase and I don't think a lot of people are highlighting Microsoft as a stock they missed out on during the last 10 years.
That claim is not phrased like that, so why would we interpret that way?
> average
So what? It's like saying that since an average person can't run a marathon it wouldn't make sense for any individual to even try it. How does that make sense?
> cherry picked
If we agree that 50% of all investors can't beat the market, what proportion can? 1%, 10%, 30%? Because there is a massive difference.
How do we even define that group? Is it any random person buying random stocks with pocket change? Is it above a certain portfolio size? etc.
"Average" is a bit misleading word when it comes to the market.
If you're a top investing expert, you do things carefully in the right way, and you don't make mistakes, you can expect average performance. Because the market primarily consists of experts like you.
Of course, investing is a random process, and you often beat the market by being lucky. But luck doesn't last indefinitely.
There are basically two ways to beat the market consistently. One is trading based on information not available to the rest of the market. This is sometimes banned, because it makes the market less fair and less efficient. It can also be a crime. The other is finding a market that's small enough or obscure enough that it's not interesting to the professionals.
But there is no investing stat that allows you to beat the market. Life is not an RPG.
> Investment is hardly a zero sum game. If it were nobody would make anything buy investing passively either. So how is that a reasonable analogy?
I think you’re reading too much into the analogy, which is maybe my fault for using an analogy. The point was just that it’s not that you can’t win, just that you very likely don’t have an edge - not because it’s mathematically impossible like in blackjack with a shoe that’s continuously shuffled, but because it’s so difficult.
> Sure, I can't. But assuming that it's not entirely random chance some proportion of people certainly can.
And if you put your house on 26-black and it came up you'd be doing great too.
Take 100 people randomly throwing darts at the companies on the SPY, and a fair few will do better than the SPY overall. Doesn't mean they can expect to beat the market
Yeah. And 20 years ago, there was no iPhone and an only somewhat interesting MP3 player compared to other brands. I did OK with Apple but not suggesting it was much other than luck.
> picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market.
Is there? It would make sense if an average individual trader can't expect to beat the market. Claiming that there are no individual investors who did/can do that over a reasonably long period is both objectively false and rather absurd.
Read the GP carefully.Expect to beat is very different than beat. You don't expect to beat the casino in roulette, but some people will luck out. That doesn't mean they could expect to win in advance: They should expect a small loss, depending on the table, and be surprised when luck smiles upon them.
> You don't expect to beat the casino in roulette,
Do you believe that investment is entirely random and there is absolutely no skill involved?
Because if not, that's a nonsensical analogy. You should use a a both both luck and skill based game like poker (probably not the casino variety, though) etc.
Otherwise if you can reasonably expect to beat 50% of all "players" (of course it takes much more time to verify that in the market) then you can expect to make more than the average.
The problem is that any active trading strategies now need to beat the market by the cost of a fund manger, the cost of their research, the cost of regular trades, and the cost of short-term capital gains taxes on those trades.
These add up significantly. Instead of having to beat the market at all, you have to beat it by an extra half of a percent or more every year. And you have to do it year after year after year.
All the evidence shows that actively-managed funds are a weighted (against you) coin flip. Less than half will beat the market in a given year. And the results from any given year are independent of the next.
Yeah managed funds sucks big times. They rip people off with fees, quite some have insane performance fees and they just don't beat the market.
Then I suspect that even with all the supervision in place, quite some manage to also do Hollywood accounting.
Not to mention the friend of the cousin of the fund manager's niece who happened to buy x shares of y or options before, shocker, the fund invested in y.
We know these people cheat. If they were so good they wouldn't need to leech on fees.
I live in a tiny country where lots of fund are managed (only second to the US). I know the drill. Most of them by very far are about suckering people's money in, no matter what the fund is about.
Creat 16 funds, after four years show the prospectus of the one fund that performed best. Rinse and repeat.
Actively managed funds are a scam.
Also depending on where you buy it, anywhere from zero (good) to 1% entrance and exit fees.
> Do you believe that investment is entirely random and there is absolutely no skill involved?
The skill involved is more just "best practices" that let you match the market: Buy-and-hold, diversify, basically, do what the index funds do and you will be roughly +0 to the market. Beyond that, it's a totally random distribution that adds between -X and +X which allows some participants to beat the market and causes some to underperform. You can't tell beforehand which participants will beat the market, even having full knowledge of their strategies and skill. If you think you can, please tell me which active funds will beat the market in the next 10 years based on their skills. I'll invest in them.
> You can't tell beforehand which participants will beat the market, even having full knowledge of their strategies and skill
I never implied that I can. That fact doesn't prove that it's somehow fundamentally impossible to do that. The problem is that it's impossible to tell if you "strategy" is working until a significant amount of time passes and by that point the markets conditions might have changed to such an extent that you don't longer have an edge (add to that the fact that it's hardly possible to determine what part of your success was luck/skill). So there is always a huge amount of uncertainty.
Albeit if we look back by ~10-15 years it's rather obvious that it was possible to beat the market by a very significant e.g. there were clear rational reasons to believe that Nvidia would do better than its competitors like AMD or Intel and that there would be significant growth in GPU compute/ML/AI (of course accurately estimating the extent and exact timing but that wasn't necessary at all to get above market return) same applies to many companies in adjacent and unrelated sectors. Was I or the overwhelming majority of investors capable of realizing that and more importantly acting on it? Certainly not. But looking back it obviously wasn't random.
The efficient-market hypothesis is clearly false, at least in the short to medium term. That in no way means that most investors are even remotely capable of utilizing this fact.
It must have been nice in the early 2010s to be so smart to predict AI would be a huge hit (after a couple previous AI winters) and that GPUs would be the key and that NVIDIA specifically would reap the benefits. But I'm sure you're smarter than me and a lot of other people. And AMD also did pretty well during much of that same period although I sadly sold my modest holdings after they went nowhere for years after spiking with some adoption by the big server makers. It would probably have made more sense to bet on Intel during that period.
Exactly. The point is that the only way you can know that a particular "strategy" was market-beating is by looking back after the fact. Just like you can only know who is a good coin flipper after running 10 trials and looking back at who flipped heads 10 times. And the strategies will be similarly repeatable.
We expect some individual traders to beat the market (and some to do much worse than the marker); that's variance. But each individual trader should not expect to beat the market, because they don't know if they're one of the lucky ones.
> But each individual trader should not expect to beat the market
In aggregate sure. But unless we believe that it's entirely random some individual investors can still certainly expect to beat the market, they just can't verify that in advance.
I offer you a bet. We flip a perfectly fair coin. On every heads you gain 10% on top of your bet. On every tails you lose 10%.
It is fair to say that after 100 flips you may profit. If one million people play this game, someone almost certainly will. But you can expect to lose money on this game. By the end, the average person will have about 60% of their original holdings (0.9^50 * 1.1^50).
In this game it’s possible for winners to exist. It’s not even uncommon! You only have to get at least 53 out of 100 flips as heads. Unfortunately there’s also no function that lets you determine a winner in advance, and the longer you play this game the greater the expected loss.
All of the available evidence shows that publicly-available actively-managed funds are essentially playing this game. As expected, many have incredible winning streaks… right until they don’t.
Yes, Ren Tech’s Medallion Fund exists. But you can’t contribute to it; they don’t want your money. Because that requires scaling market inefficiencies and that in and of itself is an intractable problem. Novel strategies ripe for profit don’t have unlimited capacity. They rapidly exhaust alpha.
That’s not what “expect” means in statistics. If we’re rolling 100-sided dice (each person rolls once), no person should expect to roll a 1, even though 1% of people will in practice roll a 1. Likewise, no one should expect to beat the market, even though many will in practice.
> Likewise, no one should expect to beat the market, even though many will in practice.
My only point is only that not every investor is rolling the same dice. It's just that it is effectively impossible to every verify whether you were rolling a 90-sided dice or a 100-sided one. It's rather clear that at least in the short to medium term (e.g 2-3 years) the stock is not even remotely perfectly efficient (that doesn't mean that the overwhelming majority of investors are somehow capable of utilizing that fact or that a significant proportion of those that did seemingly manage to do that weren't just lucky)
The common refrain is that "time in the market always beats timing the market".
The implicit assumption in that refrain is that, despite periodic dips, the U.S. stock market always goes up over time. This has been true since the Great Depression (see graph of S&P 500 since 1929)
There are various macroeconomic models which attempt to explain the factors of growth, for example the Solow growth model. In this model technological advancement is only one of three factors. The others are the savings rate and the population growth rate.
According to this model, you may not be able to innovate your way to growth if one or both of the other factors are contrary to growth. This may sound academic but there are concrete examples in the last twenty years of countries that have not grown because of a stagnant or shrinking working age population, e.g. Japan and Italy.
This has no bearing on the passive vs active debate, as I'm fairly confident that passive investing will always be the better strategy for a retail investor regardless of the growth potential of an economy.
It's just in a country with unfavorable macroeconomic conditions, passive investing may be the way to minimize losses rather than maximize gains.
The assumption of continued growth will probably hold true for the American economy through the end of the century at least, so for everyone here investing in US equities it is academic. But we can try to decompose an economy into factors and use those to check whether we expect growth to occur at all.
That is too strong of a condition. The economy doesn't need to grow for passive investing to work.
Even when the economy is flat, passive management works. As long as companies are economically productive, capitalism will hand over a chunk of the profits to the owners of the capital.
Of course, growth increases the size of that chunk year over year, but capitalism doesn't stop when growth stops.
Active investing is when you are looking to exceed this passive margin by timing your trades well. Active investing requires changes in productivity (such as growth).
Returns from stock investing come from increasing stock prices.
Stock prices increase when earnings of the company grow.
In other words: when the economy grows.
You can argue that Amazon and Apple and Google and Facebook etc. will grow earnings even if the overall economy is flat or shrinks but I don't see how that would apply to passive investing i.e. investing in S&P 500 i.e. investing in 500 largest US companies.
S&P 500 is U.S. economy and they all are sensitive to overall economic situation. If people have less money, they buy less stuff. Amazon makes less money, their stock goes down. Apple sells less iPhones, their stock goes down. All other companies make less money, they spend less on advertising, Google and Facebook make less money.
I don't see a scenario where overall U.S. (or world) economy declines and S&P 500 doesn't decline.
In fact, declining economy is an argument for active investing. Even when overall economy declines, among 6000 companies listed on stock market there will be some that will be growing and if you invest in them, you'll make money.
> Returns from stock investing come from increasing stock prices.
There are other ways to make returns. Return from stock comes mainly from increasing stock prices and from dividends. But fundamentally, it comes from profits.
> Stock prices increase when earnings of the company grow.
There are many reasons stock prices increase. But whether it does or doesn't isn't really relevant.
When a company makes a profit, either:
* the profit is reinvested, the value of the company grows and the stock price grows, making a return for the passive investor
* the profit is returned as dividends, making the passive investor a return as well.
No growth needed for the individual companies either. As long as they are profitable, they make a steady return for the passive investor.
Thought experiment: imagine a company which is going to make 1 dollar of profit per year for all eternity, which it returns as dividends. For an investor with a discount rate of 95%, that company is worth 20 dollars. Say he buys the company for 20 dollars. After 10 years, that company is still worth 20 dollars, as eternity is still eternity, but the passive investor owning the company has made 10 dollars from the company.
As you can see, the passive investor made a return, despite the company only being profitable, but not growing nor shrinking.
You will make a return on your investment when your investment makes a profit, that is capitalism. Whether the profit is increasing, decreasing, flat or going in circles does not really matter, as long as it is a profit and not a loss.
This is all correct, but missing the higher order. Most investors will not take out the dividends, but reinvest them. A few might sell, because they are in retirement. But assuming that the retired people make up a small part of investors, profit is reinvested. Further, people invest a percentage of their income for retirement. All that means that work income and dividends make the stock prices go up and retirement makes the stock prices go down. You could say that retired people consume and help companies make profit, but it is actually worse for stock prices than investment, because the consumption requires companies to sell products and services that come with cost.
> time in the market always beats timing the market
> The implicit assumption in that refrain is that,
Only if you were fine with waiting 50-100 years. The market in 1950 was more or less at the same level in real terms as in 1906, of course dividends were way higher back in those days. If we take that into:
e.g. if you invested 200$ in S&P 500 in 1906 adjusted by inflation in 1950 you would have had ~$1570 in 1950. Which is an average annual return of ~4.7% which is not terrible but you would have made approximately the same by buying high grade corporate bonds just with way less volatility.
And the assumption that the stock market will go up from now is itself a form of timing the market. It assumes that now is the best buying opportunity in the whole future. I don't like that refrain.
It is the opposite. Market timing does not work reliably. Active management produces worse results on the long run. no individual trader or active manager can consistently beat the market. however active fonds may have periods (even several years) where they out perform.
for private investors buy-and-hold of highly distributed ETFs is the best way to do it. The easiest way to get started is a one ETF portfolio like e. g. Vanguard FTSE All World or SPDR MSCI ACWI IMI. They perform internal rebalancing automatically and you virtually have nothing to do. buy them and don't look at them for the next 20 years.
Noting that it is possible to beat market, with strategies / algorithms that are generally non-public. For example medallion fund, see https://posts.voronoiapp.com/markets/Jim-Simons-Medallion-Fu... . Note that these crazy performance stats are after the steep fixed + performance fees.
Strangely, the other funds operated by the same company and actually open to outside investors, have not performed as well. It is unexplained exactly why.
Acquired.fm has a great episode on RenTec medallion fund vs their institutional funds.
‘David: The way that some folks we talked to described the difference between the institutional funds and Medallion to us is that Medallion’s average hold time for their trades and positions is (call it) a day, maybe a day-and-a-half. Whereas the average hold time for the institutional funds positions is a couple of months.’
From some of their legal settlements it seems a not insignificant part of their advantage is dreaming up obscure illegal tax dodges on short term capital gains that are later revealed as such to keep more funds invested.
It’s possible only in the sense that it is possible to flip a coin heads 10 times in a row. One out of 1024 should do it. But you don’t know which one will until the experiment is over and you look back at the results.
Yep. Statistically, there must be some outlier. Always. And… good luck having the data they use to trade and the money to just enter into the markets they participate in.
But why stress about beating the market? Just be the market with an ETF that tracks the S&P 500 index. Literally, setup auto invest from your paycheck. Go to sleep (Rip van Winkel style). Wake up 40 years later and retire comfortably.
Look at total returns over the last 40 years on the most popular indices in the world. S&P 500 crushes them all. I see a lot of "Internet advice" recommending various MSCI world indices. They are all much worse than the S&P 500.
Picking the S&P500 over a world index because you think it will outperform, has the same problem as picking individual stocks over an index. You can't actually know which will outperform in the future.
Or, where in the world do you need to spend your money?
I live in the UK: if I buy the S&P500 over the FTSE100 (or even more so the 250, the next 250 largest companies which are typically more UK-market-oriented) I'm making a US-weighted bet. But maybe I think I'll move there, and should have that exposure. Or maybe I spend a lot of money all over the world and want a more global exposure overall.
I think at least vast majority index is right for basically everybody, but you do still need to think about which index/indices are most applicable to your situation/intentions.
World indexes are normally somewhat less volatile (they’re typically _much bigger_; MSCI World is 1400 companies, and MSCI ACWI nearly 3000), which may be a useful attribute, depending on what you’re going for.
(Conversely, there are smaller indexes which tend to beat the S&P500, like the NASDAQ100, but there’s a volatility cost.)
Think of when George Soros broke The Bank of England for an example of the type of trade.
There is a lot of demand for S&P 500 index , but that demand isn’t exactly tied to the fundamentals of the index, and the price isn’t tied to value of the underlying companies, it’s tied to demand of people looking to save money for retirement or a place to store a nest egg. This is an opportunity for price discovery to get things wrong and eventually the market should correct that.
I don’t get it. Soros was able to break the pound because the UK government was committed to maintaining an artificial price. That’s nothing like an ETF or mutual fund of the S&P 500, which probably has one of the most efficient (relative to the capital involved) market price discovery mechanisms in history.
Not sure what they mean specifically but you've probably seen a lot written about it, in terms of BRICS, the petrodollar, ARM in China, subsidies on electric cars, and so on.
Personally I try to avoid investing in the US for political reasons, besides the wishful expectation that the empire could fall within my lifetime and hence be a not so good investment.
It's sort of self evident - if you are freakishly capable of spotting mispriced securities in a market full of smart hard working people who are paying attention, you can do better than average. If you aren't freakishly capable... you cant.
It's sort of like "does playing pro golf make sense?".
There’s an interesting corollary to this. There’s some evidence that low-volatility strategies can outperform, at least when not using leverage. My working theory is that it is due to an overconfidence bias. People who actively trade assume they can pick better stocks, or else they wouldn’t trade. This manifested in more volume in high-beta stocks, leaving low beta stocks undervalued.
They’re only mispriced until they’re not though, or they’re priced well until they’re suddenly mispriced. That is the say the market is an evolving system varying on the time axis - that things are mispriced assumes that time isn’t rolling along and new events don’t happen and new information doesn’t arrive. Everything’s price today is just a guesstimate until tomorrow’s guesstimate following some new data. Granted it’s not like the past where whole companies were sitting there underappreciated because of a lack of analytics, but at the same time coming out of covid companies like Rolls Royce (makes aircraft engines) had their prices crash completely, then were demonstrably “mispriced” for ages and are still recovering now air travel is back to 2019 levels. But the price wasn’t mispriced when the planes weren’t flying, just cheap to those who believed covid would get sorted eventually and the debt RR took on to survive would get repaid.
The fact they are mispriced then not mispriced at a later time is almost the entirety of the reason one has the potential to make better than average returns.
They do. But if you offer the service to other people, you get a lot more money to play with (meaning you can do more or different things than you could with less) and get to charge performance fees etc. in addition to your own capital gains.
Really, you could say it about absolutely any job, it's just a bit more direct with managing money. 'If you were any good at writing software you would just sell your own SaaS', etc.
That's the common claim, but if you actually look at the successful funds that beat market year after year, their public fund is always the low yield, experimental strategies while the internal funds demolish the market. The reality is that most lucrative strategies have a yield cap and people who find them quickly surpass the cap so they just keep the strategies to themselves.
In private equity you are employing the managers to create opportunities
And during bear markets I’ve seen some managers create the most onerous terms far beyond what I could think of, and that's paid excessive dividends for me
I think that’s the real hedge that’s overlooked here
The performance of private funds is also not a complete picture, individual limited partners have different profit and loss than whatever metric the whole fund is subject to, someone that joined as an LP after any trade doesn’t have their capital allocated to that prior or existing positions, only the subsequent ones. so its not really possible to judge performance of fund managers in comparison to indices the way that it is popularly compared. Unless LPs are showing their own performance in a scatterplot, nobody knows anything. and LPs are typically subject to NDAs.
I just think it’s too reductive to say nobody can beat the index, then move the goal post to longer and longer time frames. You only need to be successful once, in any time frame but specifically shorter ones
He means that when people are screaming at you to do something because the market's tanking, you earn your salary by yawning and saying, "No, I think we're good."
Reminds me of that scene in The Long Short where Michael Burry is hemorrhaging money on the bet against CDSes and basically everyone has completely turned on him.
- A casino's winning business model (at least behind the facade of marketing glitz and amenities) is to set odds that favor the house, make sure its rules are followed, then essentially do nothing as it gets rich on the long-term consequences of those odds.
- It's the inevitible-net-loosers...er, customers, who are the think-they're-smarter and think-they're-luckier busybodies. And always trying new strategies, to build some sort of success out of their occasional sort-term wins.
I suspect that local awareness of this dynamic is why Nevada's business leaders and government tolerate such a boring, passive pension investment strategy.
All this is true, and there are many good comments in the thread here. But this "hey dude, stock picking is for idiots and all non idiots but index funds" should be treated with caution. Index funds are an extremely clever idea but were never meant to be used on such a scale.
Index funds are not some clever hack, they are just tracking the combined productivity of the publicly traded companies that make them up. Whole market, or the top 500 as a representative slice, whatever. When you buy the whole US market for example you are saying, "I strongly believe that the overwhelming majority of companies in the US want to make shitloads of money and pass it down to themselves and their shareholders."
Index funds will never bring down the market as long as individuals and companies are allowed to trade individual stocks at prices of their choosing. There will _always_ be someone who thinks a particular stock is overvalued or undervalued. Those people set the prices.
Something I've wondered is how index funds effect companies entering the index for the first time.
Like, let's say there's a company (TryerCo) that is the 501st biggest in the US. Big, but still one step away from being in the S&P 500.
Then, one of the S&P 500s collapse. They exit the index, and TryerCo enters the index at position 500, despite no material change since the day before.
Doesn't this mean a whole _heap_ of index funds will suddenly start buying TryerCo stock, sending it up thanks to the arbitrary number 500?
This is basically priced in based on the odds of entering an index in the same way that potential acquisitions get priced in based on the odds of the acquisition going through.
I swear I've seen actively managed funds that explicitly trade based on stocks' potential to enter/leave indexes, but it's a terrible batch of terms to try to google.
The ETFs are generally rebalanced once a quarter, so yeah, it really is a big deal when a company enters one of the main indices, and the price starts to move up in anticipation of the listing, then stays up because the ETFs, as you intuit, have to start buying it as a component of the market. Supermicro entering S&P500 and Arm entering Nasdaq 100 being good examples recently.
One of my big brain investing ideas is to pick the stocks at the top of the index instead of buying the whole index. If index funds continue to rise in popularity, the stocks that are at the top will benefit most from passive investment volume.
Plus, index funds follow a kind of Pareto principle where the top stocks contribute disproportionately to the total return anyway.
As I’ve gotten older though, one of my realizations is that the tax-free rebalancing of index ETFs is their most valuable property, rather than their actual choice of equities.
Hint: this idea has been around for as long as index funds have been around, if it actually worked well, everyone would be doing it. Alas, a big part of why index funds work well in the long term is diversification, and when you cherry pick a subset you also lose out on diversification. It's one of those strategies that looks clever if you don't delve into it, but actually the returns are worse. As an example, if you take the SP100 it might outperform the SP500 on single year performance every now and then, but in the long term, SP500 has consistently outperformed it.
You can pull up SP100 and SP500 and look at their historical returns. SP100 is an actual index, not something I made up for illustration. If you look at the last 40ish years, SP100 is up roughly 45 times, SP500 is up roughly 50 times.
What might help understand this concept intuitively is if you take it to the extreme: what if you always held only the very first company of the SP500. Sure, you would have a lot of the upside, but you would also be completely naked to the downturns. Similarly, you would lose a lot of money on commissions whenever the leader changes. Taking any other smaller subsection has the same problems, it's simply a matter of what tradeoff works best for you.
Sorry I know what you mean - I’m just having trouble finding any data source / website that shows useful comparisons going back that far - what website are you looking at?
These are the 10 year returns I’m seeing according to S&P:
S&P 500: 11.1%
S&P 500 Top 50: 13.2%
S&P 500 Top 10: 18.1%
The trend is pretty clear, at least in the last decade. My other point was that the historical data may not be as relevant because the index is much more top-heavy today, perhaps in part due to the popularity of index funds and part because the top companies are actually outperforming.
To your question about picking the extreme Top 1 stock - again I’m having trouble finding good data on that, but I’d be curious what the hypothetical outcome would have been over the last 20 years.
I use IBKR for data, but you could also get ticker data from Yahoo Finance or other similar sources, albeit manually since they don't have an API afaik. A simple although simplistic way to backtest ideas like this is Portfolio Visualizer [0], you need an account, but a free one should work. I've uploaded a screenshot of a sample run where the top company in SP500 was held for a year and then swapped out if needed on an annual basis [1]. There's a few things I'd like to highlight.
Firstly, for a considerable majority of history, often for years at a time, holding the top one company, I'll just call it SP1, underperforms the index. The maximum downturn for the SP1 was 79% and I think very few people could stomach holding that for years at a time, hoping things will improve.
Secondly, pretty much the only reason the SP1 strategy comes out on top is the fact that AAPL has gone up about ten times (!!) in the last decade or so. Whether that's the new norm in the markets or an absolute anomaly I'll leave up to you. In short, the only real reason the SP1 strategy has looked favorable, and I suspect the same holds for the SP10 and SP50 if you backtested them, is that Apple has seen its value skyrocket.
Needless to say that none of this is investment advice etc.
I had an active manager reach out to me with exactly this strategy.
I didn't look at the fees or rebalancing schedule super closely, because I didn't want to invest with the guy, but IMO his market-beating claims were due to increased concentration during a bull market (risk) which could go sideways fast if he didn't rebalance at opportune times.
Which, without looking, probably means NASDAQ today--and certainly the top 50 or whatever tech stocks by whatever metric. That didn't look so great in late 2001. Certainly my T Rowe Price tech fund cratered. Tech has been very good, even relatively speaking through the great recession, since then.
The best approximation I’ve found is S&P has this Top 10 index[1]. Over the last 10 years it has performed 18% annually vs 11% for the overall S&P 500, but that’s obviously been a historic bull run in large cap growth stocks. I can’t find data going back to 2000 to see how that strategy would have played out, but curious if someone else finds it or crunches the numbers.
Yeah, for what it's worth, my financial advisor is pushing me towards more value stocks and some more bonds. (I am somewhat older as well in addition to be in a position where being conservative makes sense.) Was just doing some research.
There is an old strategy that is kind of the inverse of this this called Dogs of the Dow where. You buy with stocks with the highest dividend-to-price ratio (implicitly underperforming), looking for the rebound.
I don’t know for sure, but I have a hunch this strategy has done below-average for the past 10-20 years, because most of the above-average returns have been driven by growth stocks with low dividends. Stock buybacks have also become a really popular way of returning value to shareholders instead of dividends.
100% you're just adding additional volatility for higher returns. Backdate the strategy, doubtful you're beating the overall index on decade timescales.
The macroeconomic read between the lines takeaway for me from this is, these pension funds are big time LPs in VC firms. If that well dries, it has substantial downstream effects for the startup ecosystem and raising capital.
Private equity has not, as an asset class, had excess returns since around 2006. Prior to that, private market companies were systematically undervalued relative to public. Post-2008, an accommodative equity market has supportive private equity as a volatility dampener for portfolios. Volatility is often used as a proxy for “risk”. There are still many private market firms generating excess returns. It’s a competitive market now and many players are getting eliminated.
So in the end, what's the key takeaway regarding global economics ? If (some of) the most well-paid people cannot guess the market, then doesn't it mean that they are useless ? Then why are we paying their services ?
To any fund manager out there that truly believes you can beat the market, here is how you can sell me your fund:
We agree on an index and a time frame. You guarantee me the same return as the index within that time frame. If you beat the index, you keep 90% of returns ABOVE the index (and I get 10%). We both win, and you win big.
If you don't beat the index (within the time frame), you make up the difference (so I get the return to the index).
You’re probably aware that no fund manager would accept your offer. But it doesn’t prove that they don’t think they can beat the market (as misguided as that belief might be), it just means they’re not willing to take on an absurd amount of risk to prove it.
Exactly. No point being the one taking the risk - if the professionals don't dare take the risk then any non-professional (fund buyer) shouldn't either (under normal circumstances).
PS. Furthermore, an accurate comparison is not beating the index, it's beating it enough to cover the salary/compensation of the fund manager + some (with less risk! Risk = cost!)
Well I think many fund managers regularly take on risk to achieve higher returns. They just won’t take on 100% downside risk while being taxed 10% on the upside.
I think this gets at a deeper point I'm trying to make.
If you truly can consistently beat the market, you are already making a killing with your _own_ money.
If you want to use _my_ money to place your bets (presumably b/c you want to leverage your market beating ability), I want a guarantee (because I'm more than happy to take the return of the index).
I follow, essentially you're viewing it like a loan + interest + a minor stake in the venture. If the venture fails, you still expect to repaid loan + interest and your stake in the venture is worth $0.
Unfortunately no one will agree to this as long as everyone else is willing to invest _and_ shoulder the risk
It sounds like they're simply critically evaluating the claims of beating the market.
If you can't beat the market with your own money, you shouldn't be trying to do it with someone else's.
If you can beat the market with your own money, why are you so worried about the downside? There should be little risk for someone who claims to be able to beat the market.
If they say that's too much risk, they likely don't think they can consistently beat the market.
That's right, fund managers expect their clients to take 100% of the downside risk and tax their clients 20% on the up side.
Where I disagree with you is that fund managers regularly take risk. They never take risk themselves, rather they supply all of the risk to their clients.
You've just found a way to restate "they don't truly believe they can (consistently) beat the market."
On the flip side-- a passive fund manager would take 100% downside risk of the fund failing to properly track the index, and only in return for a modest fee. Stated differently-- passive funds can and do consistently track the market.
I don't think the risk is "absurd". Or, at least it's no different than the risk they ask any investor to take by charging them 1% of their portfolio for it to be "actively managed".
Plus, they are being compensated. I'm offering 90% of the returns above the index :-)
Active funds ask investors to accept 100% of the downside and get taxed on the upside. Actually it’s worse: they’re taxed on both the up and down sides.
If this is a terrible deal for fund managers then virtually by definition actively-managed funds are a terrible deal for investors.
The risk your (completely hypothetical) offer would involve is reputational. There's no reason for a funds manager to ever risk their reputation on your stunt since they are constantly risking money and reputation in the ways that they control. Indeed, one could almost certainly put together a bet similar to yours using derivatives and have the potential upsides and downsides without the reputational damage.
Of course, if you offered your bet to all comers and gave significant publicity, unknown "funds managers" would be happy to take you up, though they might well default if they lost.
In my eyes, "we have sincere faith in our ability to sustain higher-than-market returns on average" and "our risk management calculations tell us that we will have beat the market on average with very high probability" are the same statement.
The point of actively managed funds is not so much to "beat the market", it's to provide diversified returns via strategies that are uncorrelated with the market.
On average, the S&P500 has returned about 7% annually. If I had a strategy that returned 5% on average but was totally uncorrelated with the S&P, then you'd get the best overall long-term returns (maximize the geometric average of annual returns) by investing in a combination of my strategy and the S&P.
This is a kind of revisionism that mostly took off after Warren Buffet won his bet that hedge funds would not outperform the market over a 10 year time period.
The original goal and selling point of hedge funds was to produce consistent results regardless of the market's performance by using long and short positions to provide absolute returns in any market environment.
With that said, even if you accept the revisionism, it's untrue that actively managed funds are uncorrelated with the market. What is true is that selection bias makes it seem like they are since when interest rates rise and markets go through a down swing, the majority (and yes I mean more than 50%) of hedge funds go out of business. As such the only hedge funds that remain are the ones that happened to weather the storm so to speak.
I want to agree with you, except that almost all of the salescritters for these products promote them as "beating the market." They _have_ to sell them this way because if their customers had any idea what the whole-market returns actually were, they wouldn't pay extra for the privilege of a far riskier (and lower-performing, on average) investment.
And the S&P 500 returns more like 10% per year. A bit higher if you cherry-pick your start and stop dates. I've only seen people use 7% for portfolio value estimation purposes, after adjusting for an assumed 3% inflation.
Those returns depend on when you invest. The inflation adjusted annualized return of the S&P 500 was negative from January 2000 to January 2013 at -0.25%. The inflation adjusted total annual return from January 2000 to January 2024 was 4.5%.
The figure till 2013 was just food for thought. Inflation adjusted returns for the S&P 500 for the last 50 years are around 7-8%. I'm certainly not suggesting anyone stay out of a S&P 500 index fund, as I wouldn't take that advice myself. However, the return from 2000 to 2024 is not a cherry pick for anyone old enough to have had their money invested back in 2000, as it shows that there has only been a 4.5% real return on the money then invested since the 2000 peak.
Well then you could establish a simiar pay critera that beats the s&p 500 during recessionary moves of the index. Im guessing you wouldn't get many takers
No, it is likely the rate of return. There is generally no such mention of inflation in investment returns. The alternative to investing your dollar is to put it in a treasury (inflation tracked), so you can compare the value of your money against that as the lowest risk (the US defaulting) vs. other forms of risk.
The average return of the S&P 500 is around 10%, although you will see people use 7% as a shortcut to account for inflation when estimating the future value of their portfolios.
The citation of 7% as the true return isn't a "shortcut", though a nominal return of 10% could be argued to be, but an acknowledgement that total returns are not real without accounting for inflation. If an hypothetical index in a developing country rises by 50%, but inflation is 100%, then even though the nominal index returns may look impressive, it has actually had a negative real return, as the real inflation-adjusted value has decreased. The use of nominal terms for market returns is money illusion.
For the 50 year period from January 1974 to January 2024, the annualized inflation adjusted real return of the S&P 500 has been 7.04%, which is not a shortcut, but simply correct. The nominal annualized total return has been 11.14%, but it is an illusory return of value without being inflation adjusted.
An important component of a bet like this: you should base the win/lose calculation on returns after accounting for fees. The index fund likely has fees that are two orders of magnitude lower than the active fund. Otherwise, a random fund may beat a broad index just by chance.
Warren Buffett's very similar bet was done this way.
Sounds similar to recently launched buffer ETF products, specifically BlackRock and Innovator that hedge 100% of downside while capping your upside across different time horizons indexed to the S&P500.[1]
They don't guarantee you zero downside compared to investing in the index, though, but compared to putting your money under the mattress.
It's relatively easy to achieve a return profile like these promise with some combination of Treasuries and index options (at least while Treasuries pay 5%!), and the ETFs are doing this kind of financial engineering rather than promising to beat the market through stock-picking skill.
> “Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”
You are not an UHNW individual/institutional investor, so no "fund managers" of any note are going to waste their time on this wager.
"Beating an index" is really easy. Up to $10MM you can choose most any financial instrument class in the U.S markets and have a good probability of finding alpha for a long time (that would beat the S&P500 18.40% YTD). Many proprietary trading firms, or market makers, or quantitative trading shops do this regularly. Discretionary and systematic funds? Usually not. If their processes worked consistently, they would have no need to take outside capital and deal with relationship management. They could simply use more leverage (not exactly, but simplified for the general reader).
This is also ignoring the fact there are no details in TFA about actual portfolio compositions or returns -- i.e. this is a PR piece.
If your NW is under <$100MM, you should be focusing on hyper-growth strategies -- and not mentally limiting yourself on what is basically financial propaganda.
Why would anyone take the other side of this bet? It's an incredible financial instrument, that anyone on the buyside would buy in an instant (as formulated -- ignored fees/tcosts etc).
> Why would anyone take the other side of this bet?
People accept this bet every single day… when they buy actively-managed funds.
Actually they accept a worse bet. Instead of taking 100% downside risk and being taxed on anything above the index, they’re taxed on both gains and losses.
You’re right that it’s an incredible financial instrument. Actively-managed funds are extremely profitable… for fund managers, who get paid out of investors’ assets in bad years and also get to skim off the gains in good years.
Something I don’t see talked about enough is the extent to which the rise of passive investing increases the extent to which passive investing is the best strategy. Passive investing is predicated entirely on either freeloading off of the decisions of actively managed portfolios, who will adjust the market prices of securities efficiently, therefore resulting in passively managed funds automatically owning the “best” stocks because the bad ones will fall out of the indices; or it is predicated on what is effectively a Ponzi scheme wherein if everyone passively invests the same, then that form of passive investing will yield the best returns.
For analogy, consider school students trying to get all the questions right on the test. The first scenario is equivalent to one student studying hard to find the right answers. The rest of the class copies his answers and benefits from his efforts. The other scenario is no student trying hard, them all failing, but succeeding because the teacher curves the grades.
Note that both of these scenarios, especially the second scenario, results in stock prices which become increasingly detached from the economic reality of companies in proportion to the extent to which passive investing becomes prevalent.
For instance, assume stock XYZ is a bad investment but is in the S&P 500. If 90% of funds are actively managed, maybe they can sell a sufficiently large amount of it to push it out of the S&P 500 and save the passive investors from owning it. But if 90% of funds are passively managed, even if XYZ is hot garbage, the 10% of passively managed funds cannot possibly sell enough to make up for the fact that 90% of the market participants are indiscriminately buying a terrible stock.
Passive investing breaks the market to some extent. The free market system is predicated on having rational participants, not zombie participants.
What you describe can be measured with return dispersion, as more people invest with passive index more opportunities arise for active investors. So they balance each other
Disclaimer, I work for a market-neutral fund, and have close friends high up in prop shops.
Presuming all strategies have a curve of diminishing marginal returns as assets under management increase, you would not expect any fund accepting outside money to have expected returns beating the market, but you would expect many of them to have a combination of correlation to the market and expected returns that would make them an attractive component in a basket of broad index ETFs and market-neutral funds. (Assuming risk-adjusted returns are the utility function being optimized. If variance is their preferred risk metric, this results in optimizing Sharpe ratio via mean-variance optimization, MVO.)
It's fair to assume that any fund manager is optimizing the sum of returns from their own personal investments in the fund plus fees from outside investors. They pick the place on the volume/risk-adjusted-returns curve that still keeps their fund attractive enough to outside investors, and maximizes their personal profits (personal returns plus fund fees).
If that optimal point on the volume/risk-adjusted returns curve for their particular strategy is at a point where risk-adjusted returns beat the market, then they maximize their returns by either never accepting outside funds (prop shops) or by not accepting additional funds and gradually buying out their investors (such as RenTech's famous Medallion fund).
So, (assuming diminishing marginal returns) it's not rational to simultaneously accept outside investment and beat the market on a risk-adjusted basis.
I suspect that many market-neutral funds could reliably beat the market on a risk-adjusted basis, but their volume/risk-adjusted-returns curve shape and their fee structures make it optimal for them to operate at a point on that curve where their expected returns are below the market.
Note that this rational self-interest optimization below market returns isn't bad for the investors. Under most fee structures, it ends up being close to maximizing total investor returns. Increasing percentage returns would mean kicking out some investors.
RenTech's Medallion Fund and many prop shops, and funds that are currently slowly buying out their investors seem to indicate there are at least some strategies where the optimal volume/returns trade-off is above market returns. You would expect all funds that are currently open to more outside investment to either be young and lacking capital or else have an optimal point on the volume/returns curve that is below market returns.
Note that as previously mentioned, a simple mean-variance optimization on a basket would allocate funds to both index ETFs and market-neutral funds returning a bit under the market on average. It's entirely possible that both fund investors and fund managers are being perfectly rational.
Of course, there are also plenty of people out there who fool themselves into thinking they know what they're doing. The world certainly isn't perfectly rational.
I'm just saying that in a perfectly rational world, assuming (1) utility function of risk-adjusted-returns (e.g. Sharpe ratio, resulting in mean-variance-optimization) (2) declining marginal returns on investment, you would expect all funds accepting outside investors (except for young funds desperate for money) to under-perform the market in expected returns.
Now, everyone talks about Sharpe ratio on the outside, but the particular risk models actually used internally by any fund are almost certainly not just variance of returns. I presume all funds simultaneously apply a mixture of commercially available risk models and internally developed risk models. Sharpe ratio is far from perfect, but it's a good least-common-denominator for discussion, and doesn't give away any secret sauce.
Side note: it would be rational for someone to take you up on your proposal and simply use index futures to take a highly leveraged position on your benchmark index. As long as they had enough money to make you whole in the case of bad tracking error and large downturns, their expected returns would be large. However, you wouldn't be very smart to take such an agreement instead of just getting leverage yourself. This demonstrates why risk-adjusted returns are usually more important than expected returns.
The claim is that there are no funds that can make a convincing argument that they will beat S&P.
When you say funds did "exactly that", the "exactly that" you're talking about is not the thing OP is asking for.
Taking on 90% of upside and 100% of downside is one way to make a convincing argument, and nobody does it.
Let's make the dice analogy. You can't make a convincing argument that you will roll a 5, even though people roll 5 all the time. Talking about people that rolled 5 in the past is proving entirely the wrong point.
Fundsmith for example has beaten the market for a long time (not this year though). I can also mention another Spanish fund that I know: Tercio Capital.
There are some research (instead of cherry picking/anecdotes). I don't have any links right now but basically half of the funds lose compared to the index (by law of nature - averages and all that). Furthermore, taking fees into account, just a few percentages make anything more (over time) - which is probably within scope of randomness.
In general hard working prudent value investors are able to beat the index. It's just that those are very few. I mean Buffet has done it for half a century, that's not a coincidence.
Given the statistics and number of investors involved, it seems like an absolute certainty that a few people would beat the index for the entirety of their lives simply by chance.
Find me the one who knows they got there by chance alone...
It's very easy to create a narrative around random movements. I expect that anyone who is ahead of the market creates such a narrative, and declare themselves a genius. And then half of the geniuses underperform each year, same as every year...
Half will beat index by definition. The key is to beat it including the cost of beating - and we've also seen that the extra value have generally been captured by the fund managers - not the fund buyers.
> The dormancy period for IRAs cannot begin until the account owner reaches the age at which one must begin taking required minimum distributions. As of 2023, the required minimum distribution age is 73.
While I do believe set-and-forget passive investing is best for the vast majority of people, last time I checked that Fidelity study does not actually exist, and the story is apocryphal (no one seems to be able to actually link to it).
If you ask Fidelity about it, they'll tell you it does not exist:
Those are the lucky ones that get paid back in kind in the crypto currency they had. Some like the FTX folks are unfortunately paid in the dollar value of their account at the time.
Bitcoin was like 15-20k at the time of the FTX collapse and is now 60k again like the highs in 2021.
Funny. Just today I receive main from Fidelity to review my account. The only thing I wish to but can't afford to change is retirement age to an earlier date.
I sometimes worry if I have a forgotten paid subscription on an e-mail of mine I don't check, that slowly drains a bank account I forgot I have. There's just Too Many Accounts, and Too Many Subscriptions.
That's the thing with subscriptions. The default is just to let them continue to leak. I've periodically discovered subscriptions that presumably resulted from me not explicitly not checking a box somewhere,
The title was correct yesterday. Why is the title editorialized today?
"What Does Nevada’s $35 Billion Fund Manager Do All Day? Nothing"
This is the actual title of the article, the page, and the printed version. There was no reason to have edited this except for optics. If true, that's absurd, dang.
Pretty much standard for HN, there are endless mod comments explaining it. Although they make more sense if you distinguish between 'changing' and 'editorializing'.
He doesn't literally do nothing, does he? So I don't think it was exactly correct. And it was vague because it didn't explain what the article was actually about.
> 1. The benchmark for hedge funds is not the sp500, it’s the bond market
There is not _a_ benchmark for "hedge funds" as they are not really _a_ thing.
In some cases S&P 500 may be an appropriate benchmark. Unless Bill Ackman is not a true hedge fund manager, I guess. "In 2023, Pershing Square’s 20th year, Pershing Square Holdings generated strong NAV performance of 26.7% versus 26.3% for our principal benchmark, the S&P 500 index."
Completely off-topic. The article is paywalled, and for once I decided to go down the subscription rabbit hole. I am viewing this in Firefox on Windows. But every "subscribe" button on the WSJ page points to an Apple store page for the "app". WTF?!
So, for SURE it is possible to beat "the market", but:
- strategy is limited up to max 1mio per account (well, maybe 2 pr 3)
- you need a tailored software, tools like MT/et al wont help you
- with a leverage of 5-10, its possible to achieve gigantic returns
- system needs to be capable of going short as well
- your individual application should abstract-away all dauly charting&news noise: what counts is statistics and propability only, do not check CNN et al
EDIT:
- this approach cant be done by ANY institutional corp due to regulations, so they are not doing it
Depending on the jurisdiction, funds are allowed to invest only in certain securities, like stocks or bonds.
In most countries, they are not allowed to use all available products; esp all products which offer high leverage (and highlosschances) are not allowed for institutionals.
A private prop trading company may do it, though they are not managing billions (as the pension fund in the article); and those prop traders in reverse can not that easily attract "other people money"
