The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: user43423 on February 19, 2015, 12:47:40 PM
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While I'm sure most here lean towards indexing, I was wondering if there are others who also invest in individual stocks. Value Investing (the approach used by Buffett) seems to have a lot of overlap with FI so I wouldn't be surprised to see some here that search for stocks using that approach.
Personally, I'm 50% indexed and 50% in individual stocks and am trying to build up my cash position to take advantage of any attractive opportunities that present themselves in the future. I've been teaching myself finance, valuation, and accounting over the past year and it's been a really eye opening experience. If you stay disciplined and have a knack for it, I think you can do pretty well. Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line.
What do you look for with individual stocks, and have you had success?
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The fact that you didn't even do a search for this discussed-to-death topic does not bode well for your stock-picking success...
-W
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But Warren Buffett doesn't use a computer and therefore wouldn't know how to search either.... ; )
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I think the idea is to exploit the advantages that you have as a tiny individual investor. Namely, (a) you can have a substantial position in virtually any security, even in the smallest of companies with <$100M market cap, and these securities are little followed by professionals, and (b) you have perfectly sticky capital: there is no need to worry about investors in your fund redeeming, so with the right psychological framework, you can truly think long-term in a way that few investment managers can.
But it certainly isn't for everyone. I think you have to love thinking about the market and reading financials to even consider investing in individual stocks. And I think it also makes a lot of sense to put a substantial portion of your portfolio into an index and/or a security like Berkshire, and then actively invest perhaps 10-20% of your portfolio at first. Beyond reducing the risk that you will make mistakes that substantially impact your net worth, psychologically you are much more likely to be able to think long-term and ignore short term market fluctuations if you know that most of your money is tucked away in an index outside of your control.
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But it certainly isn't for everyone. I think you have to love thinking about the market and reading financials to even consider investing in individual stocks. And I think it also makes a lot of sense to put a substantial portion of your portfolio into an index and/or a security like Berkshire, and then actively invest perhaps 10-20% of your portfolio at first. Beyond reducing the risk that you will make mistakes that substantially impact your net worth, psychologically you are much more likely to be able to think long-term and ignore short term market fluctuations if you know that most of your money is tucked away in an index outside of your control.
This is my approach. I'd like to eventually work up toward maybe 50/50 but right now individual stocks are a tiny portion of my overall portfolio. I love the indexing strategy but after I switched over to the passive strategy, 100% passive just didn't sit right with me -- and I realized the more I thought about it, was how the index funds are allocated.. namely by market cap. The fact that I/the fund held more of a company because they cost more and were larger was inherently flawed to me.
I still have loads more to learn but I enjoy doing it, and I'm finally happy with how things are going. I look for value plays to buy and hold for the long term. I've read a lot of Joshua Kennon and the way he's mapped it out has really opened my eyes.
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I managed my taxable account and index the retirement savings. I didn't really add to it from 2005-2012 because I was working on fueling pretax savings and a downpayment. So it isn't really a substantial amount.
I like reading financials and I usually dig into a new sector every couple of years. I don't have a problem spending time on it. But if someone were to honestly ask me if it was worth it, I'd say no. The market doesn't really compensate for business risk at all because index funds effectively allow people to ignore it, and prices reflect it. The further away you get from the S&P500 the better, but at the same time the risk factors grow.
If someone's goal is FIRE on the least amount of work, I would include investing time as work and in that context it really doesn't help. Faster depends on your stock picking capability and the lost opportunity cost of your time.
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
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The first few years I spent thousands of hours doing research and reading books, but I've got my system down to where I'm only spending a few minutes a day looking through charts of potential stocks.
Once a month I'll rebalance my index fund momentum strategy if it needs it. I use that for my taxable and retirement accounts, and I'll go on margin in the taxable account if I find a stock I like. If the stock does well, I'll add to it and take away the index funds until the entire account is in stocks. Then once those stocks stop going up, I'll go back to the index funds. So, I could be 100% in index funds (like right now) or I could be 100% in stocks or a mix, depending on the market environment.
The entire process takes just a few minutes to execute each day, but I continue to read and do research in the evenings because I enjoy it.
Doing a strategy like the Magic Formula only takes a few minutes a year to execute and works well, probably better than most stock pickers. I would expect to incorporate the magic formula into my strategies when my account gets big enough one day.
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Buffet is not a simple investor like the rest of us. He creates his own reality by buying whole companies and running them. Buffett is a businessman, not an investor. He buys whole companies, hires the managers and ultimately makes business decisions. Investors in stocks almost never get to do this stuff. They cannot influence their investments. At this point in his career, Buffett's reputation gives him other advantages (buying preferred stock before it's publicly available for a below-market price), but the bottom line is that he is lucky and/or good businessman, not an investor.
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
Love this.
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"Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line."
Pretty ballsy statement to think you could beat the S&P index. A VAST MAJORITY of the best and brightest financial minds on Wall St cant do it....whats makes you think you can?
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"Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line."
Pretty ballsy statement to think you could beat the S&P index. A VAST MAJORITY of the best and brightest financial minds on Wall St cant do it....whats makes you think you can?
If I remember correctly, most studies on the topic include fees, which he wouldn't have.
Most fund managers also need to buy the "popular" names, reduce volatility and address many suboptimal conditions to deal with what fund holders want. He wouldn't need to.
Buffet is not a stock picker, and I wish people stopped referring to him as such. His genius was in the structure of his holdings.
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Buffet is not a simple investor like the rest of us. He creates his own reality by buying whole companies and running them. Buffett is a businessman, not an investor. He buys whole companies, hires the managers and ultimately makes business decisions. Investors in stocks almost never get to do this stuff. They cannot influence their investments. At this point in his career, Buffett's reputation gives him other advantages (buying preferred stock before it's publicly available for a below-market price), but the bottom line is that he is lucky and/or good businessman, not an investor.
He may not be simple today, but in his early days he was much closer to an individual investor than what he is now. He did ~30%/yr after large fees for his partnership investors using a mixture of value, special situations, arbitrage and growth investing.
Buffett can be used as an example but there are many ways to make money in the market. The key is to find out what your edge is and what works for you as an individual. If you don't have an edge, then you won't do well. And if you're trying to be someone else, you won't do well either.
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"Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line."
Pretty ballsy statement to think you could beat the S&P index. A VAST MAJORITY of the best and brightest financial minds on Wall St cant do it....whats makes you think you can?
Several points:
(1) You as a small individual investor have serious advantages over anyone running a large amount of money for clients. As I noted above, you can (a) invest in virtually any security, whereas large managers are confined to big, well-known companies, and (b) you can truly think long-term, whereas most managers have to think about short-term results because their clients are obsessed about short-term results. These points are especially true of large mutual funds.
(2) Professionals have to deliver strong returns net of fees, which can be substantial. If the S&P does 10% per year, a hedge fund charging 2/20 has to do 15%/yr just to equal the S&P net of fees. A fund doing, say, 12%/yr gross would be delivering 7.6%/yr to investors, and would be substantially under performing despite beating the market. Viewed in this context, it's not at all surprising that in good times, most hedge funds will underperform the index even if their managers are in fact skilled.
(3) You have to evaluate returns in the context of risk. From 2009 to the present, in hindsight it's always been best to be 100%+ invested in U.S. equities. For many hedge funds, maximizing returns in frothy times is not their objective. The objective is earning a good absolute return over long periods of time. Hedge funds that fall into this category [Baupost Group is the perfect example] fared significantly better than the index in 2008 and also fared very well during the previous market crash in 2000-2002. Even if you look at all hedge funds lumped together, they fell much less than the market in 2008. Low cost index funds are one of the greatest inventions of all time, but I think it's prudent to remember that while being 100% invested in equity indexes has been an incredible strategy since 2009, you have to evaluate that performance in light of 2009-2014 being one of the greatest 5 year bull markets in history.
And for what it's worth, on the Bogle quote; it's damn easy to copy Buffett, just buy BRK.
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Personally, I'm 50% indexed and 50% in individual stocks and am trying to build up my cash position to take advantage of any attractive opportunities that present themselves in the future.
Be sure to count your cash position (losing against inflation) in your overall self-picked portfolio returns. You'll have to outperform the market with negative leverage (due to your cash position) for your self-picked portfolio to make any sense other than providing you with entertainment.
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hodedofome- your posts are pretty succint and makes sense. You said you read a lot of books to help define your system/edge, any of those books stick out that you would recommend?
Even within this forum there are a myriad of investing styles advocated for and the arguments for/against certain styles are great to read and I have learned greatly from them. Stock screeners and analysis tools are so easily accessed now, however, they are useless if you don't have a base "starting point strategy". Trying to define my investing mission statement is something I'm focused on this year so any thoughts would help.
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I invest in individual stocks and I use a specific portfolio recommendations service that outperformed the S&P 500 last year. I am also learning to use options under the guidance of a paid service that makes conservative recommendations and has an 90% accuracy rate.
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But it certainly isn't for everyone. I think you have to love thinking about the market and reading financials to even consider investing in individual stocks. And I think it also makes a lot of sense to put a substantial portion of your portfolio into an index and/or a security like Berkshire, and then actively invest perhaps 10-20% of your portfolio at first. Beyond reducing the risk that you will make mistakes that substantially impact your net worth, psychologically you are much more likely to be able to think long-term and ignore short term market fluctuations if you know that most of your money is tucked away in an index outside of your control.
This is my approach. I'd like to eventually work up toward maybe 50/50 but right now individual stocks are a tiny portion of my overall portfolio. I love the indexing strategy but after I switched over to the passive strategy, 100% passive just didn't sit right with me -- and I realized the more I thought about it, was how the index funds are allocated.. namely by market cap. The fact that I/the fund held more of a company because they cost more and were larger was inherently flawed to me.
I still have loads more to learn but I enjoy doing it, and I'm finally happy with how things are going. I look for value plays to buy and hold for the long term. I've read a lot of Joshua Kennon and the way he's mapped it out has really opened my eyes.
I've heard very good things about Joshua Kennon's blog. I need to check it out more regularly
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hodedofome- your posts are pretty succint and makes sense. You said you read a lot of books to help define your system/edge, any of those books stick out that you would recommend?
Even within this forum there are a myriad of investing styles advocated for and the arguments for/against certain styles are great to read and I have learned greatly from them. Stock screeners and analysis tools are so easily accessed now, however, they are useless if you don't have a base "starting point strategy". Trying to define my investing mission statement is something I'm focused on this year so any thoughts would help.
Yeah I made a list here: https://docs.google.com/spreadsheets/d/1Eqoa0AS0Vll5mSyCqSsU7TsBKwjMI9Jl-LNwRqwTW5A/edit?usp=sharing
You read enough, follow enough guys on twitter, read enough blogs, watch enough videos, do enough thinking...eventually, if you keep at it, you'll start coming up with your own ideas. You'll never make any money following someone else's ideas, you have to figure out what works for you. There is no holy grail unfortunately.
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
Believe me, I'm a huge proponent of indexing and for 99.9% of people it's the obvious best choice. But to say that it's impossible to beat the market is a bit hard for me to believe. As Buffett has said, it's much easier to win at a game where your opponents have been taught that it's futile to even try to play.
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Can we be clear on one thing?
Very few beat the indexes over their investing lifetime (40+ years). That's just a cold hard fact. This is the entire point of passive investing. Many things in this world are possible and many of those same things aren't likely....make sense?
If you want to play with the laws of math and statistics then be my guest but my passive investment portfolio just about guarantees me to beat your individual stocks at the finish line. All this without me doing anything......I'd rather be out surfing or playing a good game of golf.
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The first few years I spent thousands of hours doing research and reading books, but I've got my system down to where I'm only spending a few minutes a day looking through charts of potential stocks.
Once a month I'll rebalance my index fund momentum strategy if it needs it. I use that for my taxable and retirement accounts, and I'll go on margin in the taxable account if I find a stock I like. If the stock does well, I'll add to it and take away the index funds until the entire account is in stocks. Then once those stocks stop going up, I'll go back to the index funds. So, I could be 100% in index funds (like right now) or I could be 100% in stocks or a mix, depending on the market environment.
The entire process takes just a few minutes to execute each day, but I continue to read and do research in the evenings because I enjoy it.
Doing a strategy like the Magic Formula only takes a few minutes a year to execute and works well, probably better than most stock pickers. I would expect to incorporate the magic formula into my strategies when my account gets big enough one day.
Do you index specifically when you feel the market is overheated and there are fewer value opportunities? Also, how do you account for transaction costs because it sounds like those might be high for you.
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Buffet is not a simple investor like the rest of us. He creates his own reality by buying whole companies and running them. Buffett is a businessman, not an investor. He buys whole companies, hires the managers and ultimately makes business decisions. Investors in stocks almost never get to do this stuff. They cannot influence their investments. At this point in his career, Buffett's reputation gives him other advantages (buying preferred stock before it's publicly available for a below-market price), but the bottom line is that he is lucky and/or good businessman, not an investor.
Yes and no. His earlier investments, which actually performed a lot better than his current ones, were when he just took a position in the stock rather than in ownership.
Additionally, he's a notoriously hands-off manager, and leaves most day-to-day decisions up to the leadership of the company.
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Can we be clear on one thing?
Very few beat the indexes over their investing lifetime (40+ years). That's just a cold hard fact. This is the entire point of passive investing. Many things in this world are possible and many of those same things aren't likely....make sense?
If you want to play with the laws a of math and statistics then be my guest but my passive investment portfolio just about garuntees me to beat your individual stocks at the finish line. All this without me doing anything......I'd rather be out surfing or playing a good game of golf.
Is there any actual data on individual investors for this? Sure, there's plenty of data on mutual fund managers, but most of what I've seen on individual investors is that the average investor (no distribution data) of a mutual fund underperforms the mutual fund they invest in due to bad timing.
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"Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line."
Pretty ballsy statement to think you could beat the S&P index. A VAST MAJORITY of the best and brightest financial minds on Wall St cant do it....whats makes you think you can?
Their incentivizes are perverse and reward constant trading and taking on more capital, as well as paying for marketing to attract new customers.
While it makes THEM money, their customers lose out due to high fees, which drag down their total returns. They also have little reason to go against the "popular opinion" (i.e. average) lest they bet wrong and wind up unemployed.
I think if you stay disciplined and focused, it is possible. Look at all the "Graham and Doddsville" investors that have consistently done well for themselves. To simply brush them aside as an aberration is a bit crazy.
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Do you index specifically when you feel the market is overheated and there are fewer value opportunities? Also, how do you account for transaction costs because it sounds like those might be high for you.
I am not currently a value investor. Everything I currently do is more momentum/trend following. When my individual stock system is not identifying any opportunities, I'll be 100% in index funds. However even the index funds are based on which asset classes are doing well. If stock funds are down and bond funds are up, I'll be 100% in bonds. If stocks and bonds are down and commodities are up, I'll be 100% in commodities. Or Real Estate, or whatever.
I only buy individual stocks when there are good opportunities and low risk to do so. When I can make a low risk play on an individual stock, and have a payoff of 5, 10 or even 100 times my risk, I'll take it. If I get enough of those opportunities, then I'll lower my allocation to the index fund system because there's no better time to make a ton of money than a rip-roaring bull market.
As far as trading costs go, I use Interactive Brokers and pay about $1/trade. Obviously keeping my costs low is paramount. I may make 0-5 round trip individual stock trades in a year, I try to trade as little as possible and only take the absolute best opportunities. I may only have 20-50% winning trades, depending on the environment, but it only takes 1 stock like TSLA or VIPS or TARO to double or triple my entire account.
You could consider my index fund strategy my consistent/income strategy, I'm looking to make 10-20%/yr off of that. The individual stocks pay off rarely, but doubling or tripling my account 2-3 times in a 10 year period, on top of the index funds, makes for pretty decent returns over the long haul.
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
Oversimplifies it too much.
People often paint Buffett as a freak of a nature, an oracle... but he's not.
He follows an investment theory that's older than he is, modified from his experience.
Much of the rest comes down to opportunity and being in the right time at the right place. Buffett had access to incredibly cheap, and good companies. Plus, he purchased Geico, which was a pretty big driver for him (he was after the float).
People can be really successful practicing value investing. Too often though the faults of individuals cause their issues but the blame gets placed elsewhere.
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"Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line."
Pretty ballsy statement to think you could beat the S&P index. A VAST MAJORITY of the best and brightest financial minds on Wall St cant do it....whats makes you think you can?
Their incentivizes are perverse and reward constant trading and taking on more capital, as well as paying for marketing to attract new customers.
While it makes THEM money, their customers lose out due to high fees, which drag down their total returns. They also have little reason to go against the "popular opinion" (i.e. average) lest they bet wrong and wind up unemployed.
I think if you stay disciplined and focused, it is possible. Look at all the "Graham and Doddsville" investors that have consistently done well for themselves. To simply brush them aside as an aberration is a bit crazy.
Once again, Im not saying its impossible. Just more and more unlikely the longer your investing timeline continues.
If investing and financials are your hobby and you are willing to take the extra risk along with the hours spent reading reports, then go for it.
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Shhh....you have broken the forbidden code.
People here do not believe in thinking. Apparently, you can never the difference between Netflix vs. Apple, or know that the oil sector is in trouble.
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Very few beat the indexes over their investing lifetime (40+ years). That's just a cold hard fact. This is the entire point of passive investing. Many things in this world are possible and many of those same things aren't likely....make sense?
If you want to play with the laws of math and statistics then be my guest but my passive investment portfolio just about guarantees me to beat your individual stocks at the finish line. All this without me doing anything......I'd rather be out surfing or playing a good game of golf.
+1
However, I LIKE trying to pick so a small part of my portfolio is made up of hand picked stocks. May prove to be a drag on overall performance but it's less than 5% of my assets and is my 'fun money'. Some years a drag, some years not.
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I think if you stay disciplined and focused, it is possible. Look at all the "Graham and Doddsville" investors that have consistently done well for themselves. To simply brush them aside as an aberration is a bit crazy.
If you acknowledge the Graham and Doddsville's of the world, make up a tiny percentage of the people actively trading, then yes, they are an aberration.
This post is a perfect example of the traps people fall into. They see people achieving things that seem impossible, then when they see the statistics of how few people are able to beat the market over the long term, they think it's possible for them to do that too! Things like this don't phase them:
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"Of the 355 equity funds in 1970, fully 233 of those funds have gone out of business. Only 24 oupaced the market by more than 1% a year. These are terrible odds." Jack Bogle (2007)
Bill Bernstein, author of The Four Pillars of Investing: "Does this (three fund) portfolio seem overly simplistic, even amateurish? Get over it. Over the next few decades, the overwhelming majority of all professional investors will not be able to beat it."
"Only about one out of every four equity funds outperforms the stock market. That's why I'm a firm believer in the power of indexing." Charles Schwab
"The fund industry's dirty little secret: most actively managed funds never do as well as their benchmark." Arthur Levitt, Chairman, SEC
"Over the long-term the superiority of indexing is a mathematical certainty." Jason Zweig, senior writer for "Money"
"Indexing virtually guarantees you superior performance. Bill Bernstein, author, financial adviser
"With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me." Bill Miller, portfolio manager
Sources:
http://www.bogleheads.org/forum/viewtopic.php?t=173#p20484
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=88005
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But there's a big thing they're missing there. They don't see that it's a competition. Tell someone they can beat Michael Jordan in a game of basketball, and they will laugh in your face...but give them a sales pitch for "one weird trick" to beat the market, and people will line up to give you money.
For the newbies in the thread, it's important to understand this next point. When someone claims they can beat that market over the long term, they're saying you can beat over half of all money invested in the market this year, then again next year, and again the year after that...for as long as they live. All by using a published, widely known strategy, that the other market participants (the people they claim to be beating) are aware of. This is essentially the claim:
"<Insert Strategy Here> beat over half of all invested dollars in the past. While this information is public, I do not expect the losers to adopt my published strategy, or change to a better strategy, so I expect it to continue beating over half of all invested dollars in the future."
This isn't just someone saying, "I can beat Lebron James in a 1 on 1 basketball game, you can too!"
It's, "I can beat Lebron James in a 1 on 1 basketball game, every single year, and he knows exactly what I'm going to do each time, and he doesn't copy my strategy or figure out a way to beat me, so I expect I will continue beating him in the future, you can too!"
Compared to:
"Indexing beat or matched half of all invested dollars in the past, I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future."
Which one of these statements are you willing to bet your life savings on?
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
Oversimplifies it too much.
People often paint Buffett as a freak of a nature, an oracle... but he's not.
He follows an investment theory that's older than he is, modified from his experience.
Much of the rest comes down to opportunity and being in the right time at the right place. Buffett had access to incredibly cheap, and good companies. Plus, he purchased Geico, which was a pretty big driver for him (he was after the float).
People can be really successful practicing value investing. Too often though the faults of individuals cause their issues but the blame gets placed elsewhere.
I love it when people use Buffet as evidence that "I too can beat the market!", when apparently it's so rare to beat the market, that when someone does it everyone knows their name!
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Dodge, you're arguing against a straw man. The fact that the average actively managed mutual fund has not beat the market tells you that investing in a random actively managed mutual fund is a terrible idea. It does not tell you that active investing in and of itself is destined to fail.
I'll quote my previous post in this thread on this subject, which your argument does nothing to respond to. In addition to these points, most active fund managers are not value investors. They are speculators, they are betting as to whether or not somebody else is going to be willing to pay more for the stock tomorrow. They are not value investors. Value investing is the one philosophy where I think the evidence supports that, with the right analysis and psyche, you can do better than average over time. There are many people who will tell you that they are value investors, but few active managers who actually invest in such a way. I don't think anyone betting on guessing next quarter's earnings is going to beat the market.
(1) You as a small individual investor have serious advantages over anyone running a large amount of money for clients. As I noted above, you can (a) invest in virtually any security, whereas large managers are confined to big, well-known companies, and (b) you can truly think long-term, whereas most managers have to think about short-term results because their clients are obsessed about short-term results. These points are especially true of large mutual funds.
(2) Professionals have to deliver strong returns net of fees, which can be substantial. If the S&P does 10% per year, a hedge fund charging 2/20 has to do 15%/yr just to equal the S&P net of fees. A fund doing, say, 12%/yr gross would be delivering 7.6%/yr to investors, and would be substantially under performing despite beating the market. Viewed in this context, it's not at all surprising that in good times, most hedge funds will underperform the index even if their managers are in fact skilled.
(3) You have to evaluate returns in the context of risk. From 2009 to the present, in hindsight it's always been best to be 100%+ invested in U.S. equities. For many hedge funds, maximizing returns in frothy times is not their objective. The objective is earning a good absolute return over long periods of time. Hedge funds that fall into this category [Baupost Group is the perfect example] fared significantly better than the index in 2008 and also fared very well during the previous market crash in 2000-2002. Even if you look at all hedge funds lumped together, they fell much less than the market in 2008. Low cost index funds are one of the greatest inventions of all time, but I think it's prudent to remember that while being 100% invested in equity indexes has been an incredible strategy since 2009, you have to evaluate that performance in light of 2009-2014 being one of the greatest 5 year bull markets in history.
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Dodge, you're arguing against a straw man. The fact that the average actively managed mutual fund has not beat the market tells you that investing in a random actively managed mutual fund is a terrible idea. It does not tell you that active investing in and of itself is destined to fail.
I'll quote my previous post in this thread on this subject, which your argument does nothing to respond to. In addition to these points, most active fund managers are not value investors. They are speculators, they are betting as to whether or not somebody else is going to be willing to pay more for the stock tomorrow. They are not value investors. Value investing is the one philosophy where I think the evidence supports that, with the right analysis and psyche, you can do better than average over time. There are many people who will tell you that they are value investors, but few active managers who actually invest in such a way. I don't think anyone betting on guessing next quarter's earnings is going to beat the market.
(1) You as a small individual investor have serious advantages over anyone running a large amount of money for clients. As I noted above, you can (a) invest in virtually any security, whereas large managers are confined to big, well-known companies, and (b) you can truly think long-term, whereas most managers have to think about short-term results because their clients are obsessed about short-term results. These points are especially true of large mutual funds.
(2) Professionals have to deliver strong returns net of fees, which can be substantial. If the S&P does 10% per year, a hedge fund charging 2/20 has to do 15%/yr just to equal the S&P net of fees. A fund doing, say, 12%/yr gross would be delivering 7.6%/yr to investors, and would be substantially under performing despite beating the market. Viewed in this context, it's not at all surprising that in good times, most hedge funds will underperform the index even if their managers are in fact skilled.
(3) You have to evaluate returns in the context of risk. From 2009 to the present, in hindsight it's always been best to be 100%+ invested in U.S. equities. For many hedge funds, maximizing returns in frothy times is not their objective. The objective is earning a good absolute return over long periods of time. Hedge funds that fall into this category [Baupost Group is the perfect example] fared significantly better than the index in 2008 and also fared very well during the previous market crash in 2000-2002. Even if you look at all hedge funds lumped together, they fell much less than the market in 2008. Low cost index funds are one of the greatest inventions of all time, but I think it's prudent to remember that while being 100% invested in equity indexes has been an incredible strategy since 2009, you have to evaluate that performance in light of 2009-2014 being one of the greatest 5 year bull markets in history.
I find a value tilt to be utter crap, meant to sell people who don't know any better on a more expensive fund that "beats the market". I wouldn't put my money there if there were no added expense ratio, I'm definitely not paying for that. Paying extra for a value tilt is utter crap. Fama himself says it's reasonable to expect the market to adjust:
EFF/KRF (Fama & French): The premise is that until the last couple of decades, individual investors had limited access to diversified portfolios of small stocks and value stocks. As a result, the prices of small and value stocks were lower than they would be if all investors had easy access, and their expected returns were higher. The introduction and growth of mutual funds that invest in small-cap and value stocks would then reduce the expected returns on these securities. Since expected security returns depend on supply and demand, an increase in the average allocation to small and value stocks will reduce the size and value premiums.
Another prominent skeptic regarding the importance of a value tilt is John C. Bogle, as articulated in a 2002 speech and paper, The Telltale Chart (http://www.vanguard.com/bogle_site/sp20020626.html). Bogle looks at the data (section 2. RTM - Value Stocks vs. Growth Stocks), and shows that while the theoretical Fama-French portfolio exhibits a dramatic outperformance, the mutual fund performance of the strategy actually underperformed the market. "So investors should not ignore the obvious costs of implementing a strategy that rises, pristinely, out of academic studies that cannot be precisely replicated in the real world." I would prefer not to try to summarize a complicated story, and I don't see any soundbites to cherry-pick that would serve as a short summary. Perhaps it is "This too, shall pass"
Portfolio Constituency Rules and the Value Premium in the Small-Cap Space (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2394711) supports Mr.Bogle's conclusion regarding Value stock performance in actual mutual funds over time, and provides a possible reason. It seems to imply that when actual mutual-funds (index or otherwise) are implemented, that the most illiquid stocks are often excluded, removing the Value Premium.
"...We suggest these results might go a long way in explaining why market-based growth fund returns generally equal those of their value fund counterparts over time..."
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
Oversimplifies it too much.
People often paint Buffett as a freak of a nature, an oracle... but he's not.
He follows an investment theory that's older than he is, modified from his experience.
Much of the rest comes down to opportunity and being in the right time at the right place. Buffett had access to incredibly cheap, and good companies. Plus, he purchased Geico, which was a pretty big driver for him (he was after the float).
People can be really successful practicing value investing. Too often though the faults of individuals cause their issues but the blame gets placed elsewhere.
I love it when people use Buffet as evidence that "I too can beat the market!", when apparently it's so rare to beat the market, that when someone does it everyone knows their name!
You act as if Buffett is the only one that routinely beats the market. I'll give you a hint... Many people do. The thing with value investing though, is it's in their best interest not to talk about it.
Buffett is the poster child because he's turned his operation into a full fledged holding company.
Dodge, you're arguing against a straw man. The fact that the average actively managed mutual fund has not beat the market tells you that investing in a random actively managed mutual fund is a terrible idea. It does not tell you that active investing in and of itself is destined to fail.
I'll quote my previous post in this thread on this subject, which your argument does nothing to respond to. In addition to these points, most active fund managers are not value investors. They are speculators, they are betting as to whether or not somebody else is going to be willing to pay more for the stock tomorrow. They are not value investors. Value investing is the one philosophy where I think the evidence supports that, with the right analysis and psyche, you can do better than average over time. There are many people who will tell you that they are value investors, but few active managers who actually invest in such a way. I don't think anyone betting on guessing next quarter's earnings is going to beat the market.
A lot of mutual funds are just crowd chasers. Not much different from retail investors. The majority of managers shouldn't be managing money.
Funds that specialize in what they're good at (not the walmarts of funds, where they have one fund for everything) are the funds to look at. The managers > the funds performance. Managers change, funds don't.
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(http://im.ft-static.com/content/images/d6d02358-aadf-4d56-bc27-3e62e5f5691c.img)
Oversimplifies it too much.
People often paint Buffett as a freak of a nature, an oracle... but he's not.
He follows an investment theory that's older than he is, modified from his experience.
Much of the rest comes down to opportunity and being in the right time at the right place. Buffett had access to incredibly cheap, and good companies. Plus, he purchased Geico, which was a pretty big driver for him (he was after the float).
People can be really successful practicing value investing. Too often though the faults of individuals cause their issues but the blame gets placed elsewhere.
I love it when people use Buffet as evidence that "I too can beat the market!", when apparently it's so rare to beat the market, that when someone does it everyone knows their name!
You act as if Buffett is the only one that routinely beats the market. I'll give you a hint... Many people do.
Source? The typical investment horizon for people here is around 40-50 years. Can you provide a source, or better yet a list of managers/funds, who have consistently (not just riding high on the first few years of great performance, but consistently, year after year, so it doesn't matter when I got in) beat the market over the last 40-50 years?
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@Dodge: Again, you're arguing against a very different proposition than what I proposed. You're arguing against quantitative strategies that try to pick out stocks based on things like P/E ratios and so forth. I agree completely that a strategy which relies on screening investments solely on quantitative criteria is not going to work long-term.
That's not what value investing is. Value investing is saying "I'd be willing to buy 1/1000th of this business for X, because I think the cash flows the business produces will be worth X. Today the market is offering me the opportunity to buy it today at Y. If Y<X, I'll buy." The value of a business is way too complicated to be encapsulated in a simple number like a P/E ratio, and this makes quantitative screens useless.
Continuing this argument is pointless because we are clearly speaking different languages.
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On the subject of data that supports outperformance: first of all, there are few funds that have existed for 40-50 years, so that's a tall order. Of those that have, few will be made up of the same managers.
You can find a large number of hedge funds founded in the 80s-90s that have returned in the range of 15-25%/yr over time since inception. For most of these funds, the outperformance has been consistent with the exception being 2010-present, which as I argued above is a very particular period in which anyone who was prudent about risk has lagged the equity averages. Baupost Group / Seth Klarman is the best example IMO. They have returned 17%/yr since the early 1980s, with very low volatility, holding on average ~30% cash.
Mutual funds: Sequoia Fund and Dodge & Cox are the best two examples. The problem w/ mutual funds is that the successful ones grow too quickly, and size reduces returns. Sequoia has been careful about limiting size, and they are closed to new investors. When Buffett closed his partnership around 1970, he recommended his clients invest in the Sequoia fund. Their track record is exceptional: http://www.sequoiafund.com/fp-investment-comparison.htm
For an academic look at whether or not smaller, individual investors who follow a value strategy can beat the market, this is the only quantitative data I've ever seen, but it is encouraging: http://www.retailinvestor.org/pdf/HedgeFund.pdf
^It looks at investment pitches on a site which is mostly made up of individual value investors and smaller fund managers, and finds they have outperformed the market, and moreover that pitches which are highly rated by the community have outperformed low-rated pitches.
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On the subject of data that supports outperformance: first of all, there are few funds that have existed for 40-50 years, so that's a tall order.
Indeed. Funds don't typically last that long. I suspect the funds mentioned in your post will share the same fate.
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On the subject of data that supports outperformance: first of all, there are few funds that have existed for 40-50 years, so that's a tall order.
Indeed. Funds don't typically last that long. I suspect the funds mentioned in your post will share the same fate.
Well that's a really strong counterargument to all the evidence I brought up :)
The Dodge & Cox stock fund has been around for 50 years, and Sequoia for about the same.
Fund managers are human beings, and even if they are successful, people die and/or retire. So of course they will not on average last 40-50 years, even if they have the skills to beat the market.
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@Dodge: Again, you're arguing against a very different proposition than what I proposed. You're arguing against quantitative strategies that try to pick out stocks based on things like P/E ratios and so forth. I agree completely that a strategy which relies on screening investments solely on quantitative criteria is not going to work long-term.
That's not what value investing is. Value investing is saying "I'd be willing to buy 1/1000th of this business for X, because I think the cash flows the business produces will be worth X. Today the market is offering me the opportunity to buy it today at Y. If Y<X, I'll buy." The value of a business is way too complicated to be encapsulated in a simple number like a P/E ratio, and this makes quantitative screens useless.
Continuing this argument is pointless because we are clearly speaking different languages.
I understand you perfectly. You think you have the ability to look at a piece of paper and predict the future better than at least half of all invested dollars. This year. And again next year. And every year thereafter.
"<Buying stocks I predict will do well in the future> beat over half of all invested dollars in the past. While the information I'm using for these predictions is public, I do not expect the losers to adopt my published strategy, or change to a better strategy, so I expect to continue beating over half of all invested dollars in the future."
I'm not comfortable putting my life's savings into such a statement. If you are, good luck!
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On the subject of data that supports outperformance: first of all, there are few funds that have existed for 40-50 years, so that's a tall order.
Indeed. Funds don't typically last that long. I suspect the funds mentioned in your post will share the same fate.
Well that's a really strong counterargument to all the evidence I brought up :)
The Dodge & Cox stock fund has been around for 50 years, and Sequoia for about the same.
Fund managers are human beings, and even if they are successful, people die and/or retire. So of course they will not on average last 40-50 years, even if they have the skills to beat the market.
For someone who started investing 40-50 years ago, the odds of them choosing one of these two funds, out of all the available funds, is very poor. This supports my assertion. Apparently it's so rare to beat the market, that when someone does it everyone knows their name!
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Its already been establish in this thread thats its possible to beat the market and that there are funds which have outperformed the indexes.
The point is that it takes extra time and luck to do something which may or may not happen.
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Can you beat the market? Yes.
Consistently? Yes, but highly unlikely.
Using stocks? Yes, but.... Why would you want to?
Index VS individual stocks for me isn't what can get the best returns, its what can get the best risk adjusted returns. When you own individual stocks you are taking on a ton of extra risk over owning the index. Those companies can go belly up, regardless of how much research you do. RIM(Blackberry) once had a near monopoly on smart phones at the key time smart phones were taking off. A few dozen people on the entire planet knew about the iPhone[project purple] at that time. There are always unknowns.
Paying yourself: I've seen several arguments stating that part of the reason active funds underperform is because of fees, and as an individual you aren't affected by those fees. That manager is getting paid so much because of his experience/education, to pay his staff of analysts(w/ experience/education) that are doing far more due diligence than you can, and he has the advantage of buying things in bulk likely in the dark pools. So he pays less per trade for stock. MMM recommends figuring out what you would pay yourself to manage properties and calculate that into your real estate returns. Do the same for stock picking and watch any alpha disappear. If you are managing 20+ companies that is a lot of time dedicated to research not counting any expenses for the research tools[even if its Fidelity's built in tools, those tools are built into their higher costs ;)]. If you aren't doing the research you probably shouldn't be dealing with individual stocks, and having less than 19 companies means you are still pretty exposed to unsystematic risk(company risk... IE you're not diversified).
Buffett: Would you compare your returns to Bain Capital? Buffett has more in common with Mitt Romney than the average investor. He has a huge multinational corporation that pumps money into companies it buys up, and then helps manage those companies. Buffett by the way also recommended people just index, and when he passes 90% of his money is going into the Vanguard 500 index fund so his wife doesn't have to worry about it. Buffett and Cramer are both advocates of indexing. The guy who is known for beating the market, and the guy who tells everyone else they can... both say you should index.
The secret on Wall Street: Many active fund managers, analysts, staff, and salespeople.... own index funds in their own accounts. Just look at a lot of the proponents for indexing. They are CFPs and CFAs. The people who are suppose to be able to get you better returns... index!
Over the past few years I've actually managed to squeeze out 'slightly' better returns than the indexes. 90% of my portfolio is always in big stock index funds, and sometimes its 100%. If things start to look expensive I put the 10% in what I think looks cheap. A lot goes into figuring out what I think looks expensive or cheap, but thats the basic idea.
I could do the same thing with stocks, but it would require a lot more work on my end, entail a whole lot more risk, and the difference in returns probably wouldn't be worth it... and given the risk... I might actually do worse.
As for active funds, a very small few have beaten the markets over a long time period. There is no guarantee they will continue to do so. There is no way of knowing today which funds will outperform over the next 20 years.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
But you're forgetting about fees.
Before fees, 50% of invested dollars do better than the average of the total market, and 50% do worse. But factor in fees, and that bell curve shifts to the left, and a majority of invested dollars do worse than the average. Vanguard illustrates this quite nicely https://personal.vanguard.com/us/insights/investingtruths/investing-truth-about-cost (https://personal.vanguard.com/us/insights/investingtruths/investing-truth-about-cost)
And you make it seem like settling for average is a bad thing. I see it differently. By using a broad market index like Vanguard's Total (US) Stock Market Index, I'm guaranteeing myself just slightly under average performance (slightly under average because VTSAX's fee is 0.05%). But if I were to try to pick individual stocks, or pick an actively managed mutual fund, or some combination in between, I'm no longer guaranteeing myself slightly under average. I might do better, or I might do worse. Nobody really knows.
It may not be satisfying to settle for just under average. And index investing is boring as shit - there's no reading into headlines of what stocks might be hot, or how a possible geopolitical crisis might affect certain sectors of the economy, etc. But guaranteeing myself just under average performance is going to get me exactly where I want to be. Picking stocks or active mutual funds can get me where I want to be as well, but I have no idea if that's going to be faster (probably not), or slower (probably).
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
Huh? When did the index become the avg mean return for investors? LOL!
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No, you beat 50% (or more, if you account for fees) ... without lifting a fucking finger.
You can spend you time poring over earnings reports. I'll be out riding my mountain bike, thanks.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
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I have re-read this thread multiple times and am still confused. The OP was weighing the merits of index stocks versus individually purchased stocks.
So then why is so much of the rationale presented here raising an argument against actively managed funds?
And again, why does this have to be a VERSUS?
FYI, I like the post by KD, who risks 5% of her/his portfolio on individually purchased stocks and is willing to take the hit. It doesn't have to be a VERSUS.
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I have re-read this thread multiple times and am still confused. The OP was weighing the merits of index stocks versus individually purchased stocks.
So then why is so much of the rationale presented here raising an argument against actively managed funds?
And again, why does this have to be a VERSUS?
FYI, I like the post by KD, who risks 5% of her/his portfolio on individually purchased stocks and is willing to take the hit. It doesn't have to be a VERSUS.
Because many people( including the OP) think there's a VERY GOOD CHANCE of beating the indexes if they are willing to put in the time and effort. Nothing can be farther from the truth.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
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Thanks Surf. Here is where I sit. Of my stock portfolio I keep 90% indexed and am now 10% in five dividend paying stocks.
I give myself a 30-50% chance of even MEETING the S&P 500 over the long term.
And I don't care. I have a mental disorder, so to speak. And if my 10% bet keeps me 90% in the game, that's what I'll do.
I don't go to Vegas. I don't play golf. I don't ski or snowboard. And I don't think Diageo, BP, McDonald's, Johnson & Johnson, or McCormick Spice Company are going out of business anytime soon.
It sure does feel like this topic, which appears to be represented on at least three active threads in this forum, gets overly cantankerous.
Logic says, "Read 'Random Walk Down Wall Street.'" If you don't get the logic, read it again. Then for dessert read the tail end of Warren's shareholder letter from last year.
My emotion says, that 10% keeps me in the game without blowing my financial shit out the door. I am a monkey. I have a monkey brain.
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Thanks Surf. Here is where I sit. Of my stock portfolio I keep 90% indexed and am now 10% in five dividend paying stocks.
I give myself a 30-50% chance of even MEETING the S&P 500 over the long term.
And I don't care. I have a mental disorder, so to speak. And if my 10% bet keeps me 90% in the game, that's what I'll do.
I'm also fond of this approach. I first saw it on the motley fool it was called "index plus a few".
IMHO, for at least 90% of people they would be best off indexing. For the other 10% who have an interest and aptitude, the Index plus a few might be the best (and least risky) way to indulge this. Personally I feel only a minority (I'll be more generous than others and say 5%) can succeed long term at active investing.
(Note: These percentages are just my guesstimate views, no source or evidence behind)
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
This goes both ways. Say you have an edge and your edge works really well in the current environment. You can use that edge to make 100%, 500%, 1000% or more in just a year or two. You could spend the rest of the years indexing and still have handily beaten the market. You wait until your edge comes back in favor, and do it all over again. You end up taking marginally more risk for much more return.
Risk in trading can be defined, whereas in a buy and hold environment it cannot. You don't have to lose 50% as a trader if you don't want to, but a buy and hold guy is at mercy of the market. I will argue that a buy and pray strategy is taking on much more risk than I am. Certainly they are taking on more volatility per unit of return.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
This goes both ways. Say you have an edge and your edge works really well in the current environment. You can use that edge to make 100%, 500%, 1000% or more in just a year or two. You could spend the rest of the years indexing and still have handily beaten the market. You wait until your edge comes back in favor, and do it all over again. You end up taking marginally more risk for much more return.
Risk in trading can be defined, whereas in a buy and hold environment it cannot. You don't have to lose 50% as a trader if you don't want to, but a buy and hold guy is at mercy of the market. I will argue that a buy and pray strategy is taking on much more risk than I am. Certainly they are taking on more volatility per unit of return.
You make sound soooo easy! :)
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It's certainly the hardest thing you'll ever do. Most aren't willing to do the work which is why most fail at it.
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My recommendation is to passively invest and put the extra time you would have spent researching individual stocks into increasing your personal savings rate.
In my opinion, this extra time spent on researching stocks is better spent on family, exercise, and personal development.
If you can't help but scratch the itch I'd make it less than 25% of your portfolio.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
This goes both ways. Say you have an edge and your edge works really well in the current environment. You can use that edge to make 100%, 500%, 1000% or more in just a year or two. You could spend the rest of the years indexing and still have handily beaten the market. You wait until your edge comes back in favor, and do it all over again. You end up taking marginally more risk for much more return.
Risk in trading can be defined, whereas in a buy and hold environment it cannot. You don't have to lose 50% as a trader if you don't want to, but a buy and hold guy is at mercy of the market. I will argue that a buy and pray strategy is taking on much more risk than I am. Certainly they are taking on more volatility per unit of return.
I've been and will be a big defender of active investing, but this is a bit crazy - talking about making returns of 500% or 1000% in the timeframe of a year and simultaneously arguing that such a strategy can be accomplished with lower risk than investing in a diversified index. You mentioned TSLA earlier in the thread, and that's a clear example of a situation where in hindsight you made a 10X return in 2 years, but you invested in a company that could have easily ended up in failure and worth $0, and where the majority of the run up in stock price is because of speculation. There's a big difference between that and buying Apple in mid-2013 when you were able to buy an incredible, proven business at 5-6X cash flow. The former has to be summed up as incredibly speculative whereas the latter was one of the most obvious things I've ever seen.
Personally, one of the key things I admire about value investors is that there is never a promise of spectacular returns. The goal is always to earn a reasonable return over time without taking significant risk. If you can earn 15% per year, you will be incredibly rich over a lifetime. For that matter, given the environment we are in today with 2% interest rates, I think anyone who ends up earning 10%/yr from now through the next few decades will be hailed as a genius.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
This goes both ways. Say you have an edge and your edge works really well in the current environment. You can use that edge to make 100%, 500%, 1000% or more in just a year or two. You could spend the rest of the years indexing and still have handily beaten the market. You wait until your edge comes back in favor, and do it all over again. You end up taking marginally more risk for much more return.
Risk in trading can be defined, whereas in a buy and hold environment it cannot. You don't have to lose 50% as a trader if you don't want to, but a buy and hold guy is at mercy of the market. I will argue that a buy and pray strategy is taking on much more risk than I am. Certainly they are taking on more volatility per unit of return.
I've been and will be a big defender of active investing, but this is a bit crazy - talking about making returns of 500% or 1000% in the timeframe of a year and simultaneously arguing that such a strategy can be accomplished with lower risk than investing in a diversified index. You mentioned TSLA earlier in the thread, and that's a clear example of a situation where in hindsight you made a 10X return in 2 years, but you invested in a company that could have easily ended up in failure and worth $0, and where the majority of the run up in stock price is because of speculation. There's a big difference between that and buying Apple in mid-2013 when you were able to buy an incredible, proven business at 5-6X cash flow. The former has to be summed up as incredibly speculative whereas the latter was one of the most obvious things I've ever seen.
Personally, one of the key things I admire about value investors is that there is never a promise of spectacular returns. The goal is always to earn a reasonable return over time without taking significant risk. If you can earn 15% per year, you will be incredibly rich over a lifetime. For that matter, given the environment we are in today with 2% interest rates, I think anyone who ends up earning 10%/yr from now through the next few decades will be hailed as a genius.
.....or you could just keep saving and investing in low cost index funds and be in about the same ballpark figure without the hassles, mass amounts of time taken and worries of active investing.
The U.S. stock market's worst 30 year period was roughly 6% through the Depression into and out of WWII. It's best period was 12%. All this while the country went through 2 world wars, countless financial crisises, the Cold War, not to mention we were within a C hair of complete nuclear anailation for a week or so in 1962.
Oh yeah! Did I mentioned most active investors have never or will never beat the indexes no matter how smart they are or how hard they try? :). Hello!? Red flag! Whoop. Whoop whoop!
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Hey, do whatever makes you happy; no need to pee all over someone else's investing choices.
I have an active trading account and another one which is fairly index-heavy. On individual stocks, I track them versus VTSAX. Some have lagged while others have surged vs the index. Overall, dividends and tax effects included, I'm beating VTSAX over ten years. I enjoy buying individual stocks - I have a bit of a gambling bug. I have owned dogs like RIMM and HPQ but also a lot of AAPL and GOOG (which together saved my bacon). It doesn't cut into my leisure time particularly - I just read Barron's every week at the breakfast table. It is an outstanding publication which I urge all of you to read. There is nothing wrong with letting the experts do all the research for you then making up your own mind.
One of the advantages of individual stocks is that when you sell losers, you get a tax break. That never happens when the individual stock drops inside an index.
If you don't have a stomach for individual stocks, then go with the index funds. If you enjoy stock picking, give it a go but with your eyes wide open as to the risks.
It sounds like your individual stocks are focused on the tech sector. It's worth noting that VGT also handily beat VTSAX over the past 10 years.
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My recommendation is to passively invest and put the extra time you would have spent researching individual stocks into increasing your personal savings rate.
In my opinion, this extra time spent on researching stocks is better spent on family, exercise, and personal development.
If you can't help but scratch the itch I'd make it less than 25% of your portfolio.
+1
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
Huh? When did the index become the avg mean return for investors? LOL!
A misunderstanding of what average is.
You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
Wrong.
It's not 50% above, and 50% below.
It's what the average person can expect for a return.
The stock market is not zero sum.
I have re-read this thread multiple times and am still confused. The OP was weighing the merits of index stocks versus individually purchased stocks.
So then why is so much of the rationale presented here raising an argument against actively managed funds?
And again, why does this have to be a VERSUS?
FYI, I like the post by KD, who risks 5% of her/his portfolio on individually purchased stocks and is willing to take the hit. It doesn't have to be a VERSUS.
Because many people( including the OP) think there's a VERY GOOD CHANCE of beating the indexes if they are willing to put in the time and effort. Nothing can be farther from the truth.
Honestly, doesn't take a lot of time and effort. I hold only stocks, many of which are boring short term, but have higher than average returns of something like the S&P 500 long term. My fees are lower than if I held index funds, and taking something like the S&P 500, there's 400+ companies in there I wouldn't want to own. Out of the thousands of stocks out there, for the above method which is what my retirement revolves around, there's probably less than 100 companies that I'd allow to be held.
But most people should still index. Human emotion is ones worst enemy investing, it cost me $20,000 at age 22 to tame my emotions.
** I also have a huge risk tolerance, though my risk level isn't terribly high right now. At least for equities. It is in real estate currently. **
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I've been and will be a big defender of active investing, but this is a bit crazy - talking about making returns of 500% or 1000% in the timeframe of a year and simultaneously arguing that such a strategy can be accomplished with lower risk than investing in a diversified index. You mentioned TSLA earlier in the thread, and that's a clear example of a situation where in hindsight you made a 10X return in 2 years, but you invested in a company that could have easily ended up in failure and worth $0, and where the majority of the run up in stock price is because of speculation. There's a big difference between that and buying Apple in mid-2013 when you were able to buy an incredible, proven business at 5-6X cash flow. The former has to be summed up as incredibly speculative whereas the latter was one of the most obvious things I've ever seen.
Personally, one of the key things I admire about value investors is that there is never a promise of spectacular returns. The goal is always to earn a reasonable return over time without taking significant risk. If you can earn 15% per year, you will be incredibly rich over a lifetime. For that matter, given the environment we are in today with 2% interest rates, I think anyone who ends up earning 10%/yr from now through the next few decades will be hailed as a genius.
I wouldn't expect someone who only knows one way to make money in the market (value investing) to understand that there are other ways to make money in the market. There are also ways of structuring trades that increase the payoff and lower or define the risk. Even Buffett has used options and LEAPS/warrants.
And value investing certainly is anything but consistent returns. The returns are lumpy. A few mediocre years followed by a few years of fantastic returns. This is no different than what I do. What I do however is try not to trade at all unless there's a really fat pitch. There are years where value investors will tell you they are giddy. It doesn't happen very often but if you are patient enough to pass up the good deals, and wait for the great deals, then you can certainly have the years where you double or triple your capital.
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One good reason to index is that the professional fund managers often can't beat the market, or even keep from loosing money. My 403b (AXA/Equitable) lost a lot of money the past several years. The only thing worse than loosing money through your own mistakes is loosing it through someone else's mistakes. Looking through the investments available to me through my 403b I see a lot of the funds are still loosing YTD, and some that are "up" are making a very small returns. (As an aside, I've signed up for online management so I can choose investments now rather than just going with what the "advisor" um, advises. This is not a good thing. A dummy like me has no business picking his own investments, but when the "pros" are loosing me money, what's the alternative?)
I recently opened a Vanguard Roth and have bought some index funds. They will go up and down year to year but in the "long run" (10 years for me) they ought to perform reasonably close to their benchmarks. If I had a longer time line I could be even more certain that the index would perform very close to the benchmark. This, as far as I can see, is as close as one can get to "locking in" a return over the long haul. The market -or a selected benchmark sub-portion - historically returns X %, so over the long run, the index will return X %. To do well, long term, people don't need to beat the market, they just need to keep pace with the market and compound. Indexing does that.
That said, since I have no choice but to choose my own funds for my 403b, I'll probably be willing to risk 2-3% of my investment funds on picking my own stocks. I see this as forcing myself to learn more about the market. I'm willing to take the small loss if I make bad decisions. But over all I'm much better off keeping 97% of what I think of as my "Vanguard money" in index funds.
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My recommendation is to passively invest and put the extra time you would have spent researching individual stocks into increasing your personal savings rate.
In my opinion, this extra time spent on researching stocks is better spent on family, exercise, and personal development.
If you can't help but scratch the itch I'd make it less than 25% of your portfolio.
+1
+2 . Very well said and I agree fully !
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
It's aiming for the "market" return. Consider a total (US) stock market index fund. There is pretty much no mathematical chance of it under (or over) performing the market. It will perform as the market does. If the market historically returns X % then you'll likely make X % over a long time line. In a particularly bad year the market could loose money but most years it will make you something, and some years quite a lot. It will, over 30+ years, average out to X %. Couple that almost guaranteed return with compounding and you can scarcely avoid becoming wealthy. By contrast, you can pick your own stocks and try to beat the market return (X %) But if your brilliance this year turns out to be nothing more than luck, you may loose next year, and then you'll not only loose actual value from your investment account you'll also loose the opportunity to compound the "market" return. IOWs, slow and steady, along with low fees and compounding, wins the race.
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My recommendation is to passively invest and put the extra time you would have spent researching individual stocks into increasing your personal savings rate.
In my opinion, this extra time spent on researching stocks is better spent on family, exercise, and personal development.
If you can't help but scratch the itch I'd make it less than 25% of your portfolio.
That is good advice for most. But for a few of us, we get genuine satisfaction and enjoyment out of mastering an investment process and running an investment operation like a business. It is no different than the guy that wants to manage a real estate portfolio or run a business. This is what I want my full-time job to be and I'm willing to do the work to get to that point. I'll never fully retire, as there will always be something new to learn about a stock or the market in general.
My 85 year old grandfather still spends 4-6 hours a day doing stock research. He wouldn't want to be doing anything else. His mind is as sharp as ever and he has 60+ years of compounded research and knowledge to draw from. Without his stock market operations, he'd probably die in a few years out of boredom. All of us have to decide how we are going to spend our time, and some of us choose to spend it on this kind of stuff. Others want to surf or play golf and that's ok.
I'd argue learning to become a trader has done more for my personal development than just about anything else I've ever attempted in my life. You cannot become a good trader without dealing with your past, overcoming your emotions, learning to think clearly, and make good, consistent decisions. This has spilled over into all aspects of my life, for the better. I can't remember who said it, but a star poker player once said the best way to improve your poker skills is to improve your entire life and let your poker rise with it. Trading is the same.
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There was a study that found that Jim Cramer's picks are neither good nor bad. If he's an expert and he can't beat the indexes then how would you expect to do any better?
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There was a study that found that Jim Cramer's picks are neither good nor bad. If he's an expert and he can't beat the indexes then how would you expect to do any better?
Anyone that knows anything doesn't consider Cramer an expert, he's a tv personality.
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@Dodge: Again, you're arguing against a very different proposition than what I proposed. You're arguing against quantitative strategies that try to pick out stocks based on things like P/E ratios and so forth. I agree completely that a strategy which relies on screening investments solely on quantitative criteria is not going to work long-term.
That's not what value investing is. Value investing is saying "I'd be willing to buy 1/1000th of this business for X, because I think the cash flows the business produces will be worth X. Today the market is offering me the opportunity to buy it today at Y. If Y<X, I'll buy." The value of a business is way too complicated to be encapsulated in a simple number like a P/E ratio, and this makes quantitative screens useless.
Continuing this argument is pointless because we are clearly speaking different languages.
Exactly
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I think if you stay disciplined and focused, it is possible. Look at all the "Graham and Doddsville" investors that have consistently done well for themselves. To simply brush them aside as an aberration is a bit crazy.
If you acknowledge the Graham and Doddsville's of the world, make up a tiny percentage of the people actively trading, then yes, they are an aberration.
This post is a perfect example of the traps people fall into. They see people achieving things that seem impossible, then when they see the statistics of how few people are able to beat the market over the long term, they think it's possible for them to do that too! Things like this don't phase them:
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(http://i.imgur.com/rVFlM1n.png)
"Of the 355 equity funds in 1970, fully 233 of those funds have gone out of business. Only 24 oupaced the market by more than 1% a year. These are terrible odds." Jack Bogle (2007)
Bill Bernstein, author of The Four Pillars of Investing: "Does this (three fund) portfolio seem overly simplistic, even amateurish? Get over it. Over the next few decades, the overwhelming majority of all professional investors will not be able to beat it."
"Only about one out of every four equity funds outperforms the stock market. That's why I'm a firm believer in the power of indexing." Charles Schwab
"The fund industry's dirty little secret: most actively managed funds never do as well as their benchmark." Arthur Levitt, Chairman, SEC
"Over the long-term the superiority of indexing is a mathematical certainty." Jason Zweig, senior writer for "Money"
"Indexing virtually guarantees you superior performance. Bill Bernstein, author, financial adviser
"With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me." Bill Miller, portfolio manager
Sources:
http://www.bogleheads.org/forum/viewtopic.php?t=173#p20484
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=88005
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But there's a big thing they're missing there. They don't see that it's a competition. Tell someone they can beat Michael Jordan in a game of basketball, and they will laugh in your face...but give them a sales pitch for "one weird trick" to beat the market, and people will line up to give you money.
For the newbies in the thread, it's important to understand this next point. When someone claims they can beat that market over the long term, they're saying you can beat over half of all money invested in the market this year, then again next year, and again the year after that...for as long as they live. All by using a published, widely known strategy, that the other market participants (the people they claim to be beating) are aware of. This is essentially the claim:
"<Insert Strategy Here> beat over half of all invested dollars in the past. While this information is public, I do not expect the losers to adopt my published strategy, or change to a better strategy, so I expect it to continue beating over half of all invested dollars in the future."
This isn't just someone saying, "I can beat Lebron James in a 1 on 1 basketball game, you can too!"
It's, "I can beat Lebron James in a 1 on 1 basketball game, every single year, and he knows exactly what I'm going to do each time, and he doesn't copy my strategy or figure out a way to beat me, so I expect I will continue beating him in the future, you can too!"
Compared to:
"Indexing beat or matched half of all invested dollars in the past, I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future."
Which one of these statements are you willing to bet your life savings on?
I think you're either missing the point I'm making, or we're not speaking the same language. I'm not talking about "actively managed equity funds" as these are not incentivized to outperform the market. As a personal investor, I don't have to worry about people running to pull out their money when the market tanks (but I am putting money in). I'm not trying to predict the next best thing, nor am I following the herd into the next hot IPO. I'm not simply buying stocks based on a screen of "small cap + low P/E" or "large cap + low P/FCF". If you compare strategies like this to indexing, then indexing will win hands down. But again, this isn't what I'm talking about.
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I have re-read this thread multiple times and am still confused. The OP was weighing the merits of index stocks versus individually purchased stocks.
So then why is so much of the rationale presented here raising an argument against actively managed funds?
And again, why does this have to be a VERSUS?
FYI, I like the post by KD, who risks 5% of her/his portfolio on individually purchased stocks and is willing to take the hit. It doesn't have to be a VERSUS.
Because many people( including the OP) think there's a VERY GOOD CHANCE of beating the indexes if they are willing to put in the time and effort. Nothing can be farther from the truth.
When did I say "very good chance"? I simply said you can beat the market if you have a specific knowledge, are willing to put in the effort, have the temperament for it, and a slew of other factors. The fact of the matter is that most people do not have the knowledge, will not put in the effort, and cannot escape certain behavioral/psychological traps. The odds are not stacked in these people's favor, and they should undoubtedly be indexing.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
This goes both ways. Say you have an edge and your edge works really well in the current environment. You can use that edge to make 100%, 500%, 1000% or more in just a year or two. You could spend the rest of the years indexing and still have handily beaten the market. You wait until your edge comes back in favor, and do it all over again. You end up taking marginally more risk for much more return.
Risk in trading can be defined, whereas in a buy and hold environment it cannot. You don't have to lose 50% as a trader if you don't want to, but a buy and hold guy is at mercy of the market. I will argue that a buy and pray strategy is taking on much more risk than I am. Certainly they are taking on more volatility per unit of return.
I've been and will be a big defender of active investing, but this is a bit crazy - talking about making returns of 500% or 1000% in the timeframe of a year and simultaneously arguing that such a strategy can be accomplished with lower risk than investing in a diversified index. You mentioned TSLA earlier in the thread, and that's a clear example of a situation where in hindsight you made a 10X return in 2 years, but you invested in a company that could have easily ended up in failure and worth $0, and where the majority of the run up in stock price is because of speculation. There's a big difference between that and buying Apple in mid-2013 when you were able to buy an incredible, proven business at 5-6X cash flow. The former has to be summed up as incredibly speculative whereas the latter was one of the most obvious things I've ever seen.
Personally, one of the key things I admire about value investors is that there is never a promise of spectacular returns. The goal is always to earn a reasonable return over time without taking significant risk. If you can earn 15% per year, you will be incredibly rich over a lifetime. For that matter, given the environment we are in today with 2% interest rates, I think anyone who ends up earning 10%/yr from now through the next few decades will be hailed as a genius.
.....or you could just keep saving and investing in low cost index funds and be in about the same ballpark figure without the hassles, mass amounts of time taken and worries of active investing.
The U.S. stock market's worst 30 year period was roughly 6% through the Depression into and out of WWII. It's best period was 12%. All this while the country went through 2 world wars, countless financial crisises, the Cold War, not to mention we were within a C hair of complete nuclear anailation for a week or so in 1962.
Oh yeah! Did I mentioned most active investors have never or will never beat the indexes no matter how smart they are or how hard they try? :). Hello!? Red flag! Whoop. Whoop whoop!
It's not really the same ballpark figure though. A few extra % points of performance over 40 years can be a HUGE difference in ending net worth. Like 3X more.
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That is good advice for most. But for a few of us, we get genuine satisfaction and enjoyment out of mastering an investment process and running an investment operation like a business. All of us have to decide how we are going to spend our time, and some of us choose to spend it on this kind of stuff. Others want to surf or play golf and that's ok.
+1
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It's certainly possible that any investor can beat the market in a year. It's certainly possible that any investor can beat the market consistently, year after year, for 50 years straight. It's also possible that I could win the next powerball +100 million jackpot. Statistically, I don't know which has a higher rate of success, but it really doesn't make a difference, as they would both lose to the index investor the vast vast majority of the time.
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I have re-read this thread multiple times and am still confused. The OP was weighing the merits of index stocks versus individually purchased stocks.
So then why is so much of the rationale presented here raising an argument against actively managed funds?
And again, why does this have to be a VERSUS?
FYI, I like the post by KD, who risks 5% of her/his portfolio on individually purchased stocks and is willing to take the hit. It doesn't have to be a VERSUS.
Because many people( including the OP) think there's a VERY GOOD CHANCE of beating the indexes if they are willing to put in the time and effort. Nothing can be farther from the truth.
When did I say "very good chance"? I simply said you can beat the market if you have a specific knowledge, are willing to put in the effort, have the temperament for it, and a slew of other factors. The fact of the matter is that most people do not have the knowledge, will not put in the effort, and cannot escape certain behavioral/psychological traps. The odds are not stacked in these people's favor, and they should undoubtedly be indexing.
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios outperform active portfolios by a huge margin. What part of this are you not understanding?
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I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
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I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
Lol
Ok, Fair enough. You got me on a technicality;)
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
-W
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
Perhaps, though I find it frustrating that the logical, data-driven commentators on this forum resort to this sort of hand-waving and assumption. Heck, Dodge isn't even hand-waving. When repeatedly called-out for arguing against straw-men, he continues to simply ignore the matter at hand ("what is the likelihood of an individual investor beating an index?") and addresses a different topic (the value of value-investing, mutual funds vs. index, etc.)
I understand that collecting data on individual investors (particularly investors of a certain temperament following a particular strategy) is difficult, but then I think this lack-of-data should at least be acknowledged. "Yes, we know active mutual funds won't beat the index, but since we don't have data on individual-investors vs. the index, we simply can't make any statements there. Maybe they can easily beat the index, maybe they can't; we simply don't have enough information to know".
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
-W
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
I agree with skyrefuge: it seems shocking to me that so many people post what they perceive as certainties without a shred of relevant proof.
And no one has addressed the best evidence on this issue, which philly posted earlier in this thread, with a PDF showing that hedge fund managers actually did add significantly alpha.
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No, there's lots of data:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=219228
http://www.qaib.com/public/default.aspx
http://www.sciencedirect.com/science/article/pii/S0378426608002720
etc, etc. That's probably one of the most studied questions in finance!
And of course if you want to keep digging:
https://scholar.google.com/scholar?q=individual+investor+performance&hl=en&as_sdt=0&as_vis=1&oi=scholart&sa=X&ei=U3TrVKX0Ho_UoATItYDoDg&ved=0CB0QgQMwAA
None of them that I have read says anything about whether some sophisticated, smart folks can do better. But *in general* we do pretty well know that stock picking by individual investors decreases returns, in fact by quite a bit.
-W
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I think the desire to "outperform" the market is very strong in the early days of an investors path. There is not much capital and growing it is a priority. I made a lot of mistakes in those days and would have a significantly higher total net wealth today had I invested as I do today.
Once you have a large stash built up small increases cause large upticks in net wealth and steady as she goes becomes much more attractive as you don't feel such a strong urge to rush and beat the market.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
Perhaps, though I find it frustrating that the logical, data-driven commentators on this forum resort to this sort of hand-waving and assumption. Heck, Dodge isn't even hand-waving. When repeatedly called-out for arguing against straw-men, he continues to simply ignore the matter at hand ("what is the likelihood of an individual investor beating an index?") and addresses a different topic (the value of value-investing, mutual funds vs. index, etc.)
I understand that collecting data on individual investors (particularly investors of a certain temperament following a particular strategy) is difficult, but then I think this lack-of-data should at least be acknowledged. "Yes, we know active mutual funds won't beat the index, but since we don't have data on individual-investors vs. the index, we simply can't make any statements there. Maybe they can easily beat the index, maybe they can't; we simply don't have enough information to know".
The available evidence, and the crux of my argument, apply to all active investors. If the individual investors in this forum think they don't apply, the onus is on them to show it.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
-W
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
I agree with skyrefuge: it seems shocking to me that so many people post what they perceive as certainties without a shred of relevant proof.
And no one has addressed the best evidence on this issue, which philly posted earlier in this thread, with a PDF showing that hedge fund managers actually did add significantly alpha.
Every report I've seen on individual investor performance, always looks like this:
(http://i.imgur.com/IMzAKUi.png)
If the individual investors in this forum think they don't apply, the onus is on them to show it.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
-W
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
I agree with skyrefuge: it seems shocking to me that so many people post what they perceive as certainties without a shred of relevant proof.
And no one has addressed the best evidence on this issue, which philly posted earlier in this thread, with a PDF showing that hedge fund managers actually did add significantly alpha.
Every report I've seen on individual investor performance, always looks like this:
(http://i.imgur.com/IMzAKUi.png)
If the individual investors in this forum think they don't apply, the onus is on them to show it.
Just to clarify, when they say profitable, they mean made money, not made money in excess of an appropriate index?
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
-W
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
I agree with skyrefuge: it seems shocking to me that so many people post what they perceive as certainties without a shred of relevant proof.
And no one has addressed the best evidence on this issue, which philly posted earlier in this thread, with a PDF showing that hedge fund managers actually did add significantly alpha.
Every report I've seen on individual investor performance, always looks like this:
(http://i.imgur.com/IMzAKUi.png)
If the individual investors in this forum think they don't apply, the onus is on them to show it.
Just to clarify, when they say profitable, they mean made money, not made money in excess of an appropriate index?
Correct. This is not a comparison to an index.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
-W
I guess you're not reading my responses. I've said over and over that's is possible to beat the indexes.....just not likely
Actually, the odds are stacked against you as an active investor. Passive portfolios beat active portfolios by a huge margin. What part of this are you not understanding?
I know you're not replying to me, but I would point out that no one has posted any data about individual investors long term returns. There has been data on active fund managers, but nothing on individual investors.
I agree with skyrefuge: it seems shocking to me that so many people post what they perceive as certainties without a shred of relevant proof.
And no one has addressed the best evidence on this issue, which philly posted earlier in this thread, with a PDF showing that hedge fund managers actually did add significantly alpha.
Every report I've seen on individual investor performance, always looks like this:
(http://i.imgur.com/IMzAKUi.png)
If the individual investors in this forum think they don't apply, the onus is on them to show it.
Just to clarify, when they say profitable, they mean made money, not made money in excess of an appropriate index?
Correct. This is not a comparison to an index.
If this data is indeed a representative sample of all individual investors...this is just plain sad.
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No, there's lots of data:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=219228
http://www.qaib.com/public/default.aspx
http://www.sciencedirect.com/science/article/pii/S0378426608002720
etc, etc. That's probably one of the most studied questions in finance!
And of course if you want to keep digging:
https://scholar.google.com/scholar?q=individual+investor+performance&hl=en&as_sdt=0&as_vis=1&oi=scholart&sa=X&ei=U3TrVKX0Ho_UoATItYDoDg&ved=0CB0QgQMwAA
None of them that I have read says anything about whether some sophisticated, smart folks can do better. But *in general* we do pretty well know that stock picking by individual investors decreases returns, in fact by quite a bit.
-W
Thanks for the data. I'm in the process of reading the links, but I did want to point out that the first link shows that over a five year period, 43.4% of the individual accounts they looked at beat the market after costs (table IV). 49.3% of accounts beat the market before costs, although interestingly they have a large enough sample size that that's statistically different from 50%.
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Your other links, though, aren't very good. The second is a link to purchase one-year investor returns since 1984, which unfortunately tells us nothing about longer time periods. There's data out there that show that individual investors are much more likely than random to continue their out- or underperformance in investing. Also, that product is $775.
The third link is about option trading, which no one here has discussed.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
Perhaps, though I find it frustrating that the logical, data-driven commentators on this forum resort to this sort of hand-waving and assumption. Heck, Dodge isn't even hand-waving. When repeatedly called-out for arguing against straw-men, he continues to simply ignore the matter at hand ("what is the likelihood of an individual investor beating an index?") and addresses a different topic (the value of value-investing, mutual funds vs. index, etc.)
I understand that collecting data on individual investors (particularly investors of a certain temperament following a particular strategy) is difficult, but then I think this lack-of-data should at least be acknowledged. "Yes, we know active mutual funds won't beat the index, but since we don't have data on individual-investors vs. the index, we simply can't make any statements there. Maybe they can easily beat the index, maybe they can't; we simply don't have enough information to know".
The available evidence, and the crux of my argument, apply to all active investors. If the individual investors in this forum think they don't apply, the onus is on them to show it.
Well, there's already data showing that individual investors do better than active managers – see the first link that walt posted. And I've posted studies that show that individual investors are more likely to continue their relative performance than active managers.
So, from the data we have, it's clear that a majority of individual investors trail market returns after fees. But the real question (to me, anyway) - is what is the percentage of investors who can outperform the market long-term. The first link that walt posted showed that 25% of investors do better than 0.5% better than the market monthly. That means that over a five year period, depending on how they calculated it, 25% of individual investors did more than 30-35% better than the market. This is significant!
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Sure, sure - there are a gajillion studies. I just posted a few random ones. Did you look at the google search link I posted?
In general, the studies say individual investors suck. Period. There may or may not be some subset of individual investors that do great year in and year out. I don't know of any good research on that.
-W
Your other links, though, aren't very good. The second is a link to purchase one-year investor returns since 1984, which unfortunately tells us nothing about longer time periods. There's data out there that show that individual investors are much more likely than random to continue their out- or underperformance in investing. Also, that product is $775.
The third link is about option trading, which no one here has discussed.
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I was surprised by how well the folks in that first study did. To be fair, in the mid-90s you'd generally expect only the most sophisticated folks to be trading stocks (no internet worth talking about yet, so it required quite a bit more effort than it does now) - so those are arguably among the *best* individual investors, at least as compared to a modern sample. And they still trailed the index by a bit, or by a lot if you include the fees they racked up.
AND... they spent their _time_ doing this! To me, that's the worst part. These folks could have just worked more at their regular job, or done something fun, or slept in and lived a decade longer because they were less stressed.
Again, though - there's no evidence presented in anything I've seen that says that NOBODY can consistently beat the market. All this data is just telling us that the average investor is better off with an index fund.
-W
Thanks for the data. I'm in the process of reading the links, but I did want to point out that the first link shows that over a five year period, 43.4% of the individual accounts they looked at beat the market after costs (table IV). 49.3% of accounts beat the market before costs, although interestingly they have a large enough sample size that that's statistically different from 50%.
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Sure, sure - there are a gajillion studies. I just posted a few random ones. Did you look at the google search link I posted?
In general, the studies say individual investors suck. Period. There may or may not be some subset of individual investors that do great year in and year out. I don't know of any good research on that.
-W
Your other links, though, aren't very good. The second is a link to purchase one-year investor returns since 1984, which unfortunately tells us nothing about longer time periods. There's data out there that show that individual investors are much more likely than random to continue their out- or underperformance in investing. Also, that product is $775.
The third link is about option trading, which no one here has discussed.
I did, and it's similar to the research I've done before. There's lot of analysis of individual factors: trading, account size, limit orders, financial advice, mutual fund flows, etc. Unfortunately, there's not as much about long-term individual performance, which is what really counts.
Look, I agree that >50% of individual investors trail the market, and if someone is asking the question, they should simply index. But index proponents simply go too far (without sufficient data!) when they say things like, to quote one recent discussion:
As Vanguard mentioned in their study on this, your idea of researching the best companies is inherently riskier than simply owning the full stock market index. Much riskier. Off-the-charts riskier. It is pretty much a statistical certainty that you will underperform/lose money over the long run. Researching individual stocks, for your retirement portfolio, is quite literally one of the most risky things you can do.
P.S. I read what you just posted while I was writing this, and I completely agree that the average investor is better off with an index fund. And I agree that most people could spend their time more productively. I personally enjoy investing, but I realize that most people don't.
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Yeah, we're in agreement, then - I actually believe there is a subset of people that can beat the market consistently. A few percent of the investing world, maybe? I mean, it's a skill like any other, albeit one in a much more random and stressful environment than learning to knit or something.
That said, yeah, the answer to anyone who bothers to ask the question online should be "hell no". I mean, if you can't even be bothered to do the research for 15 minutes to learn about the basics of the debate... come on!
-W
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I think the desire to "outperform" the market is very strong in the early days of an investors path. There is not much capital and growing it is a priority. I made a lot of mistakes in those days and would have a significantly higher total net wealth today had I invested as I do today.
Once you have a large stash built up small increases cause large upticks in net wealth and steady as she goes becomes much more attractive as you don't feel such a strong urge to rush and beat the market.
This is a really good point that I completely agree with. James Montier (old school Graham cigar-butt investor) mentioned something like this in one of his books. Where a young manager was working with an old rich client, trying to explain to him how a certain strategy would make him richer. The old man got angry at him and said something to the effect of not caring whether or not he gets richer, as he is already. But rather that he just doesn't want to get poorer because that would be far more painful.
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
Perhaps, though I find it frustrating that the logical, data-driven commentators on this forum resort to this sort of hand-waving and assumption. Heck, Dodge isn't even hand-waving. When repeatedly called-out for arguing against straw-men, he continues to simply ignore the matter at hand ("what is the likelihood of an individual investor beating an index?") and addresses a different topic (the value of value-investing, mutual funds vs. index, etc.)
I understand that collecting data on individual investors (particularly investors of a certain temperament following a particular strategy) is difficult, but then I think this lack-of-data should at least be acknowledged. "Yes, we know active mutual funds won't beat the index, but since we don't have data on individual-investors vs. the index, we simply can't make any statements there. Maybe they can easily beat the index, maybe they can't; we simply don't have enough information to know".
The available evidence, and the crux of my argument, apply to all active investors. If the individual investors in this forum think they don't apply, the onus is on them to show it.
Well, there's already data showing that individual investors do better than active managers – see the first link that walt posted. And I've posted studies that show that individual investors are more likely to continue their relative performance than active managers.
So, from the data we have, it's clear that a majority of individual investors trail market returns after fees. But the real question (to me, anyway) - is what is the percentage of investors who can outperform the market long-term. The first link that walt posted showed that 25% of investors do better than 0.5% better than the market monthly. That means that over a five year period, depending on how they calculated it, 25% of individual investors did more than 30-35% better than the market. This is significant!
Doesn't surprise me. For a 5 year period, the 25% figure is in line with the data:
(http://i.imgur.com/rVFlM1n.png)
¯\_(ツ)_/¯
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I think it would be a bit of a stretch to think that the advantages a small individual investor has (ie, not answerable to anyone but themselves, small trades, etc) are big enough to overcome the resources available to a professional fund manager.
Perhaps, though I find it frustrating that the logical, data-driven commentators on this forum resort to this sort of hand-waving and assumption. Heck, Dodge isn't even hand-waving. When repeatedly called-out for arguing against straw-men, he continues to simply ignore the matter at hand ("what is the likelihood of an individual investor beating an index?") and addresses a different topic (the value of value-investing, mutual funds vs. index, etc.)
I understand that collecting data on individual investors (particularly investors of a certain temperament following a particular strategy) is difficult, but then I think this lack-of-data should at least be acknowledged. "Yes, we know active mutual funds won't beat the index, but since we don't have data on individual-investors vs. the index, we simply can't make any statements there. Maybe they can easily beat the index, maybe they can't; we simply don't have enough information to know".
The available evidence, and the crux of my argument, apply to all active investors. If the individual investors in this forum think they don't apply, the onus is on them to show it.
Well, there's already data showing that individual investors do better than active managers – see the first link that walt posted. And I've posted studies that show that individual investors are more likely to continue their relative performance than active managers.
So, from the data we have, it's clear that a majority of individual investors trail market returns after fees. But the real question (to me, anyway) - is what is the percentage of investors who can outperform the market long-term. The first link that walt posted showed that 25% of investors do better than 0.5% better than the market monthly. That means that over a five year period, depending on how they calculated it, 25% of individual investors did more than 30-35% better than the market. This is significant!
Doesn't surprise me. For a 5 year period, the 25% figure is in line with the data:
(http://i.imgur.com/rVFlM1n.png)
¯\_(ツ)_/¯
Perhaps I'm recalling this incorrectly, but I remember in Burton Malkiel's "Random Walk Down Wall Street" that he had a chart describing relative risk vs. number of stocks held. The data suggested that, as you would expect, the more stocks held in the investor's basket, the more diffuse the risk was and the closer the basket's performance resembled that of the benchmark index. I think I remember the conclusion being that one encounters diminishing returns in terms of risk reduction once you diversify beyond 50 holdings or so (the difference between holding 50 vs. 250 stocks didn't seem particularly significant). This tied back to Buffett, whose holdings via Berkshire were in around 50-60 places, and in significant enough volume to be a real voice and direct these companies, one might say "holding the cards". This enabled him to hedge his bet - yes, he is picking individual positions based on whatever processes he uses to vet them, but he is also, technically speaking, "indexing" according to Malkiel's definition given in the book. This approach seems to require a lot of capital investment to take a large stake in each position, and I wonder about its scalability to individual investors who don't have the zero's to buy board seats at large companies. Food for thought.
Buffett himself has suggested that for the vast majority of individual investors, a low-cost index fund is the best option, mathematically speaking. This is the option I'm using. YMMV.
What seems clear from this discussion is we are arguing past each other. If you do pursue an active management strategy, keep in mind that actively trading stocks will likely create taxable events, which will further erode your returns in addition to any fees you may incur in the process. If, in the face of these difficult odds, you manage to beat the market over the long term with a strategy that is repeatable, I'd love to read about it. Good luck :-)
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I don't care that much about how all individual investors do. I care about my portfolio and my family's future.
Our portfolio is doing well and I'm happy with it. I just completed a first year of learning about and actively using stock options, and it was profitable. Most of our stocks are up, quite a lot. Our Apple shares are up 80% over 18 months, and one of our small stocks doubled (and I took the money).
Everybody gets a choice and that is fine. I agree that the easy path for people is to invest in indexes, and that is a great option! But don't whack at the people who want to try their own thing, or assume they will all fail.
If you see someone saying they are going to go all in to one stock, then tell them they are ridiculous. But if someone is investing in a portfolio and taking time to study it and work at it, then mind your own business instead of treating these people like idiots or like they don't have a right to a difference of opinion.
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Also, an individual investor is not the same as an active fund. An individual has a lot more nimbleness in the market, and they can hold their positions longer without worrying over their returns = low turnover. If you are talking to individuals, then that individual is responsible for their own rate of return and their own goal-setting. I agree with an earlier post, the goal is not always to beat the market, sometimes it is much more about preserving capital.
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I suspect this agility is often a reason *not* to purchase individual stocks. When a company's share price declines, you will be much more likely to sell your shares, i.e. buy high and sell low.
I find the whole index / individual stock debate difficult.
Index proponents say 'Just buy the index'! Well which one? If you're American buy the S&P 500. If your in Oz, but the Australian index, and in Canada buy the Canadian index?
And then people view the index as the average of the stock market. But it's not exactly the average of the stock market. It's a basket of stocks selected by a committee of financiers whose objective is supposed to be to build something representative of the stock market. Getting your company into a major index is worth a fortune to the owners. So there's bound to be some influence peddling going on.
Comparing index investing to active fund investing is easy. Mutual fund managers aren't any smarter than anyone else, after all, so if you're coughing up a management fee you're not going to do as well. And hard data is easy to find - it's all online.
But comparing index investing to individual stocks is much harder. There's no public data on the portfolios of individual stock investors. It seems reasonable that most people won't/can't do the work to stay on top of a portfolio of individual stocks, and it's much easier to just buy index funds. But clear data? I didn't see any in the earlier links.
Has anyone tried to compare a portfolio of individual stocks to the index? I did, it's bloody hard! You have to track dividends and stock splits and companies that were acquired and companies that went out of business.
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While I'm sure most here lean towards indexing, I was wondering if there are others who also invest in individual stocks. Value Investing (the approach used by Buffett) seems to have a lot of overlap with FI so I wouldn't be surprised to see some here that search for stocks using that approach.
Personally, I'm 50% indexed and 50% in individual stocks and am trying to build up my cash position to take advantage of any attractive opportunities that present themselves in the future. I've been teaching myself finance, valuation, and accounting over the past year and it's been a really eye opening experience. If you stay disciplined and have a knack for it, I think you can do pretty well. Even if it's just a percent or two above what the S&P does, that could be hundreds of thousands of dollars in compounded gains down the line.
What do you look for with individual stocks, and have you had success?
First, apologies if I'm repeating anything that's already been written in thread; I haven't read all the replies.
Like you, I used to hold a bunch of individual dividend paying stocks and index funds. I realized all I was doing was "tilting" my portfolio heavily toward those companies; they were already held in the index. I've since sold off the individual stocks; coincidentally, some of them have been battered pretty heavily since then. No such stress with the index.
http://www.efficientfrontier.com/ef/900/15st.htm
Holding individual stocks seems like it just makes a portfolio significantly more risky while reducing risk-adjusted return.
...Index proponents say 'Just buy the index'! Well which one? If you're American buy the S&P 500. If your in Oz, but the Australian index, and in Canada buy the Canadian index?
And then people view the index as the average of the stock market. But it's not exactly the average of the stock market. It's a basket of stocks selected by a committee of financiers whose objective is supposed to be to build something representative of the stock market. Getting your company into a major index is worth a fortune to the owners. So there's bound to be some influence peddling going on...
This is covered quite extensively in writing by Jack Bogle, Rick Ferri, and William Bernstein.
"Equity" and "fixed income" are asset class; you diversify across asset classes, and within them by holding multiple indexes. (S&P500, S&P/TSX, MSCI EAFE for equity, DEX Universe bond, if you're a Canadian). Japan is a cautionary tale to us all: many there had all their eggs in one, domestic basket when their market tanked (decades ago) and they haven't recovered. Diversify internationally.
As for who decides what goes into the index, that point is addressed quite well in books by William Bernstein (Four Pillars of Investing) and Jack Bogle. See this article:
http://www.investorhome.com/W5000.htm
From it:
Bogle compares the S&P 500 and total market returns back to 1926 using data from the Center for Research in Security Prices (CRSP). He concludes that for the full period the S&P500 return was 10.4% versus 10.2% for the Total Stock Market Index. Starting from 1930 both returned 9.9%, and recently (from 1998-2006) the Total Market Index outperformed the 500 by 1%.
There are added "frictional" costs of managing an additional 4500 stocks in a total stock market fund and those stocks only account for a small amount of market capitalization compared to the top 500. Go with a total stock market (e.g Wilshire 5000) fund if you like but the S&P500 is "good enough." (Perfect being the enemy of good)
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thanks for reminding me about Bernstein's book. I'll go read this again and see if I can check out their claims in detail.
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Here's an interesting question I have for the indexers. Is it possible for an individual investor to consistently do (what I mean here is to have an expected value) worse than the market before transaction costs?
Second, who is likely to do better: someone who buys an index fund or someone who buys 50 to 500 stocks at random in that index and only sits on them for the period?
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Is this a serious question? Individual investors can, and have, lost everything! It is certainly possible to end up with all sorts of results if you're going to pick stocks. In general, you'll probably do worse than indexing, but you might get lucky/be incredibly good and do better. The longer you do it, the worse your odds of beating the index with luck get, of course.
If you buy 50 stocks at random, you are buying a mini-index. The bigger the pot of stocks, the more closely it will track the entire market. With only 50, you'd have quite a bit more volatility (and risk) but the expected result, assuming you bought them randomly, would be the same as the market as a whole, not counting fees and taxes, of course.
If what you are asking is if you can create your own index, the answer is "sure!" but it's going to cost a lot more and take a lot more time/effort. There is probably an index product out there that has what you want, just start poring over the Vanguard funds.
-W
Here's an interesting question I have for the indexers. Is it possible for an individual investor to consistently do (what I mean here is to have an expected value) worse than the market before transaction costs?
Second, who is likely to do better: someone who buys an index fund or someone who buys 50 to 500 stocks at random in that index and only sits on them for the period?
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If you buy 50 stocks at random, you are buying a mini-index. The bigger the pot of stocks, the more closely it will track the entire market. With only 50, you'd have quite a bit more volatility (and risk) but the expected result, assuming you bought them randomly, would be the same as the market as a whole, not counting fees and taxes, of course.
Some studies argue that you can get ~90% of the benefits of diversification with as small a portfolio as 12-18 stocks:
http://news.morningstar.com/classroom2/course.asp?docId=145385&page=4&CN
Others say you need 30:
https://www.wiso.uni-hamburg.de/fileadmin/sozialoekonomie/bwl/bassen/Lehre/International_Finance_I/Lectures/20080506_Number_of_stocks_in_a_diversified_portfolio.pdf
or even 100:
http://www.aaii.com/journal/article/how-many-stocks-do-you-need-to-be-diversified-.touch
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To answer Adam's question though, we'd need to know the distribution of stock returns within an index, over a given holding period. For example, if the distribution of returns of S&P 500 components is right skewed, then a relatively small number of components are responsible for a disproportionate fraction of the index return, and a random sample of the components would be more likely to trail the index. In contrast, if the distribution is left skewed, then a random sample would be more likely to beat the index. In each case, though, the average of all such portfolios would equal the index return.
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Is this a serious question? Individual investors can, and have, lost everything! It is certainly possible to end up with all sorts of results if you're going to pick stocks. In general, you'll probably do worse than indexing, but you might get lucky/be incredibly good and do better. The longer you do it, the worse your odds of beating the index with luck get, of course.
How can you square that with the efficient market hypothesis? If that were true, couldn't I outperform by just finding an individual investor and shorting what he does while going long an index?
If you buy 50 stocks at random, you are buying a mini-index. The bigger the pot of stocks, the more closely it will track the entire market. With only 50, you'd have quite a bit more volatility (and risk) but the expected result, assuming you bought them randomly, would be the same as the market as a whole, not counting fees and taxes, of course.
If what you are asking is if you can create your own index, the answer is "sure!" but it's going to cost a lot more and take a lot more time/effort. There is probably an index product out there that has what you want, just start poring over the Vanguard funds.
-W
According to the Efficient Market Hypothesis the person who bought and sat would probably OUTperform the index. The marginal benefits of diversification (volatility reduction) drop quite substantially after the first 20 equities or something. Transaction costs, taxes, and index frontrunning would lower the relative returns of the buy and hold portfolio. For an example see ING Corporate Leaders Trust Fund Series B. Now its possible that this mutual fund was simply lucky for 80 years, but buying 30 stocks and doing literally nothing outperformed the S&P 500 since the inception. $10000 invested in the trust in November 1935 paying an expense ratio of 0.46%(!) would have turned into $32 Million. The S&P 500 with dividends reinvested (and NO FEES) would have only resulted in 29 Million. This despite the fact that the 30 stocks selected were "Corporate Leaders", large cap stocks that had the small cap premium work against them over the period.
I say this simply to point out that individual investors can reliably beat the market. They just need to lose the passwords to their sharebuilder account after their initial purchases. When people suggest that they are buying large dividend payers to hold (something I don't do), this is precisely what they *intend* to do. The S&P 500's turnover is something like 3%. IF the folks who pursue these sort of buy and hold strategies stick to their strategy, their annual turnover will be substantially less. You might be inclined to claim that such "active" investors might be tempted to sell their losers and thereby screw up this plan. This is certainly possible, but its not fair to say that someone who buys an index won't do something similar.
Follow up question. Don't hedge fund managers outperform their indexes *before* fees? Hedge fund manager fee's are typically huge! Doesn't this disprove the efficient market hypothesis? A typical hedge fund manager fee structure is 2&20. If the market does 10%, to market perform after fees the hedge fund manager has to do 15% (!). If skill and hard work are adding 5 points to returns how do you square that with EMH?
Here's an interesting question I have for the indexers. Is it possible for an individual investor to consistently do (what I mean here is to have an expected value) worse than the market before transaction costs?
Second, who is likely to do better: someone who buys an index fund or someone who buys 50 to 500 stocks at random in that index and only sits on them for the period?
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There was a study that found that Jim Cramer's picks are neither good nor bad. If he's an expert and he can't beat the indexes then how would you expect to do any better?
Anyone that knows anything doesn't consider Cramer an expert, he's a tv personality.
Before you dismiss Jim Cramer, let me quote him:
"You want a cheap, low-cost index fund that mirrors the market as a whole, one that mimics the S&P 500. You have a vehicle that will let you participate in the strength of the market without spending the time picking individual stocks. This may sound like a really simple solution, but don't overthink it. The whole point of putting your money in the fund is to save you from time and effort to manage your own portfolio of stocks."
If you want to watch it to see it in context, go here: http://www.cnbc.com/id/101782773
August 22, 2014 episode on CNBC.
Cramer is a fan of index funds!
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To answer Adam's question though, we'd need to know the distribution of stock returns within an index, over a given holding period. For example, if the distribution of returns of S&P 500 components is right skewed, then a relatively small number of components are responsible for a disproportionate fraction of the index return, and a random sample of the components would be more likely to trail the index. In contrast, if the distribution is left skewed, then a random sample would be more likely to beat the index. In each case, though, the average of all such portfolios would equal the index return.
This is a really good point. I am assuming that market returns are normally distributed. But again I'm primarily concerned with the expected value of the hypothetical portfolio, rather than the median value. Maybe the median is more important.
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You guys do realize that indexing = aiming for average return. This means you get to look down on 50% of the investors and think you are doing well while forgetting the other 50% who beat your returns handily.
If you're looking at one particular year, sure. But over the long term, you're beating 50% of all invested dollars this year, then beating 50% of all invested dollars next year, and the year after that...every single year for the rest of your life.
If you're trying to beat this, even one bad year can make it almost impossible to catch up. Losing 50% one year, means you need to gain 100% next year just to break even. If you do 10% better than the index one year, then do 10% worse than the index the next year, you will still end up with less money than simply choosing the index.
It seems counterintuitive, but the opposite has the same result. Do 10% worse than the index one year, then 10% better than the index the next year, and you are still behind the index.
When looking at the long term, you're beating significantly more than 50%, you're beating almost everybody. The compounding effects of bad years make it incredibly difficult to beat the index long-term.
The math is very flawed here as you completely ignore compounding interest in the previous years.
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I think hedge fund managers generally underperform the index by a small amount but that's not a great comparison - the original premise of hedge funds was slightly lower returns but protection against catastrophic crashes (hence "hedge"). People seem to now use the term to mean any actively managed fund.
If you are talking just mutual fund managers, the evidence is mixed (lots of academic literature is available) but overall no, they don't beat the market once you account for survivor bias.
-W