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The best investment advice you'll never get

180 points by a5seo 16y ago

adamjernst 16y ago
A well-written article, but really? Investing in a low-cost broad index fund is the /only/ investment advice I get nowadays.
- JSig 16y ago
  I suppose index funds are fine if you can time buys/sells with the booms and busts. These days I sure don't feel like holding them. It's sad but the best bet is just picking the hot algo stocks.
  - flyt 16y ago
    it's impossible to time the market, so instead you use dollar cost averaging to invest at a constant rate, regardless of how things are in the market. put money in both when it's expensive and cheap to do so.
    - JSig 16y ago
      I certainly disagree with you that it is impossible to time the market. There are many forms of technical, statistical and fundamental analysis that help to time the market. A key element to trading is removing emotional bias. I am aware of many people that are successful traders. I will note that the market is much different today than it was in 2004. Today HFT accounts for 70% of volume. That is huge. I think having an investing strategy that does not assume an asset will always go up is important.
      - rdtsc 16y ago
        > I certainly disagree with you that it is impossible to time the market. ... > I am aware of many people that are successful traders. You have to ask then if they own personal airplanes, yachts and private islands? If the answer is 'no', then you have to wonder why not? I think the problem is that individual successful traders are just traders who are randomly successful. You hear about them because they are the ones that get lucky and brag about it. Those who are unsuccessful will probably remain forever anonymous to the public and even their friends. The only ones that can "beat" the market are the ones that do it via technical means (minimum latency to the exchange, fastest computers, insider info, etc.) I think these are just the large investment banks.
        JSig 16y ago
        >> I am aware of many people that are successful traders. > You have to ask then if they own personal airplanes, yachts and private islands? If the answer is 'no', then you have to wonder why not? I am a software developer. Am I not successful because I dont own personal airplanes and a private island? I don't think these things define my success. Regardless, you have provided a straw man argument. The people I know who are successful traders all have different MOs. What defines there success is that they stay in the black. Hence, they are able to time the market. You don't need minimum latency to the exchange, fastest computers, insider info. As an example check out the performance of Fund My Mutual Fund. This is a virtual mutual fund that is soon to launch for real. http://www.fundmymutualfund.com/2007/07/portfolio.html http://www.fundmymutualfund.com/2007/07/portfolio.html
        rdtsc 16y ago
        As a developer you are bounded by how much you can develop in a fixed amount of time, how much someone will pay you for it, and how many customers you have. If you could, would you not get payed more for your work? If you are working for someone, as I am, then you essentially have only one customer and they are paying you a fixed amount (+ some bonuses and raises). Or you could be like the author of minecraft, so you could be racking in hundreds of thousands a month. Now if you say you have found a way to beat the market through research, technical or fundamental analysis, your limit would be unbounded (theoretically). Your charts looks good and are very impressive, but it is only 2 years and you would not be showing them if they didn't do well. So for all I know you are just one of the random lucky ones that beat the market. Now if you had a way to consistenlty get 10% (and maybe you did!), in a decade or so you could be another Donald Trump. You need to convince others that you can do it and then soon you will start getting large investments. > What defines there success is that they stay in the black. Hence, they are able to time the market. If they can time the market, are they fully invested in it. Would they sell their house and get everyone they know to do the same so they can pour that into the market, then re-invest and eventually rule the world? Another way to ask the question is why haven't the big investment banks figured out the strategy, and as a result, diluted the strategy by now? Also what about the ones that don't stay in the black. Will they tell you, would you know how many have tried and failed? That is the true criteria. You would have to have a large group of traders commited to making money in the market. Then they all try for a fixed amount of time and in the end you see how they perform as a group. Now, essentially, you are just pickding the ones that performed in the black and using that as an argument that invididual trading can be a 100% profitable business.
    - lotharbot 16y ago
      > "it's impossible to time the market" That depends very much on exactly what you mean by "time the market". It is impossible to reliably predict whether the market will go up or down on any given day. It is also impossible to reliably predict exactly when a market will hit a peak or trough. Dollar-cost averaging is a great strategy to reduce the risk associated with the inability to "time" markets in this sense. But it is completely possible to recognize that a particular asset (or class) is over- or under-valued, as long as you have good enough information. You can't necessarily predict how long it will take for its value to be more accurately reflected in the price (another sense in which you "can't time the market"), but you can recognize that certain assets are on sale or commanding a premium price, and therefore get a good price on/for certain assets. Portfolio rebalancing is, in part, meant to help capture this. Investing more in assets that have fallen behind, and less in those that have gotten ahead, is a (very rough) mechanism for selling high and buying low. Value investing is even more about this -- explicitly putting money into assets when it is cheap to do so, and selling assets that people are putting money into when it's expensive to do so. The idea is not to "time the market" in the sense of knowing exactly what day the market will turn, but simply to take advantage of really good deals (in the long-term sense) when they present themselves.
      - tomsaffell 16y ago
        Agreed - I believe there are some ways to time the market. For example, if you want to make a 5-10 year investment, then doing so in the S&P500 when it is significantly down will yield better returns (on average) than doing it at a random time: http://saffell.wordpress.com/2008/10/26/does-timing-the-market-work/ http://saffell.wordpress.com/2008/10/26/does-timing-the-mark...
        lotharbot 16y ago
        It should be noted that your 10, 20, and 30 year charts actually show an advantage to investing in off years; your conclusion that "there is no significant advantage" is mistaken. On the 30 year chart, the peaks on the 20-50% line are a couple percent above the peaks on the all line. Boosting returns from 7% to 9% over 30 years, or from 12% to 14% over 30 years, results in over 70% more total wealth after compounding. The visual difference is not as striking on the 30 year chart as on the 5 year chart, but that's because you're presenting annualized rather than total returns.
- a5seo 16y ago
  true, you get this advice everywhere. but actually implementing it for realz isn't for the faint of heart. it's not impossible either, especially if you don't mind horseshoes-and-hand-grenades approximation. If you want optimal as in mathematically optimal fund selection, then Bill Sharpe's startup, Financial Engines, does that (if you have at least $100k at Vanguard, you get it for free, also through many employers). https://personal.vanguard.com/us/insights/retirement/financial-engines https://personal.vanguard.com/us/insights/retirement/financi...
  - weber88 16y ago
    I've come to be suspicious of anything in finance claiming to be "mathematically optimal". You can only optimise according to some simplified model, and simplified models of complex systems have a tendency to unpredictably break down.
    - Nick_C 16y ago
      Don't throw out the baby with the bathwater. Just because you have a large industry of sharks doesn't mean the good work being done by reputable investment houses is invalidated. In general, index funds work. Some are better than others because of fees or their stock selection process. But they do work. The reason is that stocks in a sector have high covariance, and the outliers that might pop up occasionally with low covariance are only a small part of the index anyway. It is trivially easy to optimise on variance with some goal such as a limit on the number of holdings.
  - Natsu 16y ago
    > (if you have at least $100k at Vanguard, you get it for free, also through many employers) Actually, the people my employer go through just dumped Vanguard and a few other funds and would've automatically enrolled us all in a fund that changes every single year to be "optimum" for your age. I opted out and I informed my coworkers that there were good reasons to be incredibly suspicious of this move, but I wonder who actually took my advice. All I could think was that they were going to churn everyone's funds every single year so that they could get huge fees under the guise of "optimizing" our portfolios.
- michaelkeenan 16y ago
  You probably have a breadth of knowledge that comes from reading sites like HN, but the problem of course is that most people get their investment advice from banks and other investment professionals.
  - a5seo 16y ago
    Like Ameriprise. Ugh.
- jerf 16y ago
  Having also read this a lot, it makes me wonder how the clever financial world will find a way to take a lot of people owning index funds and somehow fleece them. I also find myself pondering the macroeconomic effects of a lot of the market simply being in index funds, though I'm sure we're a long ways from that. My personal rule-of-thumb "By the time you've heard of it, it's too late to get in on it" is also triggering, though I have to admit for the life of me I really can't imagine how to exploit this tendency. But I am anything but a financial wizard.
  - WildUtah 16y ago
    take a lot of people owning index funds and somehow fleece them There are strategies to do this now, but they're hard to execute. One example is to target stocks that are likely to enter or drop off indicies. Index funds will be looking to buy or sell them soon. Mostly these strategies depend on your ability to set up a very high speed link to the computers that clear trades and interpret the algorithms that index funds use to establish their samples of the market. If you can get in just ahead of the index funds and their monster volume, you can shave a few tenths of pennies from the investors. You can make millions with those strategies but it's a drop in the index fund bucket. Quite a lot of "quant" trading activity is about ripping off ordinary people by unnoticed fractions by getting in ahead of them. Much more innocuous than the large scale bribery and fraud that makes up so much of the financial industry.
    - nradov 16y ago
      This was covered in a WSJ article yesterday. http://online.wsj.com/article/SB10001424052748704008704575638583030174768.html?KEYWORDS=index+fund http://online.wsj.com/article/SB1000142405274870400870457563... "Over the long run, sharp traders getting out in front of these forced portfolio changes have poached at least 0.38 percentage point of annual return away from Russell 2000 index funds, estimates a new study in the Journal of Empirical Finance."
      - amh 16y ago
        Not all index methodologies are created equal, the way that Russell handles periodic reconstitution is particularly susceptible to front running. Other indexing methods are not as bad.
- patio11 16y ago
  Just because a question is interesting doesn't mean it has multiple right answers. (I need to stop talking like this or they'll take my ArtSci degree away...)
weber88 16y ago
Just a question that popped into my head: what would happen if everyone followed a passive strategy, ie, no one was active? Isn't some sort of active strategy required, somewhere, for funds to be directed at all? Though, I do think on average fund managers probably don't actually make anything like useful predictions. But perhaps we do need someone, somewhere, looking for good investment. My guess is that there is a role in society for some conservative, value based investing, but at the moment there are more people trying to do this than is useful, and even more people trying to find good investments by worthless strategies (like trying to predict future movements from past movements).
- blurry 16y ago
  The article answers that. Look around "We need active managers".
- derefr 16y ago
  > But perhaps we do need someone, somewhere, looking for good investment. Do programs on investment-bank servers perform this function?
- dkarl 16y ago
  The advice against trying to beat the market is based on the fact that there are tens of thousands of highly intelligent people paid to analyze securities, and they're all feeding off each other's behavior. To beat the market, you have to beat a conventional wisdom based on the accumulated expertise of a lot of people. For instance, if you want to buy stock in a Malaysian steel company, you have to decide that you understand the current value of this stock better than a crowd-sourced price generated by the research of a horde of steel industry specialists, people with intimate knowledge of the Malaysian economy, business environment, and political environment, people who can afford to spend all day reading forecasts of economic conditions in the countries where this company's steel is consumed, and people who have a drink with a VP from the company and get gossip about the CEO's health and the competence of his likely successor. If no one was trying to beat the market, it would be easy to beat the market. But since so many people are busy trying, it's silly to try to compete unless you want to take it as seriously as the professionals do and get plugged in the way they are. The "random walk" hypothesis says you can beat the professionals. About half the time. By flipping a coin. But the professionals are insiders, and as well-regulated as the stock market is, I would assume that an outsider playing against insiders in a 50/50 game will not quite win his full 50% share. The hope that a person can price stocks better than the market as a whole rests on a couple of possibilities: 1. Beating full-time professional analysts at analysis in your spare time, because you're just so bad-ass. 2. Identifying a price that is heavily influenced by ignorant people and beating them by just being reasonably well-informed -- but this is not an original idea and hence is a special case of #1. 3. Finding a niche that you know intimately for some reason, and in which you have no professional competition. Oh, wait, this is just #2 again. Or maybe you found a niche small enough that it doesn't get a lot of attention from professional analysts, and you can make a little bit of money at it. That might work! 4. Being the first one to take into account a new idea or source of information. This one will make you wildly rich, and it's fun to dream, but while you're looking for that brilliant idea, there's no reason to risk real money on your ideas-in-progress.
jeffmiller 16y ago
It should be mentioned that this article is from December 2006, when index funds were less widely adopted than they are today.
- jasonkester 16y ago
  ??? Index funds were as widely adopted as you could ask for back in 1996 when I first started investing in them. And it was common knowledge even then that the S&P 500 tended to outperform 70%+ of managed mutual funds. If that's the message this article is trying to convey, it certainly has the wrong title.
kevinburke 16y ago
Along the same lines here's an interview with a guy who's essentially shaped my investment philosophy: http://www.kirkreport.info/2009/03/qa-with-less-antman.html http://www.kirkreport.info/2009/03/qa-with-less-antman.html
philfreo 16y ago
Interesting comment on that article: Index investing (applied to extremely wide market indexes) makes an assumption that there will be a continuous and infinite increase in the total market capitalization of that index. As time marches forward I beleive we will experience a deceleration of worldwide market cap increase. Anyone have thoughts on this?
- akg_67 16y ago
  I have several concerns with index fund/ETF investing: 1. How much of the underlying stocks, that make up the Index, are really owned by the Index fund/ETF? I doubt that such funds/ETF actually own 100% of the required underlying stocks, may be using some sort of option/hedge strategy. 2. In what scenario, not owning the actual underlying stocks can be detrimental to index fund/ETF? I am looking for what may cause failure of such funds/ETF and who may lose. 3. Is index fund/ETF investing artificially inflating price for underlying stocks compared to price of the rest of the non-index stocks in the market? 4. Can index investing cause Index "Bubble"?
  - joelhaus 16y ago
    1. An index is generally creared to the target mwarket.
  - regularfry 16y ago
    The problem is that "ETF" is actually quite a broad term. As far as I can tell, many ETF's do run a sort of "fractional reserve" ratio. There was an article here not long ago wringing its hands over that danger which I can't find right now. The answer to 2 I think depends on how dividends are handled. Obviously if you hold the shares yourself, you control what happens to the dividends, and are free to take them or reinvest them as you wish. For 3, it depends on the ratio of index trackers to managed funds in the market, but yes, this can have a noticeable effect. A share price always dips when the it's removed from one of the larger indices; you can see an example here: http://uk.finance.yahoo.com/q/bc?s=TATE.L&t=2y&l=on&z=l&q=l&c= http://uk.finance.yahoo.com/q/bc?s=TATE.L&t=2y&l=on&... - they were removed from the FTSE100 in March 2009.
  - 16y ago
sram 16y ago
I got a wake up call about 4 years ago when my broker tried to convince me to buy into a hedge fund. Buried in the prospectus was an entry load of 8%. Fired him, and have been in index funds since.
by 16y ago
Index funds seem to me to work by reducing churn - the percentage of your stock that is sold and bought each year - because every time you sell then buy you lose a lot of money. I am not yet convinced you have to follow an index. If you had a fund that did not sell anything and bought a random stock from an index as funds came in would this beat an index fund?
- hnhg 16y ago
  Think of the index fund as reducing the risk of depending on any one stock for your gains. I don't know what the distribution of gains is like on an index fund but an answer to your question would likely come from an examination of one.
  - by 16y ago
    My theoretical fund would have a wide range of stocks. It does not seem to be related to spreading gains or risks. I have not seen any comparative table of stock churn rates for different funds, but my guess is that index funds do well because they reduce the sell-buy transaction costs, partly by eliminating the cost of human stock pickers, but primarily by reducing the percentage of stocks in the fund that are sold then bought every year. Maybe this is wrong? My understanding is that an index fund sells and buys stocks to balance the proportions held in the fund as the market capitalisation of the companies changes inside the index. This imposes an apparently unnecessary cost on the fund. If we removed this cost by not selling and buying stocks to keep it equal to the index would the fund become more profitable? I am considering it to be a fund where people invest incrementally over a long period so there would be constant random aquisition of new stocks from the index. Maybe that doesn't make sense for some reason.
    - Benjo 16y ago
      Balancing portfolios is basically a universally recommended practice. If you manage your own portfolio, won't you have a similar "churn rate" to the index fund?
      - 16y ago
bravura 16y ago
“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S & P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.” - Warren Buffet http://www.longbets.org/362 http://www.longbets.org/362
- jules 16y ago
  > Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors. This argument is wrong? edit: it's like saying this about strategies of chess players, one group is using strategy A and another is using strategy B: Chess players using strategy A are known to perform about average (by the nature of their strategy). So this new strategy, B, has to perform about average too. This neglects that there are other strategies than A and B. The whole world is not either passive investors or hedge funds. And he's saying something even stronger: there is no subset of B players that is better than average. So while he may well be correct in his prediction, he makes it sound like he has a mathematically tight argument for why he is correct. But the conclusion of his argument (that active investors will perform about average) is not the prediction of his bet (that hedge funds will perform about average, and because they have higher operating cost they will lose).
  - drblast 16y ago
    He's making the (correct) assumption that the speculative stock market where active investors expect to make their money is a zero-sum game. For there to be winners in "buy low, sell high" there have to be an equal amount of losers. So, if there are going to be winners, there have to be an equal amount of losers. It's difficult to siphon money off of someone passively invested in an index fund, so the active investors are competing against themselves. Because active investment has a much higher cost than passive, as a group they will be significantly worse off compared to passive investors. This is so self-evident as to be not even worth betting against. Note that this isn't to say that there won't be big active winners individually. But in a chess tournament, if the top players use strategy A that wins 90% of the time, and others use strategy B that wins 51% of the time, that guarantees the existence of some other strategy that performs below average. The stock market isn't necessarily a zero-sum game like chess because companies pay dividends, but that's rare and small enough to be insignificant compared to the amount of money gained and lost through speculation.
jteo 16y ago
2 words: Renaissance Technologies http://en.wikipedia.org/wiki/Renaissance_Technologies http://en.wikipedia.org/wiki/Renaissance_Technologies
- dschobel 16y ago
  the article addresses hedge funds near the end.
- jedc 16y ago
  Agree, but: 1) They're a huge, huge outlier 2) Any of Renaissance's funds are not nearly as scalable as a passive index fund 3) As a hedge fund will still take a big chunk out of returns as fees
- rorrr 16y ago
  You can't just invest in a hedge fund, there are some crazy requirements. As an individual investor you have to make $200,000 for at least two years straight.
- ladyada 16y ago
  In some alternate HN that existed 10 years ago someone posted "4 letters: LTCM" :)
JSig 16y ago
One way to beat index funds is through piggyback investing on those who can beat them. Check out http://alphaclone.com/ http://alphaclone.com/ You have to pay for a membership but the site is top notch. They parse investment fund's sec filings and allow you to backtest strategies to see how well they would have performed over a given time frame. You will find strategies that crush any index fund. I am not affiliated with alphaclone.com.
- eru 16y ago
  In retrospect there will always be strategies that will beat any index fund. But can you identify such a strategy beforehand?
GFischer 16y ago
I always thought of the stock market as a form of gambling, and this quote hints at that: "a list of advantages of active management, which essentially boiled down to the fact that it’s more fun" also: "There is an innate cultural imperative in this country to beat the odds" and the stock market is viewed as better than casinos for this kind of gambling.
antareus 16y ago
I'm 28, and I don't want to end up like Liz Lemon ("well I have $12,000 in checking"). What's a good primer on investing? I don't have a ton of money but I'd like to get into it.
- eru 16y ago
  Depends on what country you (or your money) live in. In the US has some low fee index funds. In Germany I used an ETF of max-blue. Just find a low fee diversified index fund, and then get back to your normal work. (Unless you enjoy playing the stock market, than there's nothing wrong with active investment. Just as some people enjoy playing the lottery (only the expected value of active investment isn't as dismal as playing the lottery).) Benjamin Graham's "Security Analysis" is a good primer, if you really want to get into stock or bond trading, or are just interested on an intellectual level. It's a hard book. Make sure you use a tax efficient way to invest. If you can invest with pre-tax money, do so.
- wrs 16y ago
  I recommend Andrew Tobias's classic _The Only Investment Guide You'll Ever Need_. Very sensible, and very readable. http://www.andrewtobias.com/theonly.html http://www.andrewtobias.com/theonly.html
  - antareus 16y ago
    Will take a look, thanks.

180 points by a5seo 16y ago

A well-written article, but really? Investing in a low-cost broad index fund is the /only/ investment advice I get nowadays.

JSig 16y ago
I suppose index funds are fine if you can time buys/sells with the booms and busts. These days I sure don't feel like holding them. It's sad but the best bet is just picking the hot algo stocks.
- flyt 16y ago
  it's impossible to time the market, so instead you use dollar cost averaging to invest at a constant rate, regardless of how things are in the market. put money in both when it's expensive and cheap to do so.
  - JSig 16y ago
    I certainly disagree with you that it is impossible to time the market. There are many forms of technical, statistical and fundamental analysis that help to time the market. A key element to trading is removing emotional bias. I am aware of many people that are successful traders. I will note that the market is much different today than it was in 2004. Today HFT accounts for 70% of volume. That is huge. I think having an investing strategy that does not assume an asset will always go up is important.
    - rdtsc 16y ago
      > I certainly disagree with you that it is impossible to time the market. ... > I am aware of many people that are successful traders. You have to ask then if they own personal airplanes, yachts and private islands? If the answer is 'no', then you have to wonder why not? I think the problem is that individual successful traders are just traders who are randomly successful. You hear about them because they are the ones that get lucky and brag about it. Those who are unsuccessful will probably remain forever anonymous to the public and even their friends. The only ones that can "beat" the market are the ones that do it via technical means (minimum latency to the exchange, fastest computers, insider info, etc.) I think these are just the large investment banks.
      - JSig 16y ago
        >> I am aware of many people that are successful traders. > You have to ask then if they own personal airplanes, yachts and private islands? If the answer is 'no', then you have to wonder why not? I am a software developer. Am I not successful because I dont own personal airplanes and a private island? I don't think these things define my success. Regardless, you have provided a straw man argument. The people I know who are successful traders all have different MOs. What defines there success is that they stay in the black. Hence, they are able to time the market. You don't need minimum latency to the exchange, fastest computers, insider info. As an example check out the performance of Fund My Mutual Fund. This is a virtual mutual fund that is soon to launch for real. http://www.fundmymutualfund.com/2007/07/portfolio.html http://www.fundmymutualfund.com/2007/07/portfolio.html
        rdtsc 16y ago
        As a developer you are bounded by how much you can develop in a fixed amount of time, how much someone will pay you for it, and how many customers you have. If you could, would you not get payed more for your work? If you are working for someone, as I am, then you essentially have only one customer and they are paying you a fixed amount (+ some bonuses and raises). Or you could be like the author of minecraft, so you could be racking in hundreds of thousands a month. Now if you say you have found a way to beat the market through research, technical or fundamental analysis, your limit would be unbounded (theoretically). Your charts looks good and are very impressive, but it is only 2 years and you would not be showing them if they didn't do well. So for all I know you are just one of the random lucky ones that beat the market. Now if you had a way to consistenlty get 10% (and maybe you did!), in a decade or so you could be another Donald Trump. You need to convince others that you can do it and then soon you will start getting large investments. > What defines there success is that they stay in the black. Hence, they are able to time the market. If they can time the market, are they fully invested in it. Would they sell their house and get everyone they know to do the same so they can pour that into the market, then re-invest and eventually rule the world? Another way to ask the question is why haven't the big investment banks figured out the strategy, and as a result, diluted the strategy by now? Also what about the ones that don't stay in the black. Will they tell you, would you know how many have tried and failed? That is the true criteria. You would have to have a large group of traders commited to making money in the market. Then they all try for a fixed amount of time and in the end you see how they perform as a group. Now, essentially, you are just pickding the ones that performed in the black and using that as an argument that invididual trading can be a 100% profitable business.
  - lotharbot 16y ago
    > "it's impossible to time the market" That depends very much on exactly what you mean by "time the market". It is impossible to reliably predict whether the market will go up or down on any given day. It is also impossible to reliably predict exactly when a market will hit a peak or trough. Dollar-cost averaging is a great strategy to reduce the risk associated with the inability to "time" markets in this sense. But it is completely possible to recognize that a particular asset (or class) is over- or under-valued, as long as you have good enough information. You can't necessarily predict how long it will take for its value to be more accurately reflected in the price (another sense in which you "can't time the market"), but you can recognize that certain assets are on sale or commanding a premium price, and therefore get a good price on/for certain assets. Portfolio rebalancing is, in part, meant to help capture this. Investing more in assets that have fallen behind, and less in those that have gotten ahead, is a (very rough) mechanism for selling high and buying low. Value investing is even more about this -- explicitly putting money into assets when it is cheap to do so, and selling assets that people are putting money into when it's expensive to do so. The idea is not to "time the market" in the sense of knowing exactly what day the market will turn, but simply to take advantage of really good deals (in the long-term sense) when they present themselves.
    - tomsaffell 16y ago
      Agreed - I believe there are some ways to time the market. For example, if you want to make a 5-10 year investment, then doing so in the S&P500 when it is significantly down will yield better returns (on average) than doing it at a random time: http://saffell.wordpress.com/2008/10/26/does-timing-the-market-work/ http://saffell.wordpress.com/2008/10/26/does-timing-the-mark...
      - lotharbot 16y ago
        It should be noted that your 10, 20, and 30 year charts actually show an advantage to investing in off years; your conclusion that "there is no significant advantage" is mistaken. On the 30 year chart, the peaks on the 20-50% line are a couple percent above the peaks on the all line. Boosting returns from 7% to 9% over 30 years, or from 12% to 14% over 30 years, results in over 70% more total wealth after compounding. The visual difference is not as striking on the 30 year chart as on the 5 year chart, but that's because you're presenting annualized rather than total returns.
a5seo 16y ago
true, you get this advice everywhere. but actually implementing it for realz isn't for the faint of heart. it's not impossible either, especially if you don't mind horseshoes-and-hand-grenades approximation. If you want optimal as in mathematically optimal fund selection, then Bill Sharpe's startup, Financial Engines, does that (if you have at least $100k at Vanguard, you get it for free, also through many employers). https://personal.vanguard.com/us/insights/retirement/financial-engines https://personal.vanguard.com/us/insights/retirement/financi...
- weber88 16y ago
  I've come to be suspicious of anything in finance claiming to be "mathematically optimal". You can only optimise according to some simplified model, and simplified models of complex systems have a tendency to unpredictably break down.
  - Nick_C 16y ago
    Don't throw out the baby with the bathwater. Just because you have a large industry of sharks doesn't mean the good work being done by reputable investment houses is invalidated. In general, index funds work. Some are better than others because of fees or their stock selection process. But they do work. The reason is that stocks in a sector have high covariance, and the outliers that might pop up occasionally with low covariance are only a small part of the index anyway. It is trivially easy to optimise on variance with some goal such as a limit on the number of holdings.
- Natsu 16y ago
  > (if you have at least $100k at Vanguard, you get it for free, also through many employers) Actually, the people my employer go through just dumped Vanguard and a few other funds and would've automatically enrolled us all in a fund that changes every single year to be "optimum" for your age. I opted out and I informed my coworkers that there were good reasons to be incredibly suspicious of this move, but I wonder who actually took my advice. All I could think was that they were going to churn everyone's funds every single year so that they could get huge fees under the guise of "optimizing" our portfolios.
michaelkeenan 16y ago
You probably have a breadth of knowledge that comes from reading sites like HN, but the problem of course is that most people get their investment advice from banks and other investment professionals.
- a5seo 16y ago
  Like Ameriprise. Ugh.
jerf 16y ago
Having also read this a lot, it makes me wonder how the clever financial world will find a way to take a lot of people owning index funds and somehow fleece them. I also find myself pondering the macroeconomic effects of a lot of the market simply being in index funds, though I'm sure we're a long ways from that. My personal rule-of-thumb "By the time you've heard of it, it's too late to get in on it" is also triggering, though I have to admit for the life of me I really can't imagine how to exploit this tendency. But I am anything but a financial wizard.
- WildUtah 16y ago
  take a lot of people owning index funds and somehow fleece them There are strategies to do this now, but they're hard to execute. One example is to target stocks that are likely to enter or drop off indicies. Index funds will be looking to buy or sell them soon. Mostly these strategies depend on your ability to set up a very high speed link to the computers that clear trades and interpret the algorithms that index funds use to establish their samples of the market. If you can get in just ahead of the index funds and their monster volume, you can shave a few tenths of pennies from the investors. You can make millions with those strategies but it's a drop in the index fund bucket. Quite a lot of "quant" trading activity is about ripping off ordinary people by unnoticed fractions by getting in ahead of them. Much more innocuous than the large scale bribery and fraud that makes up so much of the financial industry.
  - nradov 16y ago
    This was covered in a WSJ article yesterday. http://online.wsj.com/article/SB10001424052748704008704575638583030174768.html?KEYWORDS=index+fund http://online.wsj.com/article/SB1000142405274870400870457563... "Over the long run, sharp traders getting out in front of these forced portfolio changes have poached at least 0.38 percentage point of annual return away from Russell 2000 index funds, estimates a new study in the Journal of Empirical Finance."
    - amh 16y ago
      Not all index methodologies are created equal, the way that Russell handles periodic reconstitution is particularly susceptible to front running. Other indexing methods are not as bad.
patio11 16y ago
Just because a question is interesting doesn't mean it has multiple right answers. (I need to stop talking like this or they'll take my ArtSci degree away...)

weber88 16y ago

Just a question that popped into my head: what would happen if everyone followed a passive strategy, ie, no one was active? Isn't some sort of active strategy required, somewhere, for funds to be directed at all? Though, I do think on average fund managers probably don't actually make anything like useful predictions. But perhaps we do need someone, somewhere, looking for good investment. My guess is that there is a role in society for some conservative, value based investing, but at the moment there are more people trying to do this than is useful, and even more people trying to find good investments by worthless strategies (like trying to predict future movements from past movements).

blurry 16y ago
The article answers that. Look around "We need active managers".
derefr 16y ago
> But perhaps we do need someone, somewhere, looking for good investment. Do programs on investment-bank servers perform this function?
dkarl 16y ago
The advice against trying to beat the market is based on the fact that there are tens of thousands of highly intelligent people paid to analyze securities, and they're all feeding off each other's behavior. To beat the market, you have to beat a conventional wisdom based on the accumulated expertise of a lot of people. For instance, if you want to buy stock in a Malaysian steel company, you have to decide that you understand the current value of this stock better than a crowd-sourced price generated by the research of a horde of steel industry specialists, people with intimate knowledge of the Malaysian economy, business environment, and political environment, people who can afford to spend all day reading forecasts of economic conditions in the countries where this company's steel is consumed, and people who have a drink with a VP from the company and get gossip about the CEO's health and the competence of his likely successor. If no one was trying to beat the market, it would be easy to beat the market. But since so many people are busy trying, it's silly to try to compete unless you want to take it as seriously as the professionals do and get plugged in the way they are. The "random walk" hypothesis says you can beat the professionals. About half the time. By flipping a coin. But the professionals are insiders, and as well-regulated as the stock market is, I would assume that an outsider playing against insiders in a 50/50 game will not quite win his full 50% share. The hope that a person can price stocks better than the market as a whole rests on a couple of possibilities: 1. Beating full-time professional analysts at analysis in your spare time, because you're just so bad-ass. 2. Identifying a price that is heavily influenced by ignorant people and beating them by just being reasonably well-informed -- but this is not an original idea and hence is a special case of #1. 3. Finding a niche that you know intimately for some reason, and in which you have no professional competition. Oh, wait, this is just #2 again. Or maybe you found a niche small enough that it doesn't get a lot of attention from professional analysts, and you can make a little bit of money at it. That might work! 4. Being the first one to take into account a new idea or source of information. This one will make you wildly rich, and it's fun to dream, but while you're looking for that brilliant idea, there's no reason to risk real money on your ideas-in-progress.

jeffmiller 16y ago

It should be mentioned that this article is from December 2006, when index funds were less widely adopted than they are today.

jasonkester 16y ago
??? Index funds were as widely adopted as you could ask for back in 1996 when I first started investing in them. And it was common knowledge even then that the S&P 500 tended to outperform 70%+ of managed mutual funds. If that's the message this article is trying to convey, it certainly has the wrong title.

kevinburke 16y ago

Along the same lines here's an interview with a guy who's essentially shaped my investment philosophy: http://www.kirkreport.info/2009/03/qa-with-less-antman.html http://www.kirkreport.info/2009/03/qa-with-less-antman.html

philfreo 16y ago

Interesting comment on that article: Index investing (applied to extremely wide market indexes) makes an assumption that there will be a continuous and infinite increase in the total market capitalization of that index. As time marches forward I beleive we will experience a deceleration of worldwide market cap increase. Anyone have thoughts on this?

akg_67 16y ago
I have several concerns with index fund/ETF investing: 1. How much of the underlying stocks, that make up the Index, are really owned by the Index fund/ETF? I doubt that such funds/ETF actually own 100% of the required underlying stocks, may be using some sort of option/hedge strategy. 2. In what scenario, not owning the actual underlying stocks can be detrimental to index fund/ETF? I am looking for what may cause failure of such funds/ETF and who may lose. 3. Is index fund/ETF investing artificially inflating price for underlying stocks compared to price of the rest of the non-index stocks in the market? 4. Can index investing cause Index "Bubble"?
- joelhaus 16y ago
  1. An index is generally creared to the target mwarket.
- regularfry 16y ago
  The problem is that "ETF" is actually quite a broad term. As far as I can tell, many ETF's do run a sort of "fractional reserve" ratio. There was an article here not long ago wringing its hands over that danger which I can't find right now. The answer to 2 I think depends on how dividends are handled. Obviously if you hold the shares yourself, you control what happens to the dividends, and are free to take them or reinvest them as you wish. For 3, it depends on the ratio of index trackers to managed funds in the market, but yes, this can have a noticeable effect. A share price always dips when the it's removed from one of the larger indices; you can see an example here: http://uk.finance.yahoo.com/q/bc?s=TATE.L&t=2y&l=on&z=l&q=l&c= http://uk.finance.yahoo.com/q/bc?s=TATE.L&t=2y&l=on&... - they were removed from the FTSE100 in March 2009.
- 16y ago

sram 16y ago

I got a wake up call about 4 years ago when my broker tried to convince me to buy into a hedge fund. Buried in the prospectus was an entry load of 8%. Fired him, and have been in index funds since.

by 16y ago

Index funds seem to me to work by reducing churn - the percentage of your stock that is sold and bought each year - because every time you sell then buy you lose a lot of money. I am not yet convinced you have to follow an index. If you had a fund that did not sell anything and bought a random stock from an index as funds came in would this beat an index fund?

hnhg 16y ago
Think of the index fund as reducing the risk of depending on any one stock for your gains. I don't know what the distribution of gains is like on an index fund but an answer to your question would likely come from an examination of one.
- by 16y ago
  My theoretical fund would have a wide range of stocks. It does not seem to be related to spreading gains or risks. I have not seen any comparative table of stock churn rates for different funds, but my guess is that index funds do well because they reduce the sell-buy transaction costs, partly by eliminating the cost of human stock pickers, but primarily by reducing the percentage of stocks in the fund that are sold then bought every year. Maybe this is wrong? My understanding is that an index fund sells and buys stocks to balance the proportions held in the fund as the market capitalisation of the companies changes inside the index. This imposes an apparently unnecessary cost on the fund. If we removed this cost by not selling and buying stocks to keep it equal to the index would the fund become more profitable? I am considering it to be a fund where people invest incrementally over a long period so there would be constant random aquisition of new stocks from the index. Maybe that doesn't make sense for some reason.
  - Benjo 16y ago
    Balancing portfolios is basically a universally recommended practice. If you manage your own portfolio, won't you have a similar "churn rate" to the index fund?
    - 16y ago

bravura 16y ago

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S & P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.” - Warren Buffet http://www.longbets.org/362 http://www.longbets.org/362

jules 16y ago
> Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors. This argument is wrong? edit: it's like saying this about strategies of chess players, one group is using strategy A and another is using strategy B: Chess players using strategy A are known to perform about average (by the nature of their strategy). So this new strategy, B, has to perform about average too. This neglects that there are other strategies than A and B. The whole world is not either passive investors or hedge funds. And he's saying something even stronger: there is no subset of B players that is better than average. So while he may well be correct in his prediction, he makes it sound like he has a mathematically tight argument for why he is correct. But the conclusion of his argument (that active investors will perform about average) is not the prediction of his bet (that hedge funds will perform about average, and because they have higher operating cost they will lose).
- drblast 16y ago
  He's making the (correct) assumption that the speculative stock market where active investors expect to make their money is a zero-sum game. For there to be winners in "buy low, sell high" there have to be an equal amount of losers. So, if there are going to be winners, there have to be an equal amount of losers. It's difficult to siphon money off of someone passively invested in an index fund, so the active investors are competing against themselves. Because active investment has a much higher cost than passive, as a group they will be significantly worse off compared to passive investors. This is so self-evident as to be not even worth betting against. Note that this isn't to say that there won't be big active winners individually. But in a chess tournament, if the top players use strategy A that wins 90% of the time, and others use strategy B that wins 51% of the time, that guarantees the existence of some other strategy that performs below average. The stock market isn't necessarily a zero-sum game like chess because companies pay dividends, but that's rare and small enough to be insignificant compared to the amount of money gained and lost through speculation.

jteo 16y ago

2 words: Renaissance Technologies http://en.wikipedia.org/wiki/Renaissance_Technologies http://en.wikipedia.org/wiki/Renaissance_Technologies

dschobel 16y ago
the article addresses hedge funds near the end.
jedc 16y ago
Agree, but: 1) They're a huge, huge outlier 2) Any of Renaissance's funds are not nearly as scalable as a passive index fund 3) As a hedge fund will still take a big chunk out of returns as fees
rorrr 16y ago
You can't just invest in a hedge fund, there are some crazy requirements. As an individual investor you have to make $200,000 for at least two years straight.
ladyada 16y ago
In some alternate HN that existed 10 years ago someone posted "4 letters: LTCM" :)

JSig 16y ago

One way to beat index funds is through piggyback investing on those who can beat them. Check out http://alphaclone.com/ http://alphaclone.com/ You have to pay for a membership but the site is top notch. They parse investment fund's sec filings and allow you to backtest strategies to see how well they would have performed over a given time frame. You will find strategies that crush any index fund. I am not affiliated with alphaclone.com.

eru 16y ago
In retrospect there will always be strategies that will beat any index fund. But can you identify such a strategy beforehand?

GFischer 16y ago

I always thought of the stock market as a form of gambling, and this quote hints at that: "a list of advantages of active management, which essentially boiled down to the fact that it’s more fun" also: "There is an innate cultural imperative in this country to beat the odds" and the stock market is viewed as better than casinos for this kind of gambling.

antareus 16y ago

I'm 28, and I don't want to end up like Liz Lemon ("well I have $12,000 in checking"). What's a good primer on investing? I don't have a ton of money but I'd like to get into it.

eru 16y ago
Depends on what country you (or your money) live in. In the US has some low fee index funds. In Germany I used an ETF of max-blue. Just find a low fee diversified index fund, and then get back to your normal work. (Unless you enjoy playing the stock market, than there's nothing wrong with active investment. Just as some people enjoy playing the lottery (only the expected value of active investment isn't as dismal as playing the lottery).) Benjamin Graham's "Security Analysis" is a good primer, if you really want to get into stock or bond trading, or are just interested on an intellectual level. It's a hard book. Make sure you use a tax efficient way to invest. If you can invest with pre-tax money, do so.
wrs 16y ago
I recommend Andrew Tobias's classic _The Only Investment Guide You'll Ever Need_. Very sensible, and very readable. http://www.andrewtobias.com/theonly.html http://www.andrewtobias.com/theonly.html
- antareus 16y ago
  Will take a look, thanks.