Author Topic: 3 Reasons Some Sophisticated Investors Don't Buy Index Funds (Joshua Kennon)  (Read 42861 times)

josstache

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On the one hand, I believe that the efficient market hypothesis is wrong (though it still offers important insights into the market).  On the other hand, I'm aware of the behavioral economics literature, the Dunning-Kruger effect, etc. 

Putting the two together, it should be possible for someone who is actually a "sophisticated investor" to beat the market. The problem is that a lot of people who think they are "sophisticated investors," aren't.  The other problem is that even if a person has the technical ability to beat the market, they may not have the emotional/psychological ability to do it.

I've only had any kind of net worth for a handful of months, and I don't yet trust either my technical or psychological skills to direct my own investments.  Once I've watched the markets rise and fall while I now have "skin in the game," and after reading A LOT more to build the technical side, I may try to pick stocks for myself.  Or, more likely, I'll try to invest in some real estate.  There seems to be a disconnect between the MMM received wisdom of maximum diversification via indexing, and putting many of your eggs in one basket via investment properties.

index

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Believing indices beat the majority of people shows a fundamental misunderstanding of how the stock market works. The price of the S&P is the sum of what investors are willing to pay for each of 500 companies added together according to market cap. By virtue of this "voting" with money, there is a buyer and seller on every trade. One person wins and one loses.

The price of a share is the amount that the last buyer was willing to pay for a usually ridiculous tiny amount of shares in a company for which he or she found a seller. The price of the S&P is the what 500 individual buyers paid for their shares.

Buying a company (which buying shares is) is fundamentally no different from buying eggs at the grocery store. Care to explain why someone is loosing and someone is winning when buying eggs?

The stock market is not like buying eggs at the market... The end are a commodity which is produced and consumed.

The stock market operates more like this:

Imagine going to a baseball card trading convention with a stack of cards you think is worth $500 and $500 in cash. You want to leave the weekend with the most money and cards you can. There are 10,000 other people there with the same objective. At the end of the weekend there will be winners and losers. Some with more cards and money. The convention happens every weekend. Some cards are perceived to be more valuable as players perform better etc. After a year there will be clear winners and losers but if no one brought new cards and money, it would be a zero sum game overall. If you ended with 2000 in cards and money, those earnings came from someone else not trading as well.

The stock market it obviously more complicated than this, but the point to take away is on the other side of the trade there is someone who is buying because they believe the stock will be more valuable in the future, or selling because they have a better use/return on the money tied up in the stock.



Bob W

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After reading the arguments here I rule the lazy shall continue to buy index funds and the sophisticated shall outperform them by 3% per year on average, thus increasing their SWR to around 6% and decreasing their needed st ache by one half.                       Seems it might be worth ones time to buy some good companies and quit buying shit companies via indexes.              Mutual fund buyer = ignorant,  index fund buyer = lazy,  good company buyers from Panamanian trust funds = sophisticated.

pbkmaine

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Let's talk about the experts. How about David Swensen, who runs the Yale Endowment? He's had a pretty good run. When asked to write a book for individual investors, he declined, saying that individual investors should buy low cost index funds. How about Warren Buffett? He has stipulated that, after he dies, his wife's money should be 80% in an equity index fund, preferably Vanguard's. I'm not going to convince anybody here, because seriously, this stuff is like religion, but I have worked with Fed governors, derivatives traders, and more finance and economics professors than I can count. Where is their personal money? In index funds at Vanguard.

innerscorecard

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Joshua has a post with his historical returns on his personal site. He has beaten the market over cycles with less risk. And it's not just him. Many individual private investors do so. It's in fact much easier as a private investor than as a mutual fund or hedge fund.

That's not to say that it's easy. It's very hard and requires either a financial background or intensive self-study in finance and accounting.

But it's not impossible. To say it's impossible or you can only do it if you're lucky is a useful lie because it makes you believe indexing is the only way to go. In fact, indexing is a good way to go for most people. But I believe in doing things for the right reasons, not the wrong ones.

surfhb

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It's quite remarkable to me that some posters in this thread think they know more about investing than Joshua Kennon, especially the posters dismissing him out of hand. It is a bit like another thread I saw where some people were suggesting that Buffett lacked skill.

Not dismissing the man or his investing knowledge but the article is a bit odd and states the obvious.    Like i said, he's missing a huge point:   basic math proves that passive index investors beat active investors overwhelmingly.   

surfhb

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Another silly article which fails to mentions the fact that the laws of math and statistics says I will beat a vast majority of active investors over my lifetime......from Buffet on down.   

All this while doing nothing:)    I have better things to do with my life than try to squeeze out a couple extra points after 40-50 years of investing.

I think you are missing the point of the article and the arguments in this thread. The common parroting around here is the index is impossible to beat, yet the same paper used incorrectly to cite this actually started 78% of mangers beat the index before fees and expenses.

The article linked in this thread simply explains why those with the aptitude choose to invest their own money. Over the long term, it's likely that someone with the aptitude of a fund manager will slightly beat the market by 1-2%.

For those with the temperament, earning an extra couple of % is the difference between retiring well and rich.

Ive never seen an argument here that says the index was impossible to beat......just not likely.         

surfhb

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Where is their personal money? In index funds at Vanguard.

This..... big time!  ^^


innerscorecard

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Buffett's public advice is also very different from his private advice and what he does. He also just gives so much advice that a lot of it is contradictory. He always talks about buying companies with moats and competitive advantages, but he does do cigar-butt net-net investing whenever he has the opportunity, even quite recently (see PetroChina, Daehan Flour Mills, etc.).

He says individual investors should index, but he also talks about how someone can do what he did in the '50s (invest in obscure securities and make high rates of return) now, too, many of the same factors exist.

The point is that disciplined index investing is in fact the optimal strategy for the vast majority of people. But that doesn't mean it's literally the only strategy that works for anyone. MMM is about DIY. If someone has the aptitude and interest in becoming educated in finance and accounting, and the emotional discipline to invest in individual securities, and the willingness to spend a lot of time on it, they may in fact be able to beat the market (or otherwise achieve their individual goals that may not have to do with beating the market as such, which was the point of Joshua's article).

It's like saying no one should make furniture because everyone can buy cheap furniture at IKEA. If you have the aptitude and ability to make furniture, it can still make sense for you because you can make better furniture and you have fun doing it. If you can get good results and enjoy the process, you shouldn't be ostracized as only a lucky gambler because you aren't only investing in index funds.

ScroogeMcDutch

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Very well worded Innerscorecard. Like I said in my previous posts, combining what Joshua has written on his blog, together with what MMM and jhcollinsnh have written on theirs gave me the comfort to go with index investing. Joshua displays the knowledge I think I should have before stepping into individual securities, and I am missing that. Most of the individual investors will miss that knowledge, but also miss that they should have this knowledge before stepping into it. They buy Apple because they make sweet iPhones, not because they consider Apple to have a fair valuation and compared it to Samsung and considered Apple to be the better buy.


Christof

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The stock market it obviously more complicated than this, but the point to take away is on the other side of the trade there is someone who is buying because they believe the stock will be more valuable in the future, or selling because they have a better use/return on the money tied up in the stock.

You seem to treat shares like a collector's item that has no inherent value and derives all value from what others collectors will pay for it. That is fine. But please do not assume that everyone else shares this point of view.

To me stock is owning part of a company. When I buy specific shares then because I believe the company will provide value in the future. When I buy, I win, because I get a great company for my money. When I sell, I win, because I get something I value more than this particular stock: cash. I'm sorry that you seem to lose half of the time.

A stock exchange differs from a trade convention in one other way. At a convention there are a significant portion of all collectors for a prolonged period. Only few share holders, however, trade shares every single day. Apple has 5.68 billion shares, but only 50 millions are traded on average. For most companies that percentage is even lower. The market price therefore does not reflect the valuation of the majority of investors in a particular stock.

Dr. A

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I'm not going to convince anybody here, because seriously, this stuff is like religion, but I have worked with Fed governors, derivatives traders, and more finance and economics professors than I can count. Where is their personal money? In index funds at Vanguard.

Come on now. Fed governors have a political, ethical and (I think) legal obligation to not invest in individual companies. Many trading houses restrict what traders can do with their personal investments. Just about the only similarity between economics and investing is that their calculations both use dollar signs.

As for the finance professors, just like Scrooge and innerscorecard have been saying, even if they possess the knowledge to invest directly, they probably understand better than most how much experience, free time, emotional control, and starting capital are required to succeed.

After following this thread, I see the following as true:
-At least 99.9% of people (and probably more) will achieve optimal returns by indexing
-The Wharton study concluded that the typical actively managed fund slightly under-performs its index after expenses.
-The Wharton study also says, "about 80% of the funds generate a sufficient performance to cover their fees."
-Mutual funds have some or all of the following disadvantages vis-a-vis a wealthy individual investor: management fees, transactions that move the market against themselves, corporate directives, restrictions against certain types of investment, restrictions against small companies, not allowed to buy into private companies, client redemption, money coming in during up markets and going out during down markets, quarterly reports that must "look good", volatility in returns is punished by clients

Based on this, I believe that:
-No one should ever invest in an actively managed mutual fund.
-You and I and (probably) every single individual on this forum should index.
-There is evidence that professional money managers are able to beat their benchmark indices by 1-2% on average.
-The above cannot be explained solely by survivorship bias.
-A successful money manager requires not just business and investment knowledge, but also the time and interest to make investing a full-time occupation, and must have the temperament to apply their investment plan with zero emotion.
-Most people who think they have those skills actually don't.
-There is a very small group of people out there with the skills and bankroll to invest their personal fortune directly and have an expected return that beats the market over the long term, on a risk-adjusted basis.
-Most of that very small group could make more money by sticking their own money in an index and going to work for a mutual fund.

LordSquidworth

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Sounds great, it makes sense on paper.

But I would love to find a 'Sophisticated Investor' in the wild that has beaten the market in the long term.  (And they cannot be selling something .....)

Can't really claim long term as I haven't been investing for ten years, but the keys to knowledge on beating the market while controlling risk aren't complex. Wallstreet just ignores them.
I think it's possible, but I guess anything is.  My questions if we find one are:
- How much effort/time does it take?  (I am a family man, and while you could compute a $/hr. that was spectacular, there are only so many hours in the day as I am still working.)
This year I've made two new purchases. One is currently up 10% since March, the other is up 35% since July. The method I follow is decades old, though with modern stock screening tools, they can potentially cut a ton of the leg work out.
- How many have tried and failed for each one we find?  This question we will never be able to answer, by default they will be harder to find.
First couple years was meh. Then I got spanked really, really hard. Then I learned to control emotion and be patient and since then things have become pretty streamlined. Controlling emotion is the most important aspect.

ScroogeMcDutch (love the name).  I am curious, when this year alone 85% of fund managers failed to beat the market (and long term the results are lower) .... what leads you to say:
Quote
I do believe I will be able to pick stocks that are good deals with proper analysis, that will beat the market on the long term (10+ years) or match it with a lower risk.
I am not trying to argue here or pick a fight at all, I am honestly curious, thanks for your feedback!

Last bit is easy; most fund managers shouldn't be managing funds. The funds have been commercialized. It's no longer a group of people focusing on what they're good at, its corporations looking for profits by running funds.

Do you think that some private businesses are ever more successful than others? Do some people do real estate investing better than others? Are you trying to live a more optimized lifestyle than others?

And yet there is the dogma that once something becomes a publicly traded, regulated market, it magically becomes perfectly efficient, so that "only Warren Buffett" can ever beat it.

Your points are good ones. Most who try to beat the market do fail. But a lot do beat it as well. In fact, it's much easier as an individual investor (who has no institutional imperative or bosses or clients to deal with) than as a mutual fund or even a hedge fund. Not that it's easy. You need financial education, and a lot of hard work. And some actual skill.

But it's not all but impossible. That's a convenient and helpful lie to tell to most people, but I believe in telling the truth rather than lies.

The efficient market is a myth, that's why Warren Buffett has had the performance he's had.

When you listen to academics, they're always trying to brush Warren Buffett aside as being a fluke. While the success he's had might be, his methods are not. They've been around on paper for decades. They're just not "popular." The past 20 or so years has seen the definition of investing merge with speculating. Spend a little time looking at the rise of discount brokerages and the internet and how it changed retail "investors"

That person seems to have a flawed understanding of the argument for index fund. He keeps going on about "sophisticated investors" and how they can do better, but index funds are "good enough" for unsophisticated ones. Except the fact is that throughout history, millions of sophisticated investors have constantly done worse that the index. Over and over and over again. Stock pickers, no matter how sophisticated, always loose to the index eventually.

They don't all lose eventually. You do know that statistically those doing well aren't going to be talking about it? That those doing bad are the ones that will be talking about it? Most sophisticated investors aren't sharing their ideas or performance with the public.

I think that the main reason so many hedge/mutual funds lose to the index is mostly due to client considerations: reducing volatility, keeping cash on hand, having to own the "hot" names, people leaving after a crash and whatnot.

I'm sure many portfolio managers would beat the market without these considerations. I know I'll give it a shot, at least.

If you watch how the different funds act, you'll start to notice they've gotten heard mentality. They'll boost number of shares held of performing companies and dump ones that have declined (with no consideration for whats overvalued or undervalued) or buy what the ones doing well are buying (again, with no concern for valuations). They're focused on the short term results, largely to appease the emotionally fickle actions of their clients. Those beating the market regularly aren't concerned with what the other fund managers are doing or bogging down their performance focusing on appeasing clients emotions.

If I ran a hedge fund, clients would only be able to withdraw money once a year.

Believing indices beat the majority of people shows a fundamental misunderstanding of how the stock market works. The price of the S&P is the sum of what investors are willing to pay for each of 500 companies added together according to market cap. By virtue of this "voting" with money, there is a buyer and seller on every trade. One person wins and one loses. At the end of the day there is approximately a normal distribution of winners and losers. Half of the investors beat the market, half lose to it.

The belief that on every trade there is a winner and a loser is another myth. The market isn't a zero sum game, gambling at the casino is.

Yes, obviously; in any one year half the people beat the index and half loose to it (before fees). But the people who win/loose changes from year to year. Therefore over a decade 90% loose to the index, which is always the average.

You can throw out all kinds of reasons why indexing is a terrible idea and anyone could do better simply by checking P/E or something and buying stocks, but historical facts show that indexing has won over any long term. Always.

Yes one can do better, but people don't . That's a fact. It has nothing to do with financial literacy or lack thereof.

You're claiming people never do better over the long run likes it's fact, which it's not.

Indexing is about getting the average. Buying the S&P 500 includes owning a lot of mediocre companies. If you were to ask me for a list of stocks I would be willing to hold over the next 50 years and never look at it again, the list would maybe have 120 companies on it out of thousands.

One problem, I think, is that even if it is true that a skilled investor can beat the market, the people who might have the knowledge, experience and temperament to do it can make a shit-ton more money buy sticking their own stash in a couple mutual funds and drawing a big salary from an investment house.

The skilled investors are running their own funds and not sharing their secrets. Why would they want to deal with a corporate investing company when they can work in their pajamas in their own office away from all the hustle and bustle?

It's quite remarkable to me that some posters in this thread think they know more about investing than Joshua Kennon, especially the posters dismissing him out of hand. It is a bit like another thread I saw where some people were suggesting that Buffett lacked skill.

If you can't understand it, act like you know it all and bash anything saying otherwise. The one who yells louder often wins because you can't get through a thick skull no matter how many times you try.

Let's talk about the experts. How about David Swensen, who runs the Yale Endowment? He's had a pretty good run. When asked to write a book for individual investors, he declined, saying that individual investors should buy low cost index funds. How about Warren Buffett? He has stipulated that, after he dies, his wife's money should be 80% in an equity index fund, preferably Vanguard's. I'm not going to convince anybody here, because seriously, this stuff is like religion, but I have worked with Fed governors, derivatives traders, and more finance and economics professors than I can count. Where is their personal money? In index funds at Vanguard.

That's not surprising. I felt my economics and finance professors only taught theory with anything to do with investing, but woefully lacked anything to do with the real world. Others can take away a lot of headache just buying funds. Certain jobs restrict what you can own.

IE: I can't buy into IPOs.

On the one hand, I believe that the efficient market hypothesis is wrong (though it still offers important insights into the market).  On the other hand, I'm aware of the behavioral economics literature, the Dunning-Kruger effect, etc. 

Putting the two together, it should be possible for someone who is actually a "sophisticated investor" to beat the market. The problem is that a lot of people who think they are "sophisticated investors," aren't.  The other problem is that even if a person has the technical ability to beat the market, they may not have the emotional/psychological ability to do it.

I've only had any kind of net worth for a handful of months, and I don't yet trust either my technical or psychological skills to direct my own investments.  Once I've watched the markets rise and fall while I now have "skin in the game," and after reading A LOT more to build the technical side, I may try to pick stocks for myself.  Or, more likely, I'll try to invest in some real estate.  There seems to be a disconnect between the MMM received wisdom of maximum diversification via indexing, and putting many of your eggs in one basket via investment properties.

^^ He gets it.

Buffett's public advice is also very different from his private advice and what he does. He also just gives so much advice that a lot of it is contradictory. He always talks about buying companies with moats and competitive advantages, but he does do cigar-butt net-net investing whenever he has the opportunity, even quite recently (see PetroChina, Daehan Flour Mills, etc.).

He says individual investors should index, but he also talks about how someone can do what he did in the '50s (invest in obscure securities and make high rates of return) now, too, many of the same factors exist.

The point is that disciplined index investing is in fact the optimal strategy for the vast majority of people. But that doesn't mean it's literally the only strategy that works for anyone. MMM is about DIY. If someone has the aptitude and interest in becoming educated in finance and accounting, and the emotional discipline to invest in individual securities, and the willingness to spend a lot of time on it, they may in fact be able to beat the market (or otherwise achieve their individual goals that may not have to do with beating the market as such, which was the point of Joshua's article).

It's like saying no one should make furniture because everyone can buy cheap furniture at IKEA. If you have the aptitude and ability to make furniture, it can still make sense for you because you can make better furniture and you have fun doing it. If you can get good results and enjoy the process, you shouldn't be ostracized as only a lucky gambler because you aren't only investing in index funds.

^^ This one too.

I bought from IKEA (indexed) till I learned to make my own furniture (individual stocks) and found the quality much higher.
« Last Edit: December 30, 2014, 08:24:24 AM by LordSquidworth »

JayGatsby

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Buffett's public advice is also very different from his private advice and what he does. He also just gives so much advice that a lot of it is contradictory.

He says individual investors should index, but he also talks about how someone can do what he did in the '50s (invest in obscure securities and make high rates of return) now, too, many of the same factors exist.


As I said in a previous post, I do the same as well. I invest aggressively and concentrated in my own portfolios, but recommend indexing to anyone who asks. The reason anyone who does this would never recommend out this strategy to another (or even have friends/family follow their exact strategy) is for two reasons.

1.) Everyone's situation is different. I know my exact situation. I know what would happen if my portfolio was chopped in half tomorrow. No matter what someone else tells me, I cannot know for sure.
2.) Wipe out risk.  Wipe out risk is what you absolutely have to avoid. If less sophisticated investors (whether that be due to knowledge or emotional reasons) were to attempt an aggressive strategy they could put themselves at risk for a complete wipe out. With indexing, as long as you don't touch your money, you will do well over the long term. Emotions can more easily come into play when you're picking individual stocks. Greed can come in and cause you to put 80% of your net worth in a "can't miss" stock.

Recently, I've had people ask me, "Now's a really good time to invest in the market right?" In reality, the "really good time" was in 2009.  Now? I don't know. I know prices have gone up for the last five years and averaged somewhere around a 17% return. I know the historical market return is about 10%. Using past history as a judge, the long term average *should* revert closer back to 10%, meaning we should expect less than a 10% return, and probably about a 4% return over the next 5 years.

But it's possible we're about to repeat 1998 and 1999 and see the market double over the next two years. Who knows? So long winded answer, but that's why I think it's best for 99% of people to invest in indexes (and why people who don't still recommend to others that they do).

Scandium

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So it's so very easy to pick companies out of the S&P that will outperform? Several here have claimed they can. (and apparently many individual investors beat the market easily but they don't tell any one? Suuuure)

To the people who lament indexing because you buy "crap" companies. Please write your list of good companies in the S&P that you'd want to own. Then we can look back at it in 5 and 10 years.

Or go back to 1998 and forget everything you know and tell me which companies will be successful now. Or pre-internet which will? Or pre iPhone? Can you do it?


The IKEA analogy is bull. It assumes you have skills to make better furniture, which you don't. Maybe more like saying why pay to fly in an airplane when you can make your own out of aluminum foil and styrofoam (believing you have the skills and resources to do something that it's extremely unlike you actually can)
« Last Edit: December 30, 2014, 09:35:08 AM by Scandium »

Bob W

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http://mreverydaydollar.com/3-reasons-not-to-invest-in-index-funds/

Nice short piece -- 

I agree with the writer of the above piece that diversification over time is more important than diversification over sectors.   

I agree for many here that for the person who wants to put no time into investing (that seems crazy to me as your portfolio is you job post FIRE?),  or is completely ignorant on what company ownership is, that index funds serve a purpose.

I also agree with the original piece that using tax loss harvesting can be a nice strategy and that can be accomplished by using either funds or individual stocks. 

Is there anyone reading this today that doesn't believe that buying oil and gas sector stocks or index funds is a good thing now?   

So even if someone wants to stick with index funds,  my suggestion would be to divide them by sectors vs doing a straight S and P 500.   That way when a sector is under performing one can easily sell the over performing (relative) sector and buy more of the sector on sale.  This doesn't happen too often.

Here is one super deal that someone who takes time to follow the market should have noticed.

http://www.bing.com/search?q=bank+of+america+stock+price+history&form=HPDMHP&pc=HPDTDF&mkt=en-us&refig=606a4b80cf424af8a523be8139f77345&ghc=1&qs=AS&sk=LS1AS1&pq=bank+of+america+stoc&sc=8-20&sp=3&cvid=606a4b80cf424af8a523be8139f77345

In 2011 Buffet was buying the crap out of Bank of America around $6.   It was obvious that BOA is a good company having a tough time.  Buffet saw that and told everyone.   Today (3 years hence) it is selling at 18ish with a PE of something like 45.   I'll bet Buffet isn't transmitting his sell orders?

The fact is that for someone with even a basic knowledge of buy low sell high that BOA was a no brainer.    One could have easily dumped their entire S and P index into it and tripled their portfolio.  They then could repark their money in the S and P index and wait patiently for 2 - 8 years until another super deal appears.

By the way,  the oil and gas sector probably is either a very good deal today or will be a buy very soon.  It would be the type of play that one could feel comfortable dumping all their money into a oil index fund.   Pretty much guaranteed to significantly out perform the general S and P 500 over the next 3 years. 

So, IMHO the S and P 500 index funds are great parking places for funds until a real bargain comes along.  Treat them as you would cash savings accounts.  The cash is setting there waiting for a nice investment to buy.

It saddens me that MMM readers (who are taking the time to air dry laundry for God sake)  won't take the time to become sophisticated investors. 

Of course I could be completely wrong and the past is not indicative of the future.

JayGatsby

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I think you're correct that it takes at least 10 years to figure out who is actually a good investor versus who is just lucky (and probably even longer than that). Due to my occupation, I cannot provide individual stock names. I would be all for that game though, as yes, I am confident the stocks I own will significantly outperform the market over the next 10 years. Over the next two? I have no idea.

There's the Benjamin Graham quote: Over the short term, the market is a voting contest. Over the longer term, it is a weighing machine. I believe in that. It'll take 10 years to figure out (or more).

I can say my weighted average return over the last three years is about 40%. Even I know I got lucky with some of the picks. By lucky, I mean I was extremely confident the companies would go up over the long term. The lucky part was how quickly and how rapidly the companies went up. All of the companies I own that had the best performance, went down by 10% or more after I purchased them. That is why I also know the short term is a bad judge. Because I was confident in my research, anytime the companies went down, I did everything I could to find more money to buy additional shares.

I also know that as I get older, and the sums of money I'm dealing with become larger, the risk will increase. I'll have less time to make up for losses, and the losses will be bigger in a nominal sense. I do not expect to have 40% returns until the day I die. But I do think I can consistently beat the market over rolling five year periods. There's legions of data pointing towards simple ways to do this (value investing, momentum investing are probably the most well known).
« Last Edit: December 30, 2014, 09:54:34 AM by JayGatsby »

Bob W

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Value investing?   Who'd a thunk that buying good companies for a reasonable price would beat buying 500 companies regardless of price or how good they are.  Crazy Man!  That's just crazy.  lol

mak1277

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I agree for many here that for the person who wants to put no time into investing (that seems crazy to me as your portfolio is you job post FIRE?)


No...my job post FIRE will be to do whatever I want...and managing a stock portfolio is not what I want to be doing.  If it was, I'd have gone to Wall Street for my career.

I'm smart enough to know my strengths and limitations...picking individual stocks is not a strength and on top of that I believe that indexing is going to be good enough to keep me set in retirement.  Good enough is fine by me, I don't feel a burning need to beat the market.

LordSquidworth

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So it's so very easy to pick companies out of the S&P that will outperform? Several here have claimed they can. (and apparently many individual investors beat the market easily but they don't tell any one? Suuuure)

If you share your methods, others start following. When others start following, the profitability of your methods decline.

It's intelligent not to share any more than you have to share. There were many deals Buffett told nobody about until after the money had been made.

To the people who lament indexing because you buy "crap" companies. Please write your list of good companies in the S&P that you'd want to own. Then we can look back at it in 5 and 10 years.

Or go back to 1998 and forget everything you know and tell me which companies will be successful now. Or pre-internet which will? Or pre iPhone? Can you do it?

Most of those companies have been around for 50+ years. They're not popular, they're not hot, they're not going to make huge gains over the short term.

Over the long term though, they'll beat indexes and any short term speculating.

The IKEA analogy is bull. It assumes you have skills to make better furniture, which you don't. Maybe more like saying why pay to fly in an airplane when you can make your own out of aluminum foil and styrofoam (believing you have the skills and resources to do something that it's extremely unlike you actually can)

Anyone can have the skill to make better furniture. It just takes time and practice. Most can't, why the IKEA furniture is better. Not everybody can pick individual stocks, it takes patience and learning.

Value investing?   Who'd a thunk that buying good companies for a reasonable price would beat buying 500 companies regardless of price or how good they are.  Crazy Man!  That's just crazy.  lol

People look for discounts on the shelves everyday knowing they can get it when it's discounted or buy it later when it's full price again. They just can't seem to connect the dots.

No...my job post FIRE will be to do whatever I want...and managing a stock portfolio is not what I want to be doing.  If it was, I'd have gone to Wall Street for my career.

I'm smart enough to know my strengths and limitations...picking individual stocks is not a strength and on top of that I believe that indexing is going to be good enough to keep me set in retirement.  Good enough is fine by me, I don't feel a burning need to beat the market.

A lot of your long term successful stock pickers stay far, far away from Wallstreet.

Wallstreet changes people... often for the worst.

Picking individual stocks is about a clear head and patience, you don't have that working on Wallstreet.
« Last Edit: December 30, 2014, 10:34:51 AM by LordSquidworth »

Eric

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Value investing?   Who'd a thunk that buying good companies for a reasonable price would beat buying 500 companies regardless of price or how good they are.  Crazy Man!  That's just crazy.  lol

You're so sophisticated Bob!  That Ivy League MBA must really be paying off.  Your hindsight on BoA was also outstanding.  Great job on telling us how other people bought it.

All you have to do is not pick the bad companies.  It's so easy!  Which explains why most people beat indexes.  Oh, wait....

LordSquidworth

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Value investing?   Who'd a thunk that buying good companies for a reasonable price would beat buying 500 companies regardless of price or how good they are.  Crazy Man!  That's just crazy.  lol

You're so sophisticated Bob!  That Ivy League MBA must really be paying off.  Your hindsight on BoA was also outstanding.  Great job on telling us how other people bought it.

All you have to do is not pick the bad companies.  It's so easy!  Which explains why most people beat indexes.  Oh, wait....

Most people don't value invest.

Bob W

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I agree for many here that for the person who wants to put no time into investing (that seems crazy to me as your portfolio is you job post FIRE?)


No...my job post FIRE will be to do whatever I want...and managing a stock portfolio is not what I want to be doing.  If it was, I'd have gone to Wall Street for my career.

I'm smart enough to know my strengths and limitations...picking individual stocks is not a strength and on top of that I believe that indexing is going to be good enough to keep me set in retirement.  Good enough is fine by me, I don't feel a burning need to beat the market.

Oh, I totally agree with you.   I believe the original article referred to sophisticated investors.  Much of the hyperbole here has been that sophisticated investors cannot possibly beat the market over the long term.  That is just plan wrong.  (by the way,  hedge fund managers are not "sophisticated" investors they are fee generating sales organizations)

For the unsophisticated investor please do feel free to index but I would suggest you up it just a notch and use the tax loss harvesting strategy as well as set your indexs up so that there are 5-7 funds that you can reconfigure as opportunities become evident.  Simply by doing those two things you will likely add 1 -2% to your returns.

1-2% is huge with regards to the SWR calculations often sited here.  For many people it can make the difference between working an additional 15 years or retiring today.   So you could read 5 or 8 books on value investing/tax loss harvesting/sector rotation in about 40 hours or you could work several thousand additional hours at a job you may not like.

It is frustrating because MMM often promotes DIY and is willing to become highly educated and spend lots of time on certain tasks.  He calls this building the muscles.   

Probably 80% of the stuff I do post FI will be things I don't "want" to do.   If I had wanted to cook I would have gone to chef school.  If I wanted to take out the trash I would have been a trash man.  If I had wanted to drive a car I would have been a chauffer.   Life is made up of the mundane taking care of business activities primarily. 

I plan to spend the 30 minutes per week to take care of my portfolio and beat the S and P substantially.  I also plan to own rental property that substantially beats the S and P by an average of 5% per year.   Of course that will take some effort and forethought on my part. 

But everyone else is welcome to do as they please.   

Dicey

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Since I am positive that any individual stock I buy will immediately tank, I am not a Sophisticated Investor ;-). I use the services of an investment professional who stresses low cost, index funds, ETF's, diversity and rebalancing. It works for me. The fees are more than made up for by the results. Yes, results. I am positive that this strategy puts me well ahead of what I could achieve on my own. I'm sure there are others who will disagree with this approach, but it got me to FIRE, so I'm not complaining. I'm not sophisticated, but you could call me rich.

Scandium

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I feel like we have some True Scotsman thing going on here now:

"Any sophisticated investor can easily beat the market!"
"That guy didn't beat the market so he's not a sophisticated investor"

And this sector rotation to take advantage of "opportunists that become evident"? If they're so evident wouldn't everyone act on them immediately? Usually these are only evident after the fact, like your BAC example. This kind of jumping around is exactly what index investors shouldn't do! It rarely ever works out
(yesyes, I know you're great at it and will make millions, but I guess you're special)

The reason most here don't advocate DYI investments is because it's proven not to work. Not opinion, fact. Putting in 20 hours a week messing with my portfolio will not get me more money, it will actually get me less! So why would I do this?
« Last Edit: December 30, 2014, 11:30:51 AM by Scandium »

index

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So it's so very easy to pick companies out of the S&P that will outperform? Several here have claimed they can. (and apparently many individual investors beat the market easily but they don't tell any one? Suuuure)

To the people who lament indexing because you buy "crap" companies. Please write your list of good companies in the S&P that you'd want to own. Then we can look back at it in 5 and 10 years.

Or go back to 1998 and forget everything you know and tell me which companies will be successful now. Or pre-internet which will? Or pre iPhone? Can you do it?

The IKEA analogy is bull. It assumes you have skills to make better furniture, which you don't. Maybe more like saying why pay to fly in an airplane when you can make your own out of aluminum foil and styrofoam (believing you have the skills and resources to do something that it's extremely unlike you actually can)

Instead of saying "the market" over and over. Ask yourself: What is the market you are referring to?

The S&P 500? What is it?

Quote
The index includes 500 of the largest (not necessarily the 500 largest) companies whose stocks trade on either the NYSE or NASDAQ. The components of the S&P 500 are selected by committee so they are representative of the industries in the United States economy. The S&P 500 committee operates within specific criteria. To qualify for the index, a company must have:

  • a market cap of $5.3 billion
  • its headquarters in the U.S.
  • the value of its market capitalization trade annually
  • at least a quarter-million of its shares trade in each of the previous six months
  • most of its shares in the public’s hands
  • at least half a year since its initial public offering
  • Four straight quarters of positive as-reported earnings.


Once selected the companies are weighted according to market cap * public float.

How does this selection criteria or the way the S&P 500 is weighted make this such a good investment method to follow?

I see:

-the qualitative selection criteria of representing the U.S. market as a whole i.e. (IT = 20%, Healthcare = 14%, Utilities = 3% etc...) Diversity.

-Four straight quarters of positive earnings. Profitable.

-at least half a year since its initial public offering. Avoids the IPO frenzy.


Most of the criteria actually runs contrary to making good investment decisions:

-a market cap of $5.3 billion - It is harder to compound 5+ billion dollars than a smaller sum.

-headquartered in the U.S. - Nestle, Diageo, Munich Re, Honda, Toyota, Airbus, Budweiser are all left out of the index.

-the value of its market capitalization trade annually - This was an element added for indexing funds. You cannot buy millions of shares if their is not sufficient turnover.   

-at least a quarter-million of its shares trade in each of the previous six months - Same as above. This is why Berkshire Hathaway was left out of the index before its 50:1 stock spit.

-most of its shares in the public’s hands - Wouldn't you rather partner with management who held significant "skin in the game"? Google the "wealth index" to see what happens when you invest in an index of companies where the founder still works as the ceo and ownes a significant portion of the company. Buffett, John Malone, Nicholas Howley etc...

If you want to index. That's fine, but do so intelligently. What are ways you can index and minimize the negatives of the S&P's selection criteria? My problem with many of the indexes, especially those mirrored by vanguard, is the selection criteria. The criteria centers around liquidity and is necessary so vanguard can invest 100's of billions of dollars, not because it is a good way to weight your portfolio. 

 





Scandium

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Instead of saying "the market" over and over. Ask yourself: What is the market you are referring to?

The S&P 500? What is it?
...

Doesn't matter. The S&P 500 has shown over decades to correlate to within a few percent of the return of the total US stock market, which makes sense since it is 80% of the cap of the US market. International is another issue, but the world economy is so interconnected now there is strong correlation to the S&P as well. The S&P 500 is simple, can be bought cheaply and give so close to the full market return (the whole US or world) that it doesn't matter.
This is discussed much much better in Bogle's Common Sense, which it sounds like you should read.

That said I have some extended market and international in my 401k, but I'm not 100% sure it's necessary.

JayGatsby

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The reason most here don't advocate DYI investments is because it's proven not to work. Not opinion, fact. Putting in 20 hours a week messing with my portfolio will not get me more money, it will actually get me less! So why would I do this?

Correct. It is proven not to work for the majority of individual investors.

Google "momentum investing." There's an endless amount of research showing that if you had stuck with momentum investing, you would have significantly outperformed the market over the last 200 years.  This is just as much of a fact as your fact of active investing being proven to not work. And they are both correct. (here's my disclamer: past results do not guarantee future results. But this statement is just as true for your fact as it is my fact.)

How are they both correct? Sticking with my example of momentum investing, it is very,very hard. It is hard because if you follow this strategy, your assets will get whipsawed around. If the markets up 15%, you'll be up 22%.  If the markets down 5%? You'll be down 15%. (and yes, clearly those numbers don't work, but you get the idea).  People don't have the stomach to handle that and stick with a strategy.

There are plenty of facts (from your same sources) proving that investors again and again will buy in at the worst times in the market, and sell out at the bottom. This is the biggest skill to learn with investing if you're going to outperform.  And this is why active management doesn't work. But it's also why momentum investing and value investing do work.
« Last Edit: December 30, 2014, 11:47:42 AM by JayGatsby »

index

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Instead of saying "the market" over and over. Ask yourself: What is the market you are referring to?

The S&P 500? What is it?
...

Doesn't matter. The S&P 500 has shown over decades to correlate to within a few percent of the return of the total US stock market, which makes sense since it is 80% of the cap of the US market. International is another issue, but the world economy is so interconnected now there is strong correlation to the S&P as well. The S&P 500 is simple, can be bought cheaply and give so close to the full market return (the whole US or world) that it doesn't matter.
This is discussed much much better in Bogle's Common Sense, which it sounds like you should read.

That said I have some extended market and international in my 401k, but I'm not 100% sure it's necessary.

Actually it does matter quite a bit. I'm not saying to start buying individual stocks, but here is a chart that shows the S&P 500 Cap weighted vs equal weighted since 1989.



After the dotcom bubble and including the last recession:




matchewed

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Instead of saying "the market" over and over. Ask yourself: What is the market you are referring to?

The S&P 500? What is it?
...

Doesn't matter. The S&P 500 has shown over decades to correlate to within a few percent of the return of the total US stock market, which makes sense since it is 80% of the cap of the US market. International is another issue, but the world economy is so interconnected now there is strong correlation to the S&P as well. The S&P 500 is simple, can be bought cheaply and give so close to the full market return (the whole US or world) that it doesn't matter.
This is discussed much much better in Bogle's Common Sense, which it sounds like you should read.

That said I have some extended market and international in my 401k, but I'm not 100% sure it's necessary.

Actually it does matter quite a bit. I'm not saying to start buying individual stocks,


So what are you saying then?

ScroogeMcDutch

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There is the combination of true statements here that seem to not exclude each other:

A) If skillful, then an individual investor can outperform the market
B) The majority of individual investors lack one or more critical skills to achieve a)
C) The amount of time spent with the amount of capital people have will render a) a bad investment of time for many individual investors
D) The majority of individual investors should index

I genuinely believe A) is not as hard to achieve as many people here think. Basically the only thing you need on top of achieving a success with index investing is good analytical and numerical skills. You may need stronger emotional control skills as well.

LordSquidworth

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A few percentage points really matter.

Eric

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A few percentage points really matter.

That's the argument for indexing as well.  If what you thought was skill for the first couple of years of investing during a raging bull market instead turned out to be luck once the raging bull left, well, you'd really like those few percentage points back.

eudaimonia

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There is the combination of true statements here that seem to not exclude each other:

A) If skillful, then an individual investor can outperform the market
B) The majority of individual investors lack one or more critical skills to achieve a)
C) The amount of time spent with the amount of capital people have will render a) a bad investment of time for many individual investors
D) The majority of individual investors should index

I genuinely believe A) is not as hard to achieve as many people here think. Basically the only thing you need on top of achieving a success with index investing is good analytical and numerical skills. You may need stronger emotional control skills as well.

Scrooge,

I think the problem here is that you are appealing to logic - and as Josh says in the article, many of the folks on this thread aren't interested in logic - they are essentially index religion fanatics.

While a lot of people would like to think that being a Mustachian makes them an unconventional financial thinker and therefore exceptional - we know that 50% of people are average and 50% of those people are dumber than that.

While I appreciate you, Innerscorecard, and a few others here who attempt to stand up to the sheeple in threads like these I think it is far better to let them have their way. After all, those who become sophisticated investors won't be swayed by the braying of the masses. And those braying are better off with index funds.




Eric

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I notice you didn't post any stock picks eudaimonia.

index

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Actually it does matter quite a bit. I'm not saying to start buying individual stocks,
So what are you saying then?

Here is an example of a low cost index portfolio that is more diversified than the S&P 500 or even VTI.

42.5% modeled after the S&P but sector specific to allow tax loss harvesting:

7.5% - VGT - S&P Technology
6.5% - VFH - S&P Financials
6.0% - VHT - S&P Healthcare
4.5% - VCR - S&P Consumer Discretionary
4.0% - VIS - S&P Industials
6.5% - VDC - S&P Consumer Staples
3.0% - VDE - S&P Energy
1.5% - VAW - S&P Materials
1.5% - VPU - S&P Utilities
1.5% - VOX - S&P Communication

Mid Caps specific - 20%:

3.5% - VO - Mid Cap index
4.0% - VOT - Mid Cap Growth
12.5% - VXF - Mid Caps not in the S&P (some small caps in this one)

Small Cap specific - 20%:

20% - VB - Small Cap index

International - 17.5%:

8.5% - VEU - Ex US International
9.0% - VSS - Ex US International (small cap)

From a portfolio like this you get:

-Tax loss harvesting
-Much more market cap diversity (40% Large Cap, 34% Mid Cap, 26% Small Cap)
-International Diversity (18% international, 82% U.S.)
-Sector weighting very similar to VTI (+1% on Consumer Def, Real Estate, and -1% on Energy and Health C.)
-Holding Type very similar to VTI (ie. Aggressive Growth, value, etc.)
-Long Term EPS Growth at 11.2% with a P/E of 18.5 vs 10% for VTI (PE 18.3) or 9.6% (PE 18)  for the S&P 500
-Expense ratio of 0.12% and free transactions with Vanguard

This portfolio is very similar to a VTI + VXUS portfolio with some small cap ETFs added. To eliminate the majority of the problems with indexing, you don't have to be a stock picker. You just have to be an intelligent indexer. 

 


eudaimonia

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I notice you didn't post any stock picks eudaimonia.

Right. And I don't intend to. Even if I posted a 30 year track record soundly beating the index you'd say it was luck or I cheated or I was abducted by aliens. Don't believe me? People posted Warren's track record, Tweedy & Brown's track record, Ben Graham's track record, Paul Tudor Jones' track record, George Soroes' track record - but those are all exceptions to the rule.

All hail thy Index fund god for he is almighty and thou shalt not question thy savior and lord or he shall smite thee and chastise thee fiercely and cast thy blaspheming corpse out of the garden of index fund nirvana and thou shalt weep rivers of blood while your retirement funds shrivel up and die forever. Amen.

Eric

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I notice you didn't post any stock picks eudaimonia.

Right. And I don't intend to. Even if I posted a 30 year track record soundly beating the index you'd say it was luck or I cheated or I was abducted by aliens. Don't believe me? People posted Warren's track record, Tweedy & Brown's track record, Ben Graham's track record, Paul Tudor Jones' track record, George Soroes' track record - but those are all exceptions to the rule.

All hail thy Index fund god for he is almighty and thou shalt not question thy savior and lord or he shall smite thee and chastise thee fiercely and cast thy blaspheming corpse out of the garden of index fund nirvana and thou shalt weep rivers of blood while your retirement funds shrivel up and die forever. Amen.

Good luck then.  I'm glad that you can beat index investing, especially over the long haul.  So few people can, that it's rare to come across such a verified investing superstar.  Stating it as fact on the internet will surely convince others of the superiority of your unmentioned and unchecked strategy.

matchewed

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Actually it does matter quite a bit. I'm not saying to start buying individual stocks,
So what are you saying then?

Here is an example of a low cost index portfolio that is more diversified than the S&P 500 or even VTI.

42.5% modeled after the S&P but sector specific to allow tax loss harvesting:

7.5% - VGT - S&P Technology
6.5% - VFH - S&P Financials
6.0% - VHT - S&P Healthcare
4.5% - VCR - S&P Consumer Discretionary
4.0% - VIS - S&P Industials
6.5% - VDC - S&P Consumer Staples
3.0% - VDE - S&P Energy
1.5% - VAW - S&P Materials
1.5% - VPU - S&P Utilities
1.5% - VOX - S&P Communication

Mid Caps specific - 20%:

3.5% - VO - Mid Cap index
4.0% - VOT - Mid Cap Growth
12.5% - VXF - Mid Caps not in the S&P (some small caps in this one)

Small Cap specific - 20%:

20% - VB - Small Cap index

International - 17.5%:

8.5% - VEU - Ex US International
9.0% - VSS - Ex US International (small cap)

From a portfolio like this you get:

-Tax loss harvesting
-Much more market cap diversity (40% Large Cap, 34% Mid Cap, 26% Small Cap)
-International Diversity (18% international, 82% U.S.)
-Sector weighting very similar to VTI (+1% on Consumer Def, Real Estate, and -1% on Energy and Health C.)
-Holding Type very similar to VTI (ie. Aggressive Growth, value, etc.)
-Long Term EPS Growth at 11.2% with a P/E of 18.5 vs 10% for VTI (PE 18.3) or 9.6% (PE 18)  for the S&P 500
-Expense ratio of 0.12% and free transactions with Vanguard

This portfolio is very similar to a VTI + VXUS portfolio with some small cap ETFs added. To eliminate the majority of the problems with indexing, you don't have to be a stock picker. You just have to be an intelligent indexer. 

Fair enough, so mainly you're saying that sophisticated investors can still buy index funds, which is not really all that different from Scandium's view. All you seem to be doing is just complicating the portfolio for the purposes of tax loss harvesting and weighing sectors arbitrarily.

Chuck

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A very well informed investor with a great amount of time to read public disclosures and research non-disclosed material (management in particular) who isn't burdened by annual earnings deadlines and so is free to be tax efficient... could certainly beat the S&P index.

The problem is that this person isn't me. I'm smart enough to buy JNJ or AAPL when it's terrifically undervalued, hold for a few years and then sell. I've done it before. But to consistently perform in this way is far above my skill level, and would require much more time than I can or want to devote.

That is the true, unquestionable dominance of indexing: You cannot beat the index (consistently) in earnings per effort.

index

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Actually it does matter quite a bit. I'm not saying to start buying individual stocks,
So what are you saying then?

Here is an example of a low cost index portfolio that is more diversified than the S&P 500 or even VTI.

42.5% modeled after the S&P but sector specific to allow tax loss harvesting:

7.5% - VGT - S&P Technology
6.5% - VFH - S&P Financials
6.0% - VHT - S&P Healthcare
4.5% - VCR - S&P Consumer Discretionary
4.0% - VIS - S&P Industials
6.5% - VDC - S&P Consumer Staples
3.0% - VDE - S&P Energy
1.5% - VAW - S&P Materials
1.5% - VPU - S&P Utilities
1.5% - VOX - S&P Communication

Mid Caps specific - 20%:

3.5% - VO - Mid Cap index
4.0% - VOT - Mid Cap Growth
12.5% - VXF - Mid Caps not in the S&P (some small caps in this one)

Small Cap specific - 20%:

20% - VB - Small Cap index

International - 17.5%:

8.5% - VEU - Ex US International
9.0% - VSS - Ex US International (small cap)

From a portfolio like this you get:

-Tax loss harvesting
-Much more market cap diversity (40% Large Cap, 34% Mid Cap, 26% Small Cap)
-International Diversity (18% international, 82% U.S.)
-Sector weighting very similar to VTI (+1% on Consumer Def, Real Estate, and -1% on Energy and Health C.)
-Holding Type very similar to VTI (ie. Aggressive Growth, value, etc.)
-Long Term EPS Growth at 11.2% with a P/E of 18.5 vs 10% for VTI (PE 18.3) or 9.6% (PE 18)  for the S&P 500
-Expense ratio of 0.12% and free transactions with Vanguard

This portfolio is very similar to a VTI + VXUS portfolio with some small cap ETFs added. To eliminate the majority of the problems with indexing, you don't have to be a stock picker. You just have to be an intelligent indexer. 

Fair enough, so mainly you're saying that sophisticated investors can still buy index funds, which is not really all that different from Scandium's view. All you seem to be doing is just complicating the portfolio for the purposes of tax loss harvesting and weighing sectors arbitrarily.

Tax loss harvesting adds about 1% per year to the return of a taxable account.

The above portfolio (An equal weight total market portfolio) adds ~2% to the return of a cap weighed index fund.

That's the difference between 10k turning into 27k in 15 years or 41k. The complication might be worth it...

matchewed

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Tax loss harvesting adds about 1% per year to the return of a taxable account.

The above portfolio (An equal weight total market portfolio) adds ~2% to the return of a cap weighed index fund.

That's the difference between 10k turning into 27k in 15 years or 41k. The complication might be worth it...

Only if there are the losses to use the tax loss harvesting to get that 1%.

Only if your particular weights  result in that 2% additional return.

There is not free lunch. You haven't discovered some magical index combination that will always perform better. It will sometimes and it won't others. It is essentially just a riskier and therefore potentially more profitable AA.

Furthermore the whole point of the thread was about a discussion about sophisticated investors and not buying index funds. I was merely trying to point out that you and Scandium actually share more in common in regards to the bigger picture of this thread.

dungoofed

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I'd like to offer Janus 20 fund as a data point for a "sophisticated investor" who picked 20 largecap growth stocks back in the mid-1990s.

http://portfolios.morningstar.com/fund/holdings?t=JAVLX

Returns have been comparable with S&P200.


innerscorecard

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That is the true, unquestionable dominance of indexing: You cannot beat the index (consistently) in earnings per effort.

I wholeheartedly agree with this and in fact no one has been arguing against this at all. I just take issue with the idea that literally no individual investors should ever do anything other than index.

innerscorecard

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I'd like to offer Janus 20 fund as a data point for a "sophisticated investor" who picked 20 largecap growth stocks back in the mid-1990s.

http://portfolios.morningstar.com/fund/holdings?t=JAVLX

Returns have been comparable with S&P200.

I agree and I think most do that active mutual funds are not sustainably better than indexing. The problem with mutual funds is structural and thus pervasive. You will have good managers like Bruce Berkowitz who do all the right things - but their investors flock in exactly at the wrong moments and abandon them exactly when they should be buying in. Just look at what's happened multiple time with the Fairholme Fund.

Scandium

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My point was simply that I was insulted by the ludicrous notion that index funds are "good enough" for simple, unsophisticated investors and that anyone can be a sophisticated investor and easily beat the market by reading a few financial statements.

This may (may!) be true for something like 0.1% off people, but many here imply anyone can do it easily. And decades of date refute this.

Index funds are not some second rate option for those too lazy to do some simple work; it's the best way for 99% of people to invest. You may think you have some simple way to outsmart it, but you'll join the mountains of date that prove it rarely works

innerscorecard

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My point was simply that I was insulted by the ludicrous notion that index funds are "good enough" for simple, unsophisticated investors and that anyone can be a sophisticated investor and easily beat the market by reading a few financial statements.

This may (may!) be true for something like 0.1% off people, but many here imply anyone can do it easily. And decades of date refute this.

Index funds are not some second rate option for those too lazy to do some simple work; it's the best way for 99% of people to invest. You may think you have some simple way to outsmart it, but you'll join the mountains of date that prove it rarely works

I don't disagree with your restatement here.

But Joshua's actual article didn't say that all sophisticated investors shouldn't index. Even the title says it - there are "some" reasons why "some" sophisticated investors should not index. Using basic logic, that doesn't at all say even that sophisticated investors shouldn't index!

It was just making the point that there are in fact valid reasons for some people not to index. But that actually starts from the premise (read the article, you'll see it) that low-cost indexing should in fact be the default.

Scandium, if you look at my responses in these threads: http://forum.mrmoneymustache.com/investor-alley/buy-apple-now/ http://forum.mrmoneymustache.com/investor-alley/blue-chip-stock-investing-curiosityquestion-28713/, you'll see that I really agree with your tireless advocacy of indexing for most people. The efficient market hypothesis should be the starting point and starting assumption for everyone learning about investing. People should assume that prices are generally efficient and they can't pick stocks unless there's a good reason (backed by actual research and analysis) otherwise.
« Last Edit: December 30, 2014, 07:38:02 PM by innerscorecard »

Bob W

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Actually it does matter quite a bit. I'm not saying to start buying individual stocks,
So what are you saying then?

Here is an example of a low cost index portfolio that is more diversified than the S&P 500 or even VTI.

42.5% modeled after the S&P but sector specific to allow tax loss harvesting:

7.5% - VGT - S&P Technology
6.5% - VFH - S&P Financials
6.0% - VHT - S&P Healthcare
4.5% - VCR - S&P Consumer Discretionary
4.0% - VIS - S&P Industials
6.5% - VDC - S&P Consumer Staples
3.0% - VDE - S&P Energy
1.5% - VAW - S&P Materials
1.5% - VPU - S&P Utilities
1.5% - VOX - S&P Communication

Mid Caps specific - 20%:

3.5% - VO - Mid Cap index
4.0% - VOT - Mid Cap Growth
12.5% - VXF - Mid Caps not in the S&P (some small caps in this one)

Small Cap specific - 20%:

20% - VB - Small Cap index

International - 17.5%:

8.5% - VEU - Ex US International
9.0% - VSS - Ex US International (small cap)

From a portfolio like this you get:

-Tax loss harvesting
-Much more market cap diversity (40% Large Cap, 34% Mid Cap, 26% Small Cap)
-International Diversity (18% international, 82% U.S.)
-Sector weighting very similar to VTI (+1% on Consumer Def, Real Estate, and -1% on Energy and Health C.)
-Holding Type very similar to VTI (ie. Aggressive Growth, value, etc.)
-Long Term EPS Growth at 11.2% with a P/E of 18.5 vs 10% for VTI (PE 18.3) or 9.6% (PE 18)  for the S&P 500
-Expense ratio of 0.12% and free transactions with Vanguard

This portfolio is very similar to a VTI + VXUS portfolio with some small cap ETFs added. To eliminate the majority of the problems with indexing, you don't have to be a stock picker. You just have to be an intelligent indexer. 

Fair enough, so mainly you're saying that sophisticated investors can still buy index funds, which is not really all that different from Scandium's view. All you seem to be doing is just complicating the portfolio for the purposes of tax loss harvesting and weighing sectors arbitrarily.

Tax loss harvesting adds about 1% per year to the return of a taxable account.

The above portfolio (An equal weight total market portfolio) adds ~2% to the return of a cap weighed index fund.

That's the difference between 10k turning into 27k in 15 years or 41k. The complication might be worth it...
.  Well done index!    Probably a lower Beta as well.  Add a pinch of rotation and you're probably at 3%.     3% is fucking huge when you're talking SWR.  Huge like the average reader of this forum would need half the portfolio they thought and be able to FIRE years and years sooner.  All that by simply taking 30 minutes to read and understand what you wrote.   Amazing shit!   Well done.  Glad I stuck with this thread.

index

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Here is another Vanguard ETF portfolio I actually use in one of our IRA accounts. I am not concerned with tax loss harvesting since it is not a taxable account.
This is an aggressive allocation with an 80/20 allocation to stocks and bonds, 70/30 split between US and Foreign companies, 43/32/25 Large/Mid/Small cap, and ~9% allocation to each sector (utilities and real estate included).  There are not transaction fees through Vanguard and the expense ratio is 0.13%. The PE ratio of the portfolio is 17.3, the expected EPS growth is 10.6%, and dividends of 2.2%. It returned ~8.2% this year.

The bond allocation is tilted to short term because I am worried about rising interest rates. 

US Equities:

28% VXF – Vanguard Extended Market (Everything but the S&P 500)
8% VTI – Vanguard Total Stock Market
5% VPU – Vanguard Utilities
5% VOX – Vanguard Communications
5% VAW – Vanguard Raw Materials
3% VDE – Vanguard Energy
3% VDC – Consumer Staples

International Equities:

8% VEU – Vanguard Ex-US Total Market
7% VSS – Vanguard Ex-US Small Cap
6% VWO – Vanguard Emerging Market
2% VNQI – Vanguard International Real Estate

Bonds:

14% VCSH – Vanguard Short Term Corporate Bond
3% BLV – Vanguard Long Term Bond
3% VWOB – Vanguard Emerging Market Bond

I back tested the portfolio (by asset class) from 1982 to 2014 comparing it to a 100% VTI portfolio, and a 3 fund portfolio (56% VTI, 24% International Equity, 20% Total Bond).
 
The results were:

Smart Index – 11.64% CAGR – 10K grows to 244k; Sharpe Ratio - 0.60
100% VTI – 11.07% CAGR – 10K grows to 210K; Sharpe Ratio – 0.49
3 Fund Portfolio – 10.69% CAGR - 10K grows to 190K;   Sharpe Ratio – 0.54

The take away from this is by indexing intelligently (let’s say being sophisticated indexers!), portfolio returns can be improved by ~1% per year while taking on less risk. I don’t think being lazy should be an excuse for the people on this forum. Look at it this way, this approach takes the time spent on your portfolio from 3 hours to 12 hours per year. That is an extra 135 hours over 15 years. If you started today with 50k and added 1% to your returns, this is would net you about 26k in additional earnings over 15 years; ~$190/hr. 

matchewed

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Here is another Vanguard ETF portfolio I actually use in one of our IRA accounts. I am not concerned with tax loss harvesting since it is not a taxable account.
This is an aggressive allocation with an 80/20 allocation to stocks and bonds, 70/30 split between US and Foreign companies, 43/32/25 Large/Mid/Small cap, and ~9% allocation to each sector (utilities and real estate included).  There are not transaction fees through Vanguard and the expense ratio is 0.13%. The PE ratio of the portfolio is 17.3, the expected EPS growth is 10.6%, and dividends of 2.2%. It returned ~8.2% this year.

The bond allocation is tilted to short term because I am worried about rising interest rates. 

US Equities:

28% VXF – Vanguard Extended Market (Everything but the S&P 500)
8% VTI – Vanguard Total Stock Market
5% VPU – Vanguard Utilities
5% VOX – Vanguard Communications
5% VAW – Vanguard Raw Materials
3% VDE – Vanguard Energy
3% VDC – Consumer Staples

International Equities:

8% VEU – Vanguard Ex-US Total Market
7% VSS – Vanguard Ex-US Small Cap
6% VWO – Vanguard Emerging Market
2% VNQI – Vanguard International Real Estate

Bonds:

14% VCSH – Vanguard Short Term Corporate Bond
3% BLV – Vanguard Long Term Bond
3% VWOB – Vanguard Emerging Market Bond

I back tested the portfolio (by asset class) from 1982 to 2014 comparing it to a 100% VTI portfolio, and a 3 fund portfolio (56% VTI, 24% International Equity, 20% Total Bond).
 
The results were:

Smart Index – 11.64% CAGR – 10K grows to 244k; Sharpe Ratio - 0.60
100% VTI – 11.07% CAGR – 10K grows to 210K; Sharpe Ratio – 0.49
3 Fund Portfolio – 10.69% CAGR - 10K grows to 190K;   Sharpe Ratio – 0.54

The take away from this is by indexing intelligently (let’s say being sophisticated indexers!), portfolio returns can be improved by ~1% per year while taking on less risk. I don’t think being lazy should be an excuse for the people on this forum. Look at it this way, this approach takes the time spent on your portfolio from 3 hours to 12 hours per year. That is an extra 135 hours over 15 years. If you started today with 50k and added 1% to your returns, this is would net you about 26k in additional earnings over 15 years; ~$190/hr.

It's great work but I don't know if one 32 year backtest is going to convince me. It'll be interesting to see how things like that perform over time.