4 ms·

Point two is double edged, it also picks all losers.

by epolanski 3y ago

WrongAssumption 3y ago
Sure, but the losers go down between 1-100%, while winners are virtually uncapped.
- eru 3y ago
  It's a pretty common strategy to sell covered calls on your portfolio. That caps your upside from infinite to finite. But you collect a steady stream of option premiums. The result doesn't look all that different on average from just investing in the plain index fund. You just get a different risk distribution. (Similarly, you can invest in an index fund that tracks (junk) bonds. Upside is finite there as well.)
FullyFunctional 3y ago
As Motley Fools [1] like to point out, the most you can loose is 100% whereas the upside is unbounded. This means that even if all but one investment turns completely to dust, if that one is outstanding it makes up for it all. We are actually in that situation now where the gains of S&P 500 relies completely on the top handful of companies and as much as (IIRC) 70% of the companies in S&P 500 are lagging the market. [1] This is not an endorsement; my personal experience with their pool was mediocre at best.
- jacquesm 3y ago
  > if that one is outstanding it makes up for it all. It may well be outstanding and still not make up for it all. > This is not an endorsement; my personal experience with their pool was mediocre at best. That's the opposite of an endorsement!
  - thfuran 3y ago
    >It may well be outstanding and still not make up for it all. That sounds like, at best, pretty great.
- eru 3y ago
  > As Motley Fools [1] like to point out, the most you can loose is 100% whereas the upside is unbounded. This means that even if all but one investment turns completely to dust, if that one is outstanding it makes up for it all. I doubt that qualitative assessment holds up when you add some numbers. As a thought experiment, imagine a portfolio that generally replicates the S&P500, but also sells covered out-of-the-money calls on all the stocks. (Whenever a call triggers, you re-balance your portfolio. Let's ignore transaction costs for now.) According to the efficient market hypothesis, the portfolio sketched above will have roughly the same average returns as the S&P500. Especially if the calls sold are far-out-of-the-money.
- geysersam 3y ago
  > As Motley Fools [1] like to point out, the most you can loose is 100% whereas the upside is unbounded. Reminds me of the gamblers ruin paradox. In some games even if the expected payout from each round is positive, it can be shown that the gamblers wealth goes to 0 over suffiently large time scales with probability 1.
  - chrinc9203 3y ago
    > it can be shown that the gamblers wealth goes to 0 over suffiently large time scales with probability 1. In real life, the time scales are not long enough and the number of N samples in one’s life is too small. This is why retirees over age 60 are concerned with “sequence risk”. That is, you get unlucky VTI/VOO/S&P returns for 5 years, but you don’t live long enough for the average to come back to 8-10%. Downside risk becomes more important than average return.
    - jedberg 3y ago
      I have the same sequence risk when I gamble. I know the average is that I should lose, but I also know I'll never play enough in my lifetime to get enough samples. So I play games that are more likely to have sequences -- hand shuffled blackjack -- and more likely to win quickly and loose slowly -- the don't in craps.
- lotsofpulp 3y ago
  > We are actually in that situation now where the gains of S&P 500 relies completely on the top handful of companies and as much as (IIRC) 70% of the companies in S&P 500 are lagging the market. I believe I saw data that showed this has always been the case, but I can’t quickly find it.
throw0101d 3y ago
> Point two is double edged, it also picks all losers. Yes, but picking losers is a lot easier and winners a lot harder: > We study long-run shareholder outcomes for over 64,000 global common stocks during the January 1990 to December 2020 period. We document that the majority, 55.2% of U.S. stocks and 57.4% of non-U.S. stocks, underperform one-month U.S. Treasury bills in terms of compound returns over the full sample. Focusing on aggregate shareholder outcomes, we find that the top-performing 2.4% of firms account for all of the $US 75.7 trillion in net global stock market wealth creation from 1990 to December 2020. Outside the US, 1.41% of firms account for the $US 30.7 trillion in net wealth creation. * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3710251 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3710251 > Four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages. * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447 Over ten years, most individual stocks under perform a market index (even more so if stock was initially a top performer): > […] Since 1926, the median ten-year return on individual U.S. stocks relative to the broad equity market is –7.9%, underperforming by 0.82% per year. For stocks that have been among the top 20% performers over the previous five years, the median ten-year market-adjusted return falls to –17.8%, underperforming by 1.94 per year. Since the end of World War II, the median ten-year market-adjusted return of recent winners has been negative for 93% of the time. The case for diversifying concentrated positions in individual stocks, particularly in recent market winners, is even stronger than most investors realize. * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4541122 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4541122 Most stocks suck, and chances are generally low that you'll pick the non-sucky ones. Further, you have to buy when a non-sucky stock is or becomes not-sucky and then know when it does become sucky and sell before it drags down your returns. And not only do you have to be "good", you really should be better than just going for market returns (via a low-cost index fund). > But, what about stock picking? How long would it take to determine if someone is a good stock picker? > An hour? A week? A year? > Try multiple years, and even then you still may not know for sure. The issue is that causality is harder to determine with stock picking than with other domains. When you shoot a basketball or write a computer program, the result comes immediately after the action. The ball goes in the hoop or it doesn’t. The program runs correctly or it doesn’t. But, with stock picking, you make a decision now and have to wait for it to pay off. The feedback loop can take years. […] > This is the existential crisis that I am talking about. Why would you want to play a game (or make a career) out of something that you can’t prove that you are good at? If you are doing it for fun, that’s fine. Take a small portion of your money and have at it. But, for those that aren’t doing it for fun, why spend so much time on something where your skill is so hard to measure? * https://ofdollarsanddata.com/why-you-shouldnt-pick-individual-stocks/ https://ofdollarsanddata.com/why-you-shouldnt-pick-individua...
CodeWriter23 3y ago
>Point two is double edged, it also picks all losers. Not really. Standard and Poors evaluates the top 500 on a quarterly basis. The losing stocks are naturally purged from such index funds on a regular basis.
- eru 3y ago
  They can only pick them after they have already lost. In any case, broader index funds / indices that don't eliminate users as quickly (basically, only when they stop trading on public markets), don't do worse. So the mechanism you describe is pretty much irrelevant to the success of index funds. And so is the implied mechanism of 'picking all the winners'.
  - bombcar 3y ago
    And the index fund “trick” works just as well with total market indices (mainly because the total market return is those same ten percent captured by the S/P 500).
    - CodeWriter23 3y ago
      *except top Hedge Fund Manager lost the bet. I think it was 2-3 years in when he caved.

Point two is double edged, it also picks all losers.

WrongAssumption 3y ago

Sure, but the losers go down between 1-100%, while winners are virtually uncapped.

eru 3y ago
It's a pretty common strategy to sell covered calls on your portfolio. That caps your upside from infinite to finite. But you collect a steady stream of option premiums. The result doesn't look all that different on average from just investing in the plain index fund. You just get a different risk distribution. (Similarly, you can invest in an index fund that tracks (junk) bonds. Upside is finite there as well.)

FullyFunctional 3y ago

As Motley Fools [1] like to point out, the most you can loose is 100% whereas the upside is unbounded. This means that even if all but one investment turns completely to dust, if that one is outstanding it makes up for it all. We are actually in that situation now where the gains of S&P 500 relies completely on the top handful of companies and as much as (IIRC) 70% of the companies in S&P 500 are lagging the market. [1] This is not an endorsement; my personal experience with their pool was mediocre at best.

jacquesm 3y ago
> if that one is outstanding it makes up for it all. It may well be outstanding and still not make up for it all. > This is not an endorsement; my personal experience with their pool was mediocre at best. That's the opposite of an endorsement!
- thfuran 3y ago
  >It may well be outstanding and still not make up for it all. That sounds like, at best, pretty great.
eru 3y ago
> As Motley Fools [1] like to point out, the most you can loose is 100% whereas the upside is unbounded. This means that even if all but one investment turns completely to dust, if that one is outstanding it makes up for it all. I doubt that qualitative assessment holds up when you add some numbers. As a thought experiment, imagine a portfolio that generally replicates the S&P500, but also sells covered out-of-the-money calls on all the stocks. (Whenever a call triggers, you re-balance your portfolio. Let's ignore transaction costs for now.) According to the efficient market hypothesis, the portfolio sketched above will have roughly the same average returns as the S&P500. Especially if the calls sold are far-out-of-the-money.
geysersam 3y ago
> As Motley Fools [1] like to point out, the most you can loose is 100% whereas the upside is unbounded. Reminds me of the gamblers ruin paradox. In some games even if the expected payout from each round is positive, it can be shown that the gamblers wealth goes to 0 over suffiently large time scales with probability 1.
- chrinc9203 3y ago
  > it can be shown that the gamblers wealth goes to 0 over suffiently large time scales with probability 1. In real life, the time scales are not long enough and the number of N samples in one’s life is too small. This is why retirees over age 60 are concerned with “sequence risk”. That is, you get unlucky VTI/VOO/S&P returns for 5 years, but you don’t live long enough for the average to come back to 8-10%. Downside risk becomes more important than average return.
  - jedberg 3y ago
    I have the same sequence risk when I gamble. I know the average is that I should lose, but I also know I'll never play enough in my lifetime to get enough samples. So I play games that are more likely to have sequences -- hand shuffled blackjack -- and more likely to win quickly and loose slowly -- the don't in craps.
lotsofpulp 3y ago
> We are actually in that situation now where the gains of S&P 500 relies completely on the top handful of companies and as much as (IIRC) 70% of the companies in S&P 500 are lagging the market. I believe I saw data that showed this has always been the case, but I can’t quickly find it.

throw0101d 3y ago

> Point two is double edged, it also picks all losers. Yes, but picking losers is a lot easier and winners a lot harder: > We study long-run shareholder outcomes for over 64,000 global common stocks during the January 1990 to December 2020 period. We document that the majority, 55.2% of U.S. stocks and 57.4% of non-U.S. stocks, underperform one-month U.S. Treasury bills in terms of compound returns over the full sample. Focusing on aggregate shareholder outcomes, we find that the top-performing 2.4% of firms account for all of the $US 75.7 trillion in net global stock market wealth creation from 1990 to December 2020. Outside the US, 1.41% of firms account for the $US 30.7 trillion in net wealth creation. * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3710251 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3710251 > Four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages. * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447 Over ten years, most individual stocks under perform a market index (even more so if stock was initially a top performer): > […] Since 1926, the median ten-year return on individual U.S. stocks relative to the broad equity market is –7.9%, underperforming by 0.82% per year. For stocks that have been among the top 20% performers over the previous five years, the median ten-year market-adjusted return falls to –17.8%, underperforming by 1.94 per year. Since the end of World War II, the median ten-year market-adjusted return of recent winners has been negative for 93% of the time. The case for diversifying concentrated positions in individual stocks, particularly in recent market winners, is even stronger than most investors realize. * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4541122 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4541122 Most stocks suck, and chances are generally low that you'll pick the non-sucky ones. Further, you have to buy when a non-sucky stock is or becomes not-sucky and then know when it does become sucky and sell before it drags down your returns. And not only do you have to be "good", you really should be better than just going for market returns (via a low-cost index fund). > But, what about stock picking? How long would it take to determine if someone is a good stock picker? > An hour? A week? A year? > Try multiple years, and even then you still may not know for sure. The issue is that causality is harder to determine with stock picking than with other domains. When you shoot a basketball or write a computer program, the result comes immediately after the action. The ball goes in the hoop or it doesn’t. The program runs correctly or it doesn’t. But, with stock picking, you make a decision now and have to wait for it to pay off. The feedback loop can take years. […] > This is the existential crisis that I am talking about. Why would you want to play a game (or make a career) out of something that you can’t prove that you are good at? If you are doing it for fun, that’s fine. Take a small portion of your money and have at it. But, for those that aren’t doing it for fun, why spend so much time on something where your skill is so hard to measure? * https://ofdollarsanddata.com/why-you-shouldnt-pick-individual-stocks/ https://ofdollarsanddata.com/why-you-shouldnt-pick-individua...

CodeWriter23 3y ago

>Point two is double edged, it also picks all losers. Not really. Standard and Poors evaluates the top 500 on a quarterly basis. The losing stocks are naturally purged from such index funds on a regular basis.

eru 3y ago
They can only pick them after they have already lost. In any case, broader index funds / indices that don't eliminate users as quickly (basically, only when they stop trading on public markets), don't do worse. So the mechanism you describe is pretty much irrelevant to the success of index funds. And so is the implied mechanism of 'picking all the winners'.
- bombcar 3y ago
  And the index fund “trick” works just as well with total market indices (mainly because the total market return is those same ten percent captured by the S/P 500).
  - CodeWriter23 3y ago
    *except top Hedge Fund Manager lost the bet. I think it was 2-3 years in when he caved.