One Bogleheads idea I have a hard time understanding...

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Tingting1013
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Re: One Bogleheads idea I have a hard time understanding...

Post by Tingting1013 »

galawdawg wrote: Sun Jun 06, 2021 6:48 pm
Independent George wrote: Sun Jun 06, 2021 5:48 pm Here's the thing that often gets missed by BHs - active trading has, in fact, improved dramatically over time; the kind of analysis that gets done today is far, far superior to the kind of trading that was done even just a decade ago, let alone a century ago. The problem is that everybody is doing it - it's a game of PhD quant vs PhD quant setting the market price. The absolute level of trading "skill" is undoubtedly higher than it was in the past... it's just the relative level is necessarily always going to end up at the same place: the market clearing price.

There are two rather large caveats to this, though:

1. The winners & losers do not necessarily have to follow a normal distribution - it's entirely possible (and I'd say likely) that very small portion of traders to do extremely well, while the rest of the market is slightly below average. The net of all active trades nets to the market price, but most traders actually performed below average.

2. The Grossman-Stiglitz paradox remains true - if markets everyone were to start investing passively, markets will become less efficient because no information is being exchanged on the marketplace. But once people start trading to take advantage of that inefficiency, they will eventually arbitrage out their advantage until the market becomes efficient again.
Assuming that you are correct and that active trading has improved, let's do what an average investor might do who is hearing that "active funds are the way to go." I ran a Google search for "top active mutual funds" with a search period of 2010. The first result: Kiplinger's 2010 Mutual Fund Rankings (https://www.kiplinger.com/article/inves ... kings.html) So using that article, I'll use as an example, the first subsection, Large Company Stock Funds, and look at the "proven" Large Cap funds they picked as winners: FCNTX, LLPFX, YACKX and FAIRX. What were the ten year annual average returns of each of these funds as of December 2020, ten years after the article was published?

FCNTX 15.53%
LLPFX 7.32%
YACKX 11.5%
FAIRX 8.15%

And the S&P 500 in that same time? 13.83%.

So of the four top-ranked large-cap funds that Kiplinger's recommended in 2010, only one (FCNTX) outperformed Vanguard S&P 500 Index and that was by less than 2%. The other three would have resulted in returns significantly lower for those who invested in those funds versus VFIAX. So an investor choosing from those funds vs. the S&P500 index had a 25% chance of outperforming the S&P 500 and a 75% chance of underperforming the S&P 500. I'd say the odds do not favor active investing over passive investing.
Just a few posts back you were dismissing my point by saying 10 years was too short to conclude anything...

Here are the CAGRs of those active funds since their inception through May 2021, compared against the S&P:

FCNTX 13.7%
S&P 11.5%
(Since 1976)

LLPFX 10.3%
S&P 10.5%
(Since 1987)

YACKX 10.9%
S&P 10.4%
(Since 1992)

FAIRX 10.5%
S&P 7.0%
(Since 2000)

Let me give you three more:

RYPNX 13.2%
S&P 9.2%
(Since 1996)

POAGX 14.5%
S&P 10.4%
(Since 2004)

PSLDX 16.7%
S&P 10.1%
(Since 2007)

Someone with more time than me can run the better analysis of comparing different starting points (I.e. every year since inception) through May 2021. I suspect the active funds will still win >50% of the starting dates.
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galawdawg
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Re: One Bogleheads idea I have a hard time understanding...

Post by galawdawg »

Tingting1013 wrote: Sun Jun 06, 2021 7:50 pm Just a few posts back you were dismissing my point by saying 10 years was too short to conclude anything...

Here are the CAGRs of those active funds since their inception through May 2021, compared against the S&P:...

I believe you missed my point. Investors who choose active funds at a point in time most likely do so on the belief that the fund(s) they choose will outperform passive investing in the future. So how those funds did prior to the Kiplinger article recommending them is not relevant for the investor who made his or her decision based upon the recommendations contained in that article.

I chose 2010 because the poster I responded to discussed how active funds have "improved" over the last decade and since.

Feel free to look at Kiplinger's or Money magazine or any other "consumer" oriented publication at a point in the past and gauge how well the active fund recommendations of those publications (often considered as authoritative or persuasive sources by the average investor) panned out compared to passive investing. But you are correct that it is better to look at a much longer time period. If we can find the "fund picks" for Kiplinger's or Money for 1980 (or some other date thirty or forty years ago), it would be quite interesting to see how those recommended funds have performed relative to the index over the past forty years.

Again, it is easy for us to look retrospectively to see what funds did well over the past ten, twenty or thirty years and tell ourselves that we would have selected that fund way back when as a new investor. But the reality is that the vast, vast majority of average investors who attempt to select a "winning fund" fail miserably at the endeavor.
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HomerJ
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Re: One Bogleheads idea I have a hard time understanding...

Post by HomerJ »

radR investing wrote: Sun Jun 06, 2021 6:59 am My preferred methodology for investing is a variation of Direct Indexing. If you are interested in the details, there is a good blog that can be found on the front page of the website www.investblaze.com. When I consider that 56% of the returns of the S&P500 over the last two years came from a handful of companies, then I want those companies. I have a hard time believing I am diversifying by investing in the bottom 50% of the companies who barely contribute any returns. It's pretty simple to identify the top companies in each sector and analyze their revenue, earnings, and free cash flow - if these are all growing, then I am interested. And, investing this way has zero fees, so it 'checks box #3.'
This is active investing, not "indexing". You are attempting to pick the winners.

If you pick stocks, you might do better, you might do worse. You almost certainly won't get the market return. You are not indexing.

That "bottom 50%", by the way, probably contains a few stocks that will be the big winners over the next 10 years. By buying all of them, you are guaranteed to get the market return.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
NiceUnparticularMan
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

The specific things in the OP all depend in some way on the efficient pricing of the relevant markets, meaning that all available information and understanding is very, very rapidly reflected in the market price.

The reason people believe these markets are efficiently priced isn't just historic observations, it is also the knowledge there is an active mechanism for achieving efficiency, namely well-funded arbitrageurs. These entities employ PhDs, buy supercomputers, have special rapid access to information and trading, and leverage billions of dollars. They compete with each other to identify any temporary mispricing, to go long/short first, and then to exit at a profit once everyone else arrives and the temporary mispricing is resolved.

Given this framework of understanding, it actually isn't quite true it is impossible to beat the market. Indeed, it has to be possible, or these arbitrageurs would go out of business.

More precisely, it isn't possible to beat the market if you don't employ PhDs, buy supercomputers, have special rapid access to information and trading, and leverage billions of dollars, and be prepared to enter and exit long/short positions in fractions of seconds.

Is that you? I know it isn't me.

The last question is whether there is some sort of fund you can get into which would help you benefit from this arbitrage process. The answer is no, not in the sense of something a personal investor could get into. And don't worry, you are likely not missing much. Due to all the competition, the total global profits from arbitrage are not really likely to be all that high in relative terms, and of course banking on any one arbitrageur is very risky as they may be outcompeted at any time.
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

Tingting1013 wrote: Sun Jun 06, 2021 2:11 pm But that’s not what sophisticated active fund investors do. It’s a total straw man. In fact it’s been proven that active managers with strong track records tend to sustain their outperformance:

https://www.wsj.com/articles/the-mornin ... 1508946687

Image

The average outperforming fund (with five stars) still outperforms the average underperforming fund (with one star) ten years later.
So one has to be careful with that chart and what it implies.

3 stars means the fund has performed at the average of its class of funds according to Morningstar's formula for risk-adjusted returns net of costs.

So picking five star funds didn't do better than picking random funds over the same period.

What is true is picking lower star funds did even worse than random. What this implies is we must be missing some group of funds that is averaging out those funds, and that is going to be new entrants to the class.

And I suspect a lot of what explains all that is costs. If you have a higher cost fund it will indeed be expected to do worse than average. And over time, mutual fund costs have generally been declining. So, I suspect that typically new entrants will average lower costs than older funds (although of course older funds could also try to lower their costs to compete).

Anyway, all of that gets us back to low-cost index funds. Low-cost index funds typically end up averaging better than the average of their class due to their lower-costs and otherwise average returns. And so what this data is showing is choosing a five-star active fund will on average underperform that result, and choosing a lower-star active fund will likely underperform more still, and again I suspect that is mostly just a cost issue.
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HomerJ
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Re: One Bogleheads idea I have a hard time understanding...

Post by HomerJ »

Tingting1013 wrote: Sun Jun 06, 2021 2:11 pm The average outperforming fund (with five stars) still outperforms the average underperforming fund (with one star) ten years later.
But the average outperforming fund with five starts doesn't outperform the index fund ten years later. That's what we are comparing things to.

Look, every year, a good chunk of active funds beat the market.

But it's not the SAME group of active funds every year.

The funds with the best 10-year record in 2011 aren't the usually the same funds with the best 10-year record in 2021.

There will be a few funds that outperform the market for years and years. It IS possible. But picking those funds ahead of time isn't easy.

It certainly isn't as easy as just looking at a list of morningstar 5-star funds.
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galawdawg
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Re: One Bogleheads idea I have a hard time understanding...

Post by galawdawg »

Another thread this morning (viewtopic.php?f=10&t=350722) noted that Morningstar does a semi-annual evaluation "that measures the performance of U.S. active managers against their passive peers within their respective categories" over one, three, five, ten, fifteen and twenty year time periods. You can download the most recent Active/Passive Barometer from Morningstar here: https://www.morningstar.com/lp/active-passive-barometer

A few points from the report's Key Takeaway section were particularly relevant to this discussion:
  • In general, actively managed funds have failed to survive and beat their benchmarks, especially over
    longer time horizons; only 23% of all active funds topped the average of their passive rivals over the
    10-year period ended December 2020.
  • The distribution of 10-year excess returns for surviving active funds versus the average of their passive
    peers varies widely across categories. In the case of U.S. large-cap funds, it skews negative,
    indicating that the likelihood and performance penalty for picking an underperforming manager tends
    to be greater than the probability and reward for finding a winner.
Like I was saying... :beer
Tingting1013
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Re: One Bogleheads idea I have a hard time understanding...

Post by Tingting1013 »

galawdawg wrote: Mon Jun 07, 2021 12:01 pm Another thread this morning (viewtopic.php?f=10&t=350722) noted that Morningstar does a semi-annual evaluation "that measures the performance of U.S. active managers against their passive peers within their respective categories" over one, three, five, ten, fifteen and twenty year time periods. You can download the most recent Active/Passive Barometer from Morningstar here: https://www.morningstar.com/lp/active-passive-barometer

A few points from the report's Key Takeaway section were particularly relevant to this discussion:
  • In general, actively managed funds have failed to survive and beat their benchmarks, especially over
    longer time horizons; only 23% of all active funds topped the average of their passive rivals over the
    10-year period ended December 2020.
  • The distribution of 10-year excess returns for surviving active funds versus the average of their passive
    peers varies widely across categories. In the case of U.S. large-cap funds, it skews negative,
    indicating that the likelihood and performance penalty for picking an underperforming manager tends
    to be greater than the probability and reward for finding a winner.
Like I was saying... :beer
We still have yet to see the data on five star active funds vs their index counterparts.
Thesaints
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Re: One Bogleheads idea I have a hard time understanding...

Post by Thesaints »

steve roy wrote: Sun Jun 06, 2021 4:29 pm One of my closest and oldest friends has a PhD in economics from Cornell. Long ago he told me the following:

"Economics isn't a science because no economist can know what hundreds of millions of people will do with their money at any given point in time."
There is no way to know what the trillion trillion gas molecules in a small container will each individually do, but then again thermodynamics is certainly a science.
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Re: One Bogleheads idea I have a hard time understanding...

Post by JBTX »

As an observation, the OP posted twice two days ago and has since abandoned the conversation. So I guess he was either convinced, or didn't want to hear the answer, or didn't care enough either way to follow the issue.
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Re: One Bogleheads idea I have a hard time understanding...

Post by JBTX »

galawdawg wrote: Mon Jun 07, 2021 12:01 pm Another thread this morning (viewtopic.php?f=10&t=350722) noted that Morningstar does a semi-annual evaluation "that measures the performance of U.S. active managers against their passive peers within their respective categories" over one, three, five, ten, fifteen and twenty year time periods. You can download the most recent Active/Passive Barometer from Morningstar here: https://www.morningstar.com/lp/active-passive-barometer

A few points from the report's Key Takeaway section were particularly relevant to this discussion:
  • In general, actively managed funds have failed to survive and beat their benchmarks, especially over
    longer time horizons; only 23% of all active funds topped the average of their passive rivals over the
    10-year period ended December 2020.
  • The distribution of 10-year excess returns for surviving active funds versus the average of their passive
    peers varies widely across categories. In the case of U.S. large-cap funds, it skews negative,
    indicating that the likelihood and performance penalty for picking an underperforming manager tends
    to be greater than the probability and reward for finding a winner.
Like I was saying... :beer
One could argue that there may be active managers who are competitive that may defy typical peer group comparison, in that their peer group changes from time to time. I'm skeptical that on average they do any better, but not sure if that is easily measurable.

An example is what is the best benchmark for fidelity contrafund? Probably large growth, but it isn't a clean comparison.
NiceUnparticularMan
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

Tingting1013 wrote: Mon Jun 07, 2021 1:56 pm
galawdawg wrote: Mon Jun 07, 2021 12:01 pm Another thread this morning (viewtopic.php?f=10&t=350722) noted that Morningstar does a semi-annual evaluation "that measures the performance of U.S. active managers against their passive peers within their respective categories" over one, three, five, ten, fifteen and twenty year time periods. You can download the most recent Active/Passive Barometer from Morningstar here: https://www.morningstar.com/lp/active-passive-barometer

A few points from the report's Key Takeaway section were particularly relevant to this discussion:
  • In general, actively managed funds have failed to survive and beat their benchmarks, especially over
    longer time horizons; only 23% of all active funds topped the average of their passive rivals over the
    10-year period ended December 2020.
  • The distribution of 10-year excess returns for surviving active funds versus the average of their passive
    peers varies widely across categories. In the case of U.S. large-cap funds, it skews negative,
    indicating that the likelihood and performance penalty for picking an underperforming manager tends
    to be greater than the probability and reward for finding a winner.
Like I was saying... :beer
We still have yet to see the data on five star active funds vs their index counterparts.
Based on Morningstar's definitions, it sounds to me like passive funds probably score an average of four stars.

Based on the WSJ analysis, five star funds end up scoring an average of three stars going forward.

So, seems pretty clear to me that passive funds likely outscore five star funds going forward, on average.
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Re: One Bogleheads idea I have a hard time understanding...

Post by Adenovir »

Dottie57 wrote: Sat Jun 05, 2021 6:05 pm Try portfoliovisualizer.cøm, choose Backtest portfolio. Try some different funds and compare to VOO (SP500). Use different time periods. 1 year , 5 years, 10 years, 30 years. It is amazing to see the results. This program is an extremely useful tool.
I second this. Whenever I read something about asset allocation I run to portfolio visualizer and see it for myself. The best way to stick to your plan is to have conviction and for me, at least, that's how I do it.
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Re: One Bogleheads idea I have a hard time understanding...

Post by bf0123 »

Another angle here that circles back to Bogle head thinking: when thinking of active management, it's more common to focus on the purchase decision. But with every purchase there is also a sale-from some entity that believes the stocks' future is less rosy than the purchaser. How am I to know which party in the trade is "smarter"?
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Re: One Bogleheads idea I have a hard time understanding...

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Re: One Bogleheads idea I have a hard time understanding...

Post by grabiner »

NiceUnparticularMan wrote: Mon Jun 07, 2021 3:29 am
Tingting1013 wrote: Sun Jun 06, 2021 2:11 pm But that’s not what sophisticated active fund investors do. It’s a total straw man. In fact it’s been proven that active managers with strong track records tend to sustain their outperformance:

https://www.wsj.com/articles/the-mornin ... 1508946687

Image

The average outperforming fund (with five stars) still outperforms the average underperforming fund (with one star) ten years later.
So one has to be careful with that chart and what it implies.

3 stars means the fund has performed at the average of its class of funds according to Morningstar's formula for risk-adjusted returns net of costs.

So picking five star funds didn't do better than picking random funds over the same period.

What is true is picking lower star funds did even worse than random. What this implies is we must be missing some group of funds that is averaging out those funds, and that is going to be new entrants to the class.

And I suspect a lot of what explains all that is costs. If you have a higher cost fund it will indeed be expected to do worse than average. And over time, mutual fund costs have generally been declining. So, I suspect that typically new entrants will average lower costs than older funds (although of course older funds could also try to lower their costs to compete).
I suspect that the main reason is survivorship bias. Suppose Fund A and Fund B are both well-established, while Fund C and Fund D are new. Funds A and C both do well in the next five years, while B and D do poorly. D is much more likely to close. If all the funds are average for the following five years, then A and C will earn four stars, B will earn two, and D would earn two but is more likely to be missing from the averages because it closed. But the investor who picked an old fund or a new fund would get the same returns.
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Taylor Larimore
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Re: One Bogleheads idea I have a hard time understanding...

Post by Taylor Larimore »

Bogleheads:

The above chart portends to show that past performance continues. In my opinion, this is usually incorrect as many experts have testified:

What Experts Say About Past Performance

Three kinds of lies: (1) Little lies; (2) Big lies (3) Statistics.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."
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Re: One Bogleheads idea I have a hard time understanding...

Post by sperry8 »

JBTX wrote: Sat Jun 05, 2021 5:17 pm
cone774413 wrote: Sat Jun 05, 2021 5:04 pm
JBTX wrote: Sat Jun 05, 2021 4:58 pm A broad low fee index fund will always beat the average of all active investors once fees are taken into account, by definition.

This is what I don't understand. How can you make that claim? Who's definition? What is the evidence?
This video may help. Until I saw buffet say this I really didn't fully understand why passive by definition, on average, beats active.

https://youtu.be/bzGrQUQCqCY
I love Buffet, but his comment doesn't make sense to me. He says active investors, as a group, must get average returns (assuming they own 50% and passive investors own the other 50%). But that doesn't sound right. It could be that active investors identify the creme de la creme and beat the passive investors, even including fees. Now we know that's never happened, and I surely don't believe it will, but it could. Warren says it can't. What am I missing? (again, I'm not arguing for active, just trying to understand his must comment).
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Re: One Bogleheads idea I have a hard time understanding...

Post by Ramjet »

cone774413 wrote: Sat Jun 05, 2021 4:50 pm I participate in clinical trials in my job, the typical idea is if an outcome is reproducible when accounting for all the possible confounding variables, you can feel with a certain degree of certainty there is causation or a predictable outcome. I don't understand how that can be the case with regards to the stock market or economy
There will be a monetary value of goods + services made, the economy will experience some sort of inflation, and companies will have earnings
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Re: One Bogleheads idea I have a hard time understanding...

Post by Chip »

sperry8 wrote: Fri Jun 11, 2021 10:03 am I love Buffet, but his comment doesn't make sense to me. He says active investors, as a group, must get average returns (assuming they own 50% and passive investors own the other 50%). But that doesn't sound right. It could be that active investors identify the creme de la creme and beat the passive investors, even including fees. Now we know that's never happened, and I surely don't believe it will, but it could. Warren says it can't. What am I missing? (again, I'm not arguing for active, just trying to understand his must comment).
It's just math. If the active investors were able to get more than the average then the passive investors would have to get less than the average. So if the average return of the market was 10%, and active investors made 11% gross, passive investors would have to make 9% gross. Assuming a 50/50 split. But, by definition, the passive investors get the average return. So the return of the active investors must also be the average return.
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Re: One Bogleheads idea I have a hard time understanding...

Post by sperry8 »

Chip wrote: Fri Jun 11, 2021 10:43 am
sperry8 wrote: Fri Jun 11, 2021 10:03 am I love Buffet, but his comment doesn't make sense to me. He says active investors, as a group, must get average returns (assuming they own 50% and passive investors own the other 50%). But that doesn't sound right. It could be that active investors identify the creme de la creme and beat the passive investors, even including fees. Now we know that's never happened, and I surely don't believe it will, but it could. Warren says it can't. What am I missing? (again, I'm not arguing for active, just trying to understand his must comment).
It's just math. If the active investors were able to get more than the average then the passive investors would have to get less than the average. So if the average return of the market was 10%, and active investors made 11% gross, passive investors would have to make 9% gross. Assuming a 50/50 split. But, by definition, the passive investors get the average return. So the return of the active investors must also be the average return.
I see. So he assumes the passive investors return is the average return. But that doesn't have to be. It could be the average return is 11%. Passive gets 10% and active gets 12%... thus the average is 11%. But I see where he's coming from now. He's suggesting that we use passive as the average and in that case, his comment makes sense.
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Re: One Bogleheads idea I have a hard time understanding...

Post by JBTX »

sperry8 wrote: Fri Jun 11, 2021 10:46 am
Chip wrote: Fri Jun 11, 2021 10:43 am
sperry8 wrote: Fri Jun 11, 2021 10:03 am I love Buffet, but his comment doesn't make sense to me. He says active investors, as a group, must get average returns (assuming they own 50% and passive investors own the other 50%). But that doesn't sound right. It could be that active investors identify the creme de la creme and beat the passive investors, even including fees. Now we know that's never happened, and I surely don't believe it will, but it could. Warren says it can't. What am I missing? (again, I'm not arguing for active, just trying to understand his must comment).
It's just math. If the active investors were able to get more than the average then the passive investors would have to get less than the average. So if the average return of the market was 10%, and active investors made 11% gross, passive investors would have to make 9% gross. Assuming a 50/50 split. But, by definition, the passive investors get the average return. So the return of the active investors must also be the average return.
I see. So he assumes the passive investors return is the average return. But that doesn't have to be. It could be the average return is 11%. Passive gets 10% and active gets 12%... thus the average is 11%. But I see where he's coming from now. He's suggesting that we use passive as the average and in that case, his comment makes sense.
By definition passive gets average. Passive investors own the entire market, prices are set by the market, ie market = active investors.

Think of having a game of rock paper scissors in the mirror. The mirror is passive investment. You cant beat your reflection at rock paper scissors.
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Re: One Bogleheads idea I have a hard time understanding...

Post by rob »

radR investing wrote: Sun Jun 06, 2021 6:59 amIt's pretty simple to identify the top companies in each sector and analyze their revenue, earnings, and free cash flow - if these are all growing, then I am interested. And, investing this way has zero fees, so it 'checks box #3.'
So why is everyone not a billionaire?
If it's really this easy - why?
Tesla didn't exist in the 80's - which company would you have had then?
When would you have sold that for tesla?
You realize that buying a stock is not free - even at $0 commission right?
If it's "simple" why are well funded, smart people putting in long hours not able to do it over time?
Anyone that can step from stock to stock and only hit big wins would own the world - where are they?
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien
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Re: One Bogleheads idea I have a hard time understanding...

Post by WhyNotUs »

galawdawg wrote: Sun Jun 06, 2021 7:01 am First, understand that investing is not the same as a medical trial. You don't have a test group and a control group and account for all of the variables.
The SPIVA info was pretty convincing to me.

https://www.spglobal.com/spdji/en/spiva/#/reports
I own the next hot stock- VTSAX
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Re: One Bogleheads idea I have a hard time understanding...

Post by GaryA505 »

galawdawg wrote: Sun Jun 06, 2021 6:48 pm
Independent George wrote: Sun Jun 06, 2021 5:48 pm Here's the thing that often gets missed by BHs - active trading has, in fact, improved dramatically over time; the kind of analysis that gets done today is far, far superior to the kind of trading that was done even just a decade ago, let alone a century ago. The problem is that everybody is doing it - it's a game of PhD quant vs PhD quant setting the market price. The absolute level of trading "skill" is undoubtedly higher than it was in the past... it's just the relative level is necessarily always going to end up at the same place: the market clearing price.

There are two rather large caveats to this, though:

1. The winners & losers do not necessarily have to follow a normal distribution - it's entirely possible (and I'd say likely) that very small portion of traders to do extremely well, while the rest of the market is slightly below average. The net of all active trades nets to the market price, but most traders actually performed below average.

2. The Grossman-Stiglitz paradox remains true - if markets everyone were to start investing passively, markets will become less efficient because no information is being exchanged on the marketplace. But once people start trading to take advantage of that inefficiency, they will eventually arbitrage out their advantage until the market becomes efficient again.
Assuming that you are correct and that active trading has improved, let's do what an average investor might do who is hearing that "active funds are the way to go." I ran a Google search for "top active mutual funds" with a search period of 2010. The first result: Kiplinger's 2010 Mutual Fund Rankings (https://www.kiplinger.com/article/inves ... kings.html) So using that article, I'll use as an example, the first subsection, Large Company Stock Funds, and look at the "proven" Large Cap funds they picked as winners: FCNTX, LLPFX, YACKX and FAIRX. What were the ten year annual average returns of each of these funds as of December 2020, ten years after the article was published?

FCNTX 15.53%
LLPFX 7.32%
YACKX 11.5%
FAIRX 8.15%

And the S&P 500 in that same time? 13.83%.

So of the four top-ranked large-cap funds that Kiplinger's recommended in 2010, only one (FCNTX) outperformed Vanguard S&P 500 Index and that was by less than 2%. The other three would have resulted in returns significantly lower for those who invested in those funds versus VFIAX. So an investor choosing from those funds vs. the S&P500 index had a 25% chance of outperforming the S&P 500 and a 75% chance of underperforming the S&P 500. I'd say the odds do not favor active investing over passive investing.
And, if you had bought all 4 in equal amounts, you'd have made 10.63%, still behind the SP500 13.83%.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: One Bogleheads idea I have a hard time understanding...

Post by helloeveryone »

cone774413 wrote: Sat Jun 05, 2021 5:04 pm
JBTX wrote: Sat Jun 05, 2021 4:58 pm A broad low fee index fund will always beat the average of all active investors once fees are taken into account, by definition.
This is what I don't understand. How can you make that claim? Who's definition? What is the evidence?
There is research on this (I can't quote any) that indicate this...however it's not "always" as the poster above indicates but it is true for a very very high percentage of the time. And since you can't upfront predict which active investors will go on to outperform the market once all fees are taken into account that's why a lot of books say the average investor will just be better off being in a low fee index fund. And the asset allocation plays a role in reducing risk - there is also data on this (that I also can't quote) but the books I've read and the various information on this forum all conclude the same thing about asset allocation helping reduce risk.


example - since you are involved in clinical trials - you can quote the evidence on why such and such drug is better for disease process Y. The end users may not know why such and such drug is better for disease process Y but they are correct when they say that - based on the research folks like you have done.
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

JBTX wrote: Fri Jun 11, 2021 10:51 am
sperry8 wrote: Fri Jun 11, 2021 10:46 am
Chip wrote: Fri Jun 11, 2021 10:43 am
sperry8 wrote: Fri Jun 11, 2021 10:03 am I love Buffet, but his comment doesn't make sense to me. He says active investors, as a group, must get average returns (assuming they own 50% and passive investors own the other 50%). But that doesn't sound right. It could be that active investors identify the creme de la creme and beat the passive investors, even including fees. Now we know that's never happened, and I surely don't believe it will, but it could. Warren says it can't. What am I missing? (again, I'm not arguing for active, just trying to understand his must comment).
It's just math. If the active investors were able to get more than the average then the passive investors would have to get less than the average. So if the average return of the market was 10%, and active investors made 11% gross, passive investors would have to make 9% gross. Assuming a 50/50 split. But, by definition, the passive investors get the average return. So the return of the active investors must also be the average return.
I see. So he assumes the passive investors return is the average return. But that doesn't have to be. It could be the average return is 11%. Passive gets 10% and active gets 12%... thus the average is 11%. But I see where he's coming from now. He's suggesting that we use passive as the average and in that case, his comment makes sense.
By definition passive gets average. Passive investors own the entire market, prices are set by the market, ie market = active investors.

Think of having a game of rock paper scissors in the mirror. The mirror is passive investment. You cant beat your reflection at rock paper scissors.
And this is an extremely important insight. Passive investors just ride the pricing established by all the competing entities with PhDs on staff, supercomputers, special access to information, and so on.

They just don't have to pay for any of that stuff, including often hefty guaranteed returns for managers of such entities.

And getting the benefit of their collective efforts without having to pay for it is a nice result.

Of course, if you can figure out WHICH of those entities is going to win this competition, and which is going to lose, AND you know they will win by enough to justify what they will charge you--then you should go with them.

But if you don't think you can do that, just grab some popcorn and enjoy the show, knowing you got your ticket close to free.
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Re: One Bogleheads idea I have a hard time understanding...

Post by Thesaints »

All true, but keep in mind that you can't beat the market if you don't try to beat the market and, sometimes, one needs to beat the market.
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

Thesaints wrote: Fri Jun 11, 2021 11:28 am All true, but keep in mind that you can't beat the market if you don't try to beat the market and, sometimes, one needs to beat the market.
So if you are looking at a large group of people who "need" to beat the market in order for their financial plans not to fail--that is sad, because it is a good bet most of them are destined for failure.

And knowing this, I have put considerable thought and effort into minimizing the chance we will be in that position.

That said, if tomorrow we learn the Earth is going to be destroyed by a comet in a year, but there is an Ark Ship that is being built, but tickets will cost $10 million per person . . . conversations around here would probably get really different.
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Re: One Bogleheads idea I have a hard time understanding...

Post by GaryA505 »

All this talk is about the "average" of active funds vs. index funds, and the assumption (or claim) is that "above average" funds never stay above average, so you can't consistently pick them. Now, let's look at a simple example. Investor #1 and investor #2 have holdings in their tax-deferred accounts. Both investors prefer an AA of approximately 60/40, both are "buy and hold" investors, and both prefer to keep their international equity holdings at approximately 20%. The only difference between them is that Investor #1 is an index-only investor and Investor #2 thinks selecting well-managed, low-fee active funds can beat the market average consistently by a small percentage which compounded over many years makes a big difference. Investor #2 uses the investments of Investor #1 as his benchmark, and knows that his funds have a slightly higher equity allocation, so he keeps a small allocation to cash to adjust for this.

Investor #1:
50% VSMGX (Vanguard Lifestrategy Moderate Growth)
50% VBINX/VBIAX (Vanguard Balanced Index)

Investor #2:
48% VWELX/VWENX (Vanguard Wellington)
48% VGSTX (Vanguard STAR)
4% cash

Investor #1 and Investor #2 like to discuss (and brag about) their strategies over pizza and beer, and they see this:
https://www.portfoliovisualizer.com/bac ... ation5_2=4
Investor #2 claims to have produced much greater gains with very minimal added manager risk because he only uses active funds from a highly reputable firm, and that these funds have a proven track record over long periods of time. He notes that his stddev is lower and most drawdowns have been lower, and that his Sharpe and Sortino ratios have been higher. Investor #1 notes (of course) that "past performance does not guarantee future results".

Discuss!
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: One Bogleheads idea I have a hard time understanding...

Post by dbr »

GaryA505 wrote: Fri Jun 11, 2021 12:07 pm
Discuss!
Sure. If anything of any real importance depends on the choice between the two portfolios as seen in that particular back test, then both investors are in deep trouble.
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Re: One Bogleheads idea I have a hard time understanding...

Post by galawdawg »

GaryA505 wrote: Fri Jun 11, 2021 12:07 pm All this talk is about the "average" of active funds vs. index funds, and the assumption (or claim) is that "above average" funds never stay above average, so you can't consistently pick them. Now, let's look at a simple example. Investor #1 and investor #2 have holdings in their tax-deferred accounts. Both investors prefer an AA of approximately 60/40, both are "buy and hold" investors, and both prefer to keep their international equity holdings at approximately 20%. The only difference between them is that Investor #1 is an index-only investor and Investor #2 thinks selecting well-managed, low-fee active funds can beat the market average consistently by a small percentage which compounded over many years makes a big difference. Investor #2 uses the investments of Investor #1 as his benchmark, and knows that his funds have a slightly higher equity allocation, so he keeps a small allocation to cash to adjust for this.

Investor #1:
50% VSMGX (Vanguard Lifestrategy Moderate Growth)
50% VBINX/VBIAX (Vanguard Balanced Index)

Investor #2:
48% VWELX/VWENX (Vanguard Wellington)
48% VGSTX (Vanguard STAR)
4% cash

Investor #1 and Investor #2 like to discuss (and brag about) their strategies over pizza and beer, and they see this:
https://www.portfoliovisualizer.com/bac ... ation5_2=4
Investor #2 claims to have produced much greater gains with very minimal added manager risk because he only uses active funds from a highly reputable firm, and that these funds have a proven track record over long periods of time. He notes that his stddev is lower and most drawdowns have been lower, and that his Sharpe and Sortino ratios have been higher. Investor #1 notes (of course) that "past performance does not guarantee future results".

Discuss!
Sure, anyone can go in and cherry-pick backtested funds to support a hypothesis that certain active funds beat passive investing over a certain period of time in the past. They key is an investor has to pick their funds decades before their ultimate success will be measured. And if they are indeed "buy and hold", they have just ONE shot to get it right!

**And I'm curious why you selected two overlapping "all-in-one" funds for your passive rather than a simple two, three or four fund portfolio...is that what you had to do to get your numbers to work?? :shock: :beer
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Re: One Bogleheads idea I have a hard time understanding...

Post by GaryA505 »

galawdawg wrote: Fri Jun 11, 2021 12:28 pm
GaryA505 wrote: Fri Jun 11, 2021 12:07 pm All this talk is about the "average" of active funds vs. index funds, and the assumption (or claim) is that "above average" funds never stay above average, so you can't consistently pick them. Now, let's look at a simple example. Investor #1 and investor #2 have holdings in their tax-deferred accounts. Both investors prefer an AA of approximately 60/40, both are "buy and hold" investors, and both prefer to keep their international equity holdings at approximately 20%. The only difference between them is that Investor #1 is an index-only investor and Investor #2 thinks selecting well-managed, low-fee active funds can beat the market average consistently by a small percentage which compounded over many years makes a big difference. Investor #2 uses the investments of Investor #1 as his benchmark, and knows that his funds have a slightly higher equity allocation, so he keeps a small allocation to cash to adjust for this.

Investor #1:
50% VSMGX (Vanguard Lifestrategy Moderate Growth)
50% VBINX/VBIAX (Vanguard Balanced Index)

Investor #2:
48% VWELX/VWENX (Vanguard Wellington)
48% VGSTX (Vanguard STAR)
4% cash

Investor #1 and Investor #2 like to discuss (and brag about) their strategies over pizza and beer, and they see this:
https://www.portfoliovisualizer.com/bac ... ation5_2=4
Investor #2 claims to have produced much greater gains with very minimal added manager risk because he only uses active funds from a highly reputable firm, and that these funds have a proven track record over long periods of time. He notes that his stddev is lower and most drawdowns have been lower, and that his Sharpe and Sortino ratios have been higher. Investor #1 notes (of course) that "past performance does not guarantee future results".

Discuss!
Sure, anyone can go in and cherry-pick backtested funds to support a hypothesis that certain active funds beat passive investing over a certain period of time in the past. They key is an investor has to pick their funds decades before their ultimate success will be measured. And if they are indeed "buy and hold", they have just ONE shot to get it right!

**And I'm curious why you selected two overlapping "all-in-one" funds for your passive rather than a simple two, three or four fund portfolio...is that what you had to do to get your numbers to work?? :shock: :beer
I chose the funds I did because they are very popular and it keeps the example simple for the scenario I defined. There are infinite other, more complicated, scenarios you could look at, but this is the one I defined. Investor #1 could certainly create the same overall AA and the same ex-US allocation using 3 or 4 funds, but it wouldn't change the results much since neither VSMGX or VBINX/VBIAX have a high ER.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

GaryA505 wrote: Fri Jun 11, 2021 12:07 pm All this talk is about the "average" of active funds vs. index funds, and the assumption (or claim) is that "above average" funds never stay above average, so you can't consistently pick them. Now, let's look at a simple example. Investor #1 and investor #2 have holdings in their tax-deferred accounts. Both investors prefer an AA of approximately 60/40, both are "buy and hold" investors, and both prefer to keep their international equity holdings at approximately 20%. The only difference between them is that Investor #1 is an index-only investor and Investor #2 thinks selecting well-managed, low-fee active funds can beat the market average consistently by a small percentage which compounded over many years makes a big difference. Investor #2 uses the investments of Investor #1 as his benchmark, and knows that his funds have a slightly higher equity allocation, so he keeps a small allocation to cash to adjust for this.

Investor #1:
50% VSMGX (Vanguard Lifestrategy Moderate Growth)
50% VBINX/VBIAX (Vanguard Balanced Index)

Investor #2:
48% VWELX/VWENX (Vanguard Wellington)
48% VGSTX (Vanguard STAR)
4% cash

Investor #1 and Investor #2 like to discuss (and brag about) their strategies over pizza and beer, and they see this:
https://www.portfoliovisualizer.com/bac ... ation5_2=4
Investor #2 claims to have produced much greater gains with very minimal added manager risk because he only uses active funds from a highly reputable firm, and that these funds have a proven track record over long periods of time. He notes that his stddev is lower and most drawdowns have been lower, and that his Sharpe and Sortino ratios have been higher. Investor #1 notes (of course) that "past performance does not guarantee future results".

Discuss!
As an aside, generally speaking I think it is important to control for at least value, and ideally all factors, when comparing active versus passive results. I also think the risks to factor investing might not show up well in those specific measures.

But generally, if you believe Vanguard has the secret sauce to beating the market on a risk-adjusted basis, enough to more than cover the higher costs of their active funds, then obviously you should use their active funds. I am not persuaded that is true.
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Re: One Bogleheads idea I have a hard time understanding...

Post by Lee_WSP »

GaryA505 wrote: Fri Jun 11, 2021 12:07 pm All this talk is about the "average" of active funds vs. index funds, and the assumption (or claim) is that "above average" funds never stay above average, so you can't consistently pick them. Now, let's look at a simple example. Investor #1 and investor #2 have holdings in their tax-deferred accounts. Both investors prefer an AA of approximately 60/40, both are "buy and hold" investors, and both prefer to keep their international equity holdings at approximately 20%. The only difference between them is that Investor #1 is an index-only investor and Investor #2 thinks selecting well-managed, low-fee active funds can beat the market average consistently by a small percentage which compounded over many years makes a big difference. Investor #2 uses the investments of Investor #1 as his benchmark, and knows that his funds have a slightly higher equity allocation, so he keeps a small allocation to cash to adjust for this.

Investor #1:
50% VSMGX (Vanguard Lifestrategy Moderate Growth)
50% VBINX/VBIAX (Vanguard Balanced Index)

Investor #2:
48% VWELX/VWENX (Vanguard Wellington)
48% VGSTX (Vanguard STAR)
4% cash

Investor #1 and Investor #2 like to discuss (and brag about) their strategies over pizza and beer, and they see this:
https://www.portfoliovisualizer.com/bac ... ation5_2=4
Investor #2 claims to have produced much greater gains with very minimal added manager risk because he only uses active funds from a highly reputable firm, and that these funds have a proven track record over long periods of time. He notes that his stddev is lower and most drawdowns have been lower, and that his Sharpe and Sortino ratios have been higher. Investor #1 notes (of course) that "past performance does not guarantee future results".

Discuss!
Survivorship bias and hindsight.

But to your point, Vanguard did release a white paper saying that the only way active managers are going to add value for their clientele is to follow the Wellington model of low costs and low fund turnover.
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Re: One Bogleheads idea I have a hard time understanding...

Post by epargnant »

cone774413 wrote: Sat Jun 05, 2021 4:50 pm The accepted dogma around here is that the Boglehead philosophy (broad index funds, diversification, time in market, etc.) MUST be true as historically this has led to predictable and positive outcomes in the past. I participate in clinical trials in my job, the typical idea is if an outcome is reproducible when accounting for all the possible confounding variables, you can feel with a certain degree of certainty there is causation or a predictable outcome. I don't understand how that can be the case with regards to the stock market or economy. There are literally tens of millions of variables (if not billions or trillions) both micro and macro-economically that are rapidly changing. I am not an economist but the world and the economy, both in the US and abroad, is completely different as it was 10-20 years ago...never mind the many decades ago that we often use as "evidence" that the Boglehead philosophy is incontrovertible. How can we be so sure?
Clinical trials are a terrible analogy. If you insist on using them, then indexing is the control group. The problem is, as you point out, that the variables are countless, therefore trying to figure out how to guarantee a better future return is impossible.

What is the Boglehead philosophy? Simply to accept the average market return. The burden of proof is on others to find a better way and so far no one can guarantee anything better.
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Re: One Bogleheads idea I have a hard time understanding...

Post by tadamsmar »

cone774413 wrote: Sat Jun 05, 2021 4:50 pm The accepted dogma around here is that the Boglehead philosophy (broad index funds, diversification, time in market, etc.) MUST be true as historically this has led to predictable and positive outcomes in the past. I participate in clinical trials in my job, the typical idea is if an outcome is reproducible when accounting for all the possible confounding variables, you can feel with a certain degree of certainty there is causation or a predictable outcome. I don't understand how that can be the case with regards to the stock market or economy. There are literally tens of millions of variables (if not billions or trillions) both micro and macro-economically that are rapidly changing. I am not an economist but the world and the economy, both in the US and abroad, is completely different as it was 10-20 years ago...never mind the many decades ago that we often use as "evidence" that the Boglehead philosophy is incontrovertible. How can we be so sure?
I think you are basically right that if the Boglehead philosophy was a drug then you the FDA would not approve it since it's not possible to provide evidence that is equivalent to a clinical trial or randomized controlled trial.

There is a simple mathematical proof that owning the market beats higher-fee active investing in aggregate. You own the same thing as all the investors put together and you play less fees, QED you outperform. And, you can't reject the null hypothesis that any specific active investing method does not outperform owning the market at a lower fee, so if active investing was drug then the FDA would not approve that either.
MUST be true as historically this has led to predictable and positive outcomes in the past.
Note true in general for national markets, the Russian stock market went to zero in 1919. It may be true for the US market for investors who invested part of each paycheck over time as far back as the historical record goes, not sure. But that does not assure a positive outcome in the future. Plus, using the US market is obvious cherry picking using 20-20 hindsight.

No investing method is going to get FDA-like approval. You have to make your decisions with other kinds of reasoning and evidence.
Last edited by tadamsmar on Sat Jun 12, 2021 8:01 am, edited 2 times in total.
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Re: One Bogleheads idea I have a hard time understanding...

Post by JBTX »

GaryA505 wrote: Fri Jun 11, 2021 12:07 pm All this talk is about the "average" of active funds vs. index funds, and the assumption (or claim) is that "above average" funds never stay above average, so you can't consistently pick them.
No nobody has said that. The only assertion is the passive stock market in its entirety, will beat active in its entirety, due to fees. Over the sort term roughly half of funds should beat it's benchmark, and over longer periods of times there will still be some active funds beating the index. It is just that the longer you go, the percent that beats the index will decrease. It could be simply luck, if enough people flip coins somebody will flip 10 heads in a row. Or perhaps there are some that truly have enough skill to overcome fees. The point is that's it's a very small number.
Now, let's look at a simple example. Investor #1 and investor #2 have holdings in their tax-deferred accounts. Both investors prefer an AA of approximately 60/40, both are "buy and hold" investors, and both prefer to keep their international equity holdings at approximately 20%. The only difference between them is that Investor #1 is an index-only investor and Investor #2 thinks selecting well-managed, low-fee active funds can beat the market average consistently by a small percentage which compounded over many years makes a big difference. Investor #2 uses the investments of Investor #1 as his benchmark, and knows that his funds have a slightly higher equity allocation, so he keeps a small allocation to cash to adjust for this.

Investor #1:
50% VSMGX (Vanguard Lifestrategy Moderate Growth)
50% VBINX/VBIAX (Vanguard Balanced Index)

Investor #2:
48% VWELX/VWENX (Vanguard Wellington)
48% VGSTX (Vanguard STAR)
4% cash

Investor #1 and Investor #2 like to discuss (and brag about) their strategies over pizza and beer, and they see this:
https://www.portfoliovisualizer.com/bac ... ation5_2=4
Investor #2 claims to have produced much greater gains with very minimal added manager risk because he only uses active funds from a highly reputable firm, and that these funds have a proven track record over long periods of time. He notes that his stddev is lower and most drawdowns have been lower, and that his Sharpe and Sortino ratios have been higher. Investor #1 notes (of course) that "past performance does not guarantee future results".

Discuss!
Again, nobody said that nobody ever beats the market.

In terms of Wellington and Wellesley, they clearly have beaten their peers. It appears they have selected stocks and bonds that tend to do well in a declining interest rate market. Their bond profile is slightly riskier than average. The question will be in a flat or increasing rate environment, or one of inflation, will it outperform? We shall see.

Even if you believe there are fund managers that have some secret sauce that can beat the market and fee burden, the problem is it usually doesn't persist. The funds grow very large. It's harder to outperform when you tens of billions of dollars in a fund. Or the market dynamics change, such that the secret sauce doesn't work anymore, or the market learns the secret sauce. You can find famous managers that beat the market for many years, but eventually the streak and outperformance ends.
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Re: One Bogleheads idea I have a hard time understanding...

Post by HomerJ »

Thesaints wrote: Fri Jun 11, 2021 11:28 am All true, but keep in mind that you can't beat the market if you don't try to beat the market and, sometimes, one needs to beat the market.
What times does one need to beat the market?

Beating the market is hard. NEEDing to beat the market is a dangerous place to be.

That would be like going to Vegas and NEEDing to win at blackjack.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
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Re: One Bogleheads idea I have a hard time understanding...

Post by Northern Flicker »

cone774463 wrote: The accepted dogma around here is that the Boglehead philosophy (broad index funds, diversification, time in market, etc.) MUST be true as historically this has led to predictable and positive outcomes in the past.
I don't think that is an accurate statement. The stock market is highly unpredictable. Nobody has ever demonstrated how to generate a representative random sample of independent trials for capital market returns. Historical samples of stock returns are highly biased by time period so that the results are not generalizable to future returns. The probability distributions for stock returns may even change over time.

There are no experimental results in the financial investment world that come anywhere close to the standards of experimental design, reproducibility, and statistical significance that are the norm for clinical trials.
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Re: One Bogleheads idea I have a hard time understanding...

Post by JackoC »

JBTX wrote: Sat Jun 05, 2021 5:07 pm
cone774413 wrote: Sat Jun 05, 2021 5:04 pm
JBTX wrote: Sat Jun 05, 2021 4:58 pm A broad low fee index fund will always beat the average of all active investors once fees are taken into account, by definition.
This is what I don't understand. How can you make that claim? Who's definition? What is the evidence?
Because an index fund owns all the stocks. The price is set by all active traders. So by definition the index will follow performance of all invested active traders. Now most active traders have fees to deal with, and some index funds have near zero fees. Thus indexing wins.
Agreed. This is not a 'claim', it's an axiom. It's irrefutable when applied correctly. Which is to recognize as in your explanation that if an index fund makes the index return minus average index fund expenses +/- index fund tracking error and all other investors in the same index also make the index return minus average non-index fund expenses -/+ index fund tracking error, and average index fund expenses<average non-index fund expenses, and index fund tracking error is not a large 'supply' of excess return to the rest of the market, index funds must win over other ways to invest in the index, on average. The only experimental aspect to this is to determine that index fund tracking error isn't a significant net drag on index fund returns: it's not. So that part generally isn't even mentioned. Otherwise it's purely axiomatic.

The problems come when the axiom is applied beyond its sphere of validity, as is possible in almost innumerable ways. For the easiest example, it's *possible* you could identify within the body of investors (invested $'s, really) in the index who are the consistent suckers. The consistent smart people could consistently beat the index at *their* expense, though not at the expense of index fund investors (assuming what I said about tracking error is true). But *that's* where evidence is required, and it's hard to find. I'm only pointing out you that you can't say *axiomatically* that there are no (identifiable in advance) smart people whose expected return is higher than the index (correcting for risk). You can only say axiomatically that all $'s invested in the index other than via index funds can't beat the $'s invested in index funds on average if the non-index fund invested $'s incur higher costs on average.

Then once you depart from investing in a stock index to non-stock investments, equity derivatives, etc. there is no axiom. Nor needless to say (it should be needless at least) is there any axiom by which investing in one country's stock index is superior to investing in another's. Those are among the areas where it might be fair to say there's a prevailing 'dogma' on this forum (albeit with people pushing back on it, with sometimes effective and sometimes not so effective arguments). But 'costs matter' within a stock index is axiomatic, it's not a claim, belief or 'dogma'.
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drumboy256
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Re: One Bogleheads idea I have a hard time understanding...

Post by drumboy256 »

JBTX wrote: Fri Jun 11, 2021 10:51 am
sperry8 wrote: Fri Jun 11, 2021 10:46 am
Chip wrote: Fri Jun 11, 2021 10:43 am
sperry8 wrote: Fri Jun 11, 2021 10:03 am I love Buffet, but his comment doesn't make sense to me. He says active investors, as a group, must get average returns (assuming they own 50% and passive investors own the other 50%). But that doesn't sound right. It could be that active investors identify the creme de la creme and beat the passive investors, even including fees. Now we know that's never happened, and I surely don't believe it will, but it could. Warren says it can't. What am I missing? (again, I'm not arguing for active, just trying to understand his must comment).
It's just math. If the active investors were able to get more than the average then the passive investors would have to get less than the average. So if the average return of the market was 10%, and active investors made 11% gross, passive investors would have to make 9% gross. Assuming a 50/50 split. But, by definition, the passive investors get the average return. So the return of the active investors must also be the average return.
I see. So he assumes the passive investors return is the average return. But that doesn't have to be. It could be the average return is 11%. Passive gets 10% and active gets 12%... thus the average is 11%. But I see where he's coming from now. He's suggesting that we use passive as the average and in that case, his comment makes sense.
By definition passive gets average. Passive investors own the entire market, prices are set by the market, ie market = active investors.

Think of having a game of rock paper scissors in the mirror. The mirror is passive investment. You cant beat your reflection at rock paper scissors.
This is a great insight.
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GregG3
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Re: One Bogleheads idea I have a hard time understanding...

Post by GregG3 »

Independent George wrote: Sun Jun 06, 2021 5:48 pm
dbr wrote: Sun Jun 06, 2021 5:24 pm The whole point of active investing is to pay someone who is a winner against the people you need to avoid who are losers. You find out which are going to be the winners by asking them :oops:
Here's the thing that often gets missed by BHs - active trading has, in fact, improved dramatically over time; the kind of analysis that gets done today is far, far superior to the kind of trading that was done even just a decade ago, let alone a century ago. The problem is that everybody is doing it - it's a game of PhD quant vs PhD quant setting the market price. The absolute level of trading "skill" is undoubtedly higher than it was in the past... it's just the relative level is necessarily always going to end up at the same place: the market clearing price.

There are two rather large caveats to this, though:

1. The winners & losers do not necessarily have to follow a normal distribution - it's entirely possible (and I'd say likely) that very small portion of traders to do extremely well, while the rest of the market is slightly below average. The net of all active trades nets to the market price, but most traders actually performed below average.

2. The Grossman-Stiglitz paradox remains true - if markets everyone were to start investing passively, markets will become less efficient because no information is being exchanged on the marketplace. But once people start trading to take advantage of that inefficiency, they will eventually arbitrage out their advantage until the market becomes efficient again.
The fact that the active trading is employing now an array of AI tools will lead to exactly the opposite of your presumption in point 1. If all active traders start employing artificial intelligence tools then it is more likely that the winners and losers will follow normal distribution.
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nedsaid
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Re: One Bogleheads idea I have a hard time understanding...

Post by nedsaid »

cone774413 wrote: Sat Jun 05, 2021 4:50 pm The accepted dogma around here is that the Boglehead philosophy (broad index funds, diversification, time in market, etc.) MUST be true as historically this has led to predictable and positive outcomes in the past. I participate in clinical trials in my job, the typical idea is if an outcome is reproducible when accounting for all the possible confounding variables, you can feel with a certain degree of certainty there is causation or a predictable outcome. I don't understand how that can be the case with regards to the stock market or economy. There are literally tens of millions of variables (if not billions or trillions) both micro and macro-economically that are rapidly changing. I am not an economist but the world and the economy, both in the US and abroad, is completely different as it was 10-20 years ago...never mind the many decades ago that we often use as "evidence" that the Boglehead philosophy is incontrovertible. How can we be so sure?
Two things at work here in favor of the Boglehead philosophy. Costs and market efficiency. First, costs matter. In fact they matter so much that Morningstar says that the number one predictor of future mutual fund performance relative to peers is expense, the cheaper the better. Second, the markets are pretty darned efficient though not perfectly so. If you compare the performance of actively managed funds vs. indexes within asset classes, over 15 year periods only about 2% of active funds outperform their benchmark indexes.

In the era of very fast computers and superior software, the computers crank away 24-7 looking for any mispricing of assets. You also have many very bright and talented people involved in asset management. We are also in an era when market data is very easily accessible. All of these things keep the markets efficient.
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Random Walker
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Re: One Bogleheads idea I have a hard time understanding...

Post by Random Walker »

This seems applicable to the OP’s question/thoughts:


Economics professors Dwight Lee and James Verbrugge of the University of Georgia explain the power of the efficient markets theory in the following manner:

"The efficient markets theory is practically alone among theories in that it becomes more powerful when people discover serious inconsistencies between it and the real world. If a clear efficient market anomaly is discovered, the behavior (or lack of behavior) that gives rise to it will tend to be eliminated by competition among investors for higher returns. (For example) If stock prices are found to follow predictable seasonal patterns this knowledge will elicit responses that have the effect of eliminating the very patterns that they were designed exploit. The implication is striking. The more empirical flaws that are discovered in the efficient markets theory the more robust the theory becomes. (In effect) Those who do the most to ensure that the efficient market theory remains fundamental to our
understanding of financial economics are not its intellectual defenders, but
those mounting the most serious empirical assault against it.” (1)

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gtrplayer
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Re: One Bogleheads idea I have a hard time understanding...

Post by gtrplayer »

cone774413 wrote: Sat Jun 05, 2021 5:04 pm
JBTX wrote: Sat Jun 05, 2021 4:58 pm A broad low fee index fund will always beat the average of all active investors once fees are taken into account, by definition.
This is what I don't understand. How can you make that claim? Who's definition? What is the evidence?
If you take all active investing and average it together over the long term, and you have an index that holds everything that can be actively invested, by definition, you’ll have the average. Because indexing generally charges lower fees, you’ll actually end up slightly ahead of the average, after fees.
SteadyOne
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Re: One Bogleheads idea I have a hard time understanding...

Post by SteadyOne »

Thesaints wrote: Mon Jun 07, 2021 2:05 pm
steve roy wrote: Sun Jun 06, 2021 4:29 pm One of my closest and oldest friends has a PhD in economics from Cornell. Long ago he told me the following:

"Economics isn't a science because no economist can know what hundreds of millions of people will do with their money at any given point in time."
There is no way to know what the trillion trillion gas molecules in a small container will each individually do, but then again thermodynamics is certainly a science.
So, what is the formula to beat the market?
“Every de­duc­tion is al­lowed as a mat­ter of leg­isla­tive grace.” US Federal Court
Tingting1013
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Re: One Bogleheads idea I have a hard time understanding...

Post by Tingting1013 »

SteadyOne wrote: Sat Jun 12, 2021 9:45 pm
Thesaints wrote: Mon Jun 07, 2021 2:05 pm
steve roy wrote: Sun Jun 06, 2021 4:29 pm One of my closest and oldest friends has a PhD in economics from Cornell. Long ago he told me the following:

"Economics isn't a science because no economist can know what hundreds of millions of people will do with their money at any given point in time."
There is no way to know what the trillion trillion gas molecules in a small container will each individually do, but then again thermodynamics is certainly a science.
So, what is the formula to beat the market?
Leverage
DesiCoder
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Re: One Bogleheads idea I have a hard time understanding...

Post by DesiCoder »

Here is one way I make sense of the average returns of the market (index) being better than actively invested, consider following baseline facts
1) over any period returns for all participants would be same as sum total of the market by definition (before fees and taxes)
2) the fee and tax drag for active indexing is higher than that of indexing, so in general the actively managed funds would have to beat average by that much of a drag.
2.1) if you plot a curve of returns of each stock over the given period of time, you'll see the pool of stocks (or combination thereof) becomes significantly smaller to achieve that additional required performance. this is assuming perfect security combination selection by fund manager, any mistakes or execution errors will cause underperformce
2.2) next you should consider errors in timing of selecting the right fund, this is owed to the discovery process of the fund itself. vast majority of investors select funds in (IMO) very bad ways, they search through the best performers over past few years and buy those but that almost guarantees that you are buying at the peak of gold rush.
3) as funds get popular due to outperformance they also get fat, which means the specific stocks in it starts to get crowded and lose the advantage.
4) there is documented evidence that the best performing funds and managers dont stay constant but tend to bounce around a lot. this means you are also taking a chance on betting on the 'right' fund manager and your ability to find him.
5) and finally the biggest one in my mind (because I am a bit of a chicken with my life's savings :| ) is that what happens if there is an a big drop in market. at that point do I continue holding or cut bait? if I cut bait, when do I buy back? if I am invested in a bunch of funds or stocks and they drop 40% I am betting on the correctness of my security selection along with whatever is happening in the economy. OTOH indexing is essentially a bet on the health of the overall market, which IMHO is a very different kind of risk profile.

Bottom line, the outperformance would have to be significant to tip the scale the other way.
NiceUnparticularMan
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Re: One Bogleheads idea I have a hard time understanding...

Post by NiceUnparticularMan »

Tingting1013 wrote: Sun Jun 13, 2021 12:52 am
SteadyOne wrote: Sat Jun 12, 2021 9:45 pm
Thesaints wrote: Mon Jun 07, 2021 2:05 pm
steve roy wrote: Sun Jun 06, 2021 4:29 pm One of my closest and oldest friends has a PhD in economics from Cornell. Long ago he told me the following:

"Economics isn't a science because no economist can know what hundreds of millions of people will do with their money at any given point in time."
There is no way to know what the trillion trillion gas molecules in a small container will each individually do, but then again thermodynamics is certainly a science.
So, what is the formula to beat the market?
Leverage
Choosing to expose yourself to more (or less) market risk is not beating the market, it is rather assumed to be a broadly available option. Indeed, the arbitrageurs who are assumed to set efficient prices are generally assumed to be leveraged.

So, to think you can beat the arbitrageurs, leverage alone won't do it. You also have to find a way to beat their PhDs, supercomputers, special rapid information and trading systems, and so on.
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