7 ms·

Short answer re: investing in active managers (based on my many years listening to rationalreminder.ca) is that, if you eliminate some of the worst active manag

by elil17 2y ago

Short answer re: investing in active managers (based on my many years listening to rationalreminder.ca) is that, if you eliminate some of the worst active managers, the average returns net of fees are the same. However, eliminating the worst managers is challenging (but not impossible) to do ex-ante. Even then, you’re only getting the same average returns as indexing, not better. Plus, you will experience a higher dispersion with active managers (greater chance of extreme negative or positive outcome), which is not desirable. Because of these two issues, It’s definitely better to pick an index fund. Re: picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Active managers can only beat the market gross of fees because they employ large teams of people to do a lot of work to gain a small edge (stuff like predicting retail sales numbers from satellite images of store parking lots). This is my attempt at summarizing a whole field of research in a few sentences. There are many more nuisances. I highly recommend listening to the Rational Reminder podcast if you’re curious about this sort of thing. They interview a lot of academics.

chii 2y ago
> a higher dispersion with active managers (greater chance of extreme negative or positive outcome), which is not desirable. some people prefer the chance to win the lottery rather than get a steady income stream.
- throwaway2037 2y ago
  Except this is a myth. You will not win the lottery without taking crazy amounts of risk. The active managers who do beat a major index for a long, long time almost do not exist in retail space, and they beat the market by a tiny amount (~1%). In my era Legg Mason was the most famous, but even they fell too.
  - selestify 2y ago
    How does that explain Warren Buffet’s spectacular success?
    - supertrope 2y ago
      When you own one billionth of a company you are just along for the ride. When you buy a 10% or more stake you can influence the running of the company. Another aspect is he has offered liquidity to distressed companies like GE and got richly rewarded for it with favorable terms.
    - anamax 2y ago
      Someone with Buffet's success should exist by random chance. (Flip a fair coin enough times and it will come up heads 20 times in a row.) Also, some fraction of Buffet's success comes from deals that the rest of us don't have access to.
      - mewpmewp2 2y ago
        Yeah, I have tried to simulate this several times under different conditions. Given zero sum game and random odds, there is always going to be small percentage who have a lot and most will have below what they started with. It is easy to explain as well, if you for example start with $1000 and you have 50% odds of winning 10% every time. If you win and lose 50% you are going to be below what you started. If you always win after lose and lose after win, then it would go like this: 1. $1000 2. $1100 3. $990 4. $1089 And so on... After 100 turns you would have only around 600 - 700. But it's a zero sum right. Where does the 300 - 400 go? It goes exponentially to select few who by random chance have more wins than losses. In fact the longer it goes on, the higher odds of there being outlier with a lot - you might expect that everyone would converge around $1000, but that is not the case. I did an example run with 10 000 investors, each doing 1000 trades, each trade they bet 10% of their portfolio, with 50% odds of winning. First investor had 562 wins and 438 losses, with $1,666,061. Median investor had only $7 left with 500 wins and 500 losses. Top 10th percentile investor had $364 with 520 wins and 480 losses. So interestingly even an investor that had 40 wins more than losses, lost 2/3 of portfolio.
        redox99 2y ago
        Stock market is not zero sum.
Galanwe 2y ago
There's more dimensions to an investment than average returns. Volatility adjusted returns (or Sharpe ratio) for instance, will tell you how much returns you have per unit of risk you take. This is important because getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility. You can only compare investments at equal amount of risk. An other factor to take into account is diversification. If you have an alternative investment to compare to your base, and it's average returns is lower than your base, but it is un correlated, then you actually get an increased volatility adjusted average returns by investing in both. That's just two dimensions to take into account, there are many others, but overall: - Don't compare investments based on annualized returns alone, it really doesn't make any sense. - Don't compare investments one against an other, instead look at the addivity of one on top of another.
- Karellen 2y ago
  > getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility. Doesn't this depend on how long you're planning on investing for, and what your criteria for selling your investments are? If you're planning on investing for at least 10 years, and you're willing to give yourself a 2-3 year window for selling your investments once they reach a threshhold you decide on ahead of time, isn't the 10%/10% investment better? (e.g. if retirement is 20 years away, you might consider putting your funds in that sort of investment for 10 years, with a view to moving them to something less volatile in the 5 years after that, as soon as they cross a 10% annualised return threshhold during that window.)
  - Galanwe 2y ago
    > isn't the 10%/10% investment better? If you consider that "you don't know any better" and returns are normally distributed (i.e. you don't have some secret sauce nobody else knows about), then there is no dimension in which the 10/10 is better. You can convince yourself intuitively by imagining how you would maximize each strategy. The amount of money you have is a factor of the risk you take, because if you want to do something risky you will not be able to borrow much, whereas if you want to do something safe you can easily borrow. That is, you objective is to maximize your expected return, under the constraint of not breaking your risk limit. Suppose you have a 10% annualized volatility risk tolerance. That's your budget. If you invest it all in a 10% average return / 10% annual vol strategy, that's it. Now if I propose you a 5% average return / 1% volatility strategy, you just have to go to the bank and borrow 10x your capital. You will have the same risk exposure (in dollar), but 5x the expected returns.
personjerry 2y ago
> There’s strong evidence no individual trader can expect to beat the market. I don't understand that. If you just bought Apple instead of SPY 20 years ago wouldn't you be doing great?
- desmosxxx 2y ago
  You do know there are thousands of stocks right. how many people dump their entire savings into one stock. 20 years ago you wouldn't have known apple was going on to do so well. If people did know it would have been bid up in price at the time
  - qwytw 2y ago
    Which still means that SOME individual investors will inevitably beat the market.
    - amanaplanacanal 2y ago
      Some will, but there is no reliable way to tell which one in advance.
      - ghaff 2y ago
        And a lot of the Apple run-up happened relatively late in the game. Don't get me wrong. Apple--and what I was able to do with the money--was good to me. But so was a late 2010s Microsoft purchase and I don't think a lot of people are highlighting Microsoft as a stock they missed out on during the last 10 years.
- cowthulhu 2y ago
  The key is that for every Apple, there are a ton of companies we don’t even remember the names of that went out of business or otherwise did not beat the SP500. Put another way - if you can reliably pick the next Apple before anyone else, you should go work in finance and make tons of money.
qwytw 2y ago
> picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Is there? It would make sense if an average individual trader can't expect to beat the market. Claiming that there are no individual investors who did/can do that over a reasonably long period is both objectively false and rather absurd.
- hibikir 2y ago
  Read the GP carefully.Expect to beat is very different than beat. You don't expect to beat the casino in roulette, but some people will luck out. That doesn't mean they could expect to win in advance: They should expect a small loss, depending on the table, and be surprised when luck smiles upon them.
  - qwytw 2y ago
    > You don't expect to beat the casino in roulette, Do you believe that investment is entirely random and there is absolutely no skill involved? Because if not, that's a nonsensical analogy. You should use a a both both luck and skill based game like poker (probably not the casino variety, though) etc. Otherwise if you can reasonably expect to beat 50% of all "players" (of course it takes much more time to verify that in the market) then you can expect to make more than the average.
    - ryandrake 2y ago
      > Do you believe that investment is entirely random and there is absolutely no skill involved? The skill involved is more just "best practices" that let you match the market: Buy-and-hold, diversify, basically, do what the index funds do and you will be roughly +0 to the market. Beyond that, it's a totally random distribution that adds between -X and +X which allows some participants to beat the market and causes some to underperform. You can't tell beforehand which participants will beat the market, even having full knowledge of their strategies and skill. If you think you can, please tell me which active funds will beat the market in the next 10 years based on their skills. I'll invest in them.

by elil17 2y ago

chii 2y ago

> a higher dispersion with active managers (greater chance of extreme negative or positive outcome), which is not desirable. some people prefer the chance to win the lottery rather than get a steady income stream.

throwaway2037 2y ago
Except this is a myth. You will not win the lottery without taking crazy amounts of risk. The active managers who do beat a major index for a long, long time almost do not exist in retail space, and they beat the market by a tiny amount (~1%). In my era Legg Mason was the most famous, but even they fell too.
- selestify 2y ago
  How does that explain Warren Buffet’s spectacular success?
  - supertrope 2y ago
    When you own one billionth of a company you are just along for the ride. When you buy a 10% or more stake you can influence the running of the company. Another aspect is he has offered liquidity to distressed companies like GE and got richly rewarded for it with favorable terms.
  - anamax 2y ago
    Someone with Buffet's success should exist by random chance. (Flip a fair coin enough times and it will come up heads 20 times in a row.) Also, some fraction of Buffet's success comes from deals that the rest of us don't have access to.
    - mewpmewp2 2y ago
      Yeah, I have tried to simulate this several times under different conditions. Given zero sum game and random odds, there is always going to be small percentage who have a lot and most will have below what they started with. It is easy to explain as well, if you for example start with $1000 and you have 50% odds of winning 10% every time. If you win and lose 50% you are going to be below what you started. If you always win after lose and lose after win, then it would go like this: 1. $1000 2. $1100 3. $990 4. $1089 And so on... After 100 turns you would have only around 600 - 700. But it's a zero sum right. Where does the 300 - 400 go? It goes exponentially to select few who by random chance have more wins than losses. In fact the longer it goes on, the higher odds of there being outlier with a lot - you might expect that everyone would converge around $1000, but that is not the case. I did an example run with 10 000 investors, each doing 1000 trades, each trade they bet 10% of their portfolio, with 50% odds of winning. First investor had 562 wins and 438 losses, with $1,666,061. Median investor had only $7 left with 500 wins and 500 losses. Top 10th percentile investor had $364 with 520 wins and 480 losses. So interestingly even an investor that had 40 wins more than losses, lost 2/3 of portfolio.
      - redox99 2y ago
        Stock market is not zero sum.

Galanwe 2y ago

There's more dimensions to an investment than average returns. Volatility adjusted returns (or Sharpe ratio) for instance, will tell you how much returns you have per unit of risk you take. This is important because getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility. You can only compare investments at equal amount of risk. An other factor to take into account is diversification. If you have an alternative investment to compare to your base, and it's average returns is lower than your base, but it is un correlated, then you actually get an increased volatility adjusted average returns by investing in both. That's just two dimensions to take into account, there are many others, but overall: - Don't compare investments based on annualized returns alone, it really doesn't make any sense. - Don't compare investments one against an other, instead look at the addivity of one on top of another.

Karellen 2y ago
> getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility. Doesn't this depend on how long you're planning on investing for, and what your criteria for selling your investments are? If you're planning on investing for at least 10 years, and you're willing to give yourself a 2-3 year window for selling your investments once they reach a threshhold you decide on ahead of time, isn't the 10%/10% investment better? (e.g. if retirement is 20 years away, you might consider putting your funds in that sort of investment for 10 years, with a view to moving them to something less volatile in the 5 years after that, as soon as they cross a 10% annualised return threshhold during that window.)
- Galanwe 2y ago
  > isn't the 10%/10% investment better? If you consider that "you don't know any better" and returns are normally distributed (i.e. you don't have some secret sauce nobody else knows about), then there is no dimension in which the 10/10 is better. You can convince yourself intuitively by imagining how you would maximize each strategy. The amount of money you have is a factor of the risk you take, because if you want to do something risky you will not be able to borrow much, whereas if you want to do something safe you can easily borrow. That is, you objective is to maximize your expected return, under the constraint of not breaking your risk limit. Suppose you have a 10% annualized volatility risk tolerance. That's your budget. If you invest it all in a 10% average return / 10% annual vol strategy, that's it. Now if I propose you a 5% average return / 1% volatility strategy, you just have to go to the bank and borrow 10x your capital. You will have the same risk exposure (in dollar), but 5x the expected returns.

personjerry 2y ago

> There’s strong evidence no individual trader can expect to beat the market. I don't understand that. If you just bought Apple instead of SPY 20 years ago wouldn't you be doing great?

desmosxxx 2y ago
You do know there are thousands of stocks right. how many people dump their entire savings into one stock. 20 years ago you wouldn't have known apple was going on to do so well. If people did know it would have been bid up in price at the time
- qwytw 2y ago
  Which still means that SOME individual investors will inevitably beat the market.
  - amanaplanacanal 2y ago
    Some will, but there is no reliable way to tell which one in advance.
    - ghaff 2y ago
      And a lot of the Apple run-up happened relatively late in the game. Don't get me wrong. Apple--and what I was able to do with the money--was good to me. But so was a late 2010s Microsoft purchase and I don't think a lot of people are highlighting Microsoft as a stock they missed out on during the last 10 years.
cowthulhu 2y ago
The key is that for every Apple, there are a ton of companies we don’t even remember the names of that went out of business or otherwise did not beat the SP500. Put another way - if you can reliably pick the next Apple before anyone else, you should go work in finance and make tons of money.

qwytw 2y ago

> picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Is there? It would make sense if an average individual trader can't expect to beat the market. Claiming that there are no individual investors who did/can do that over a reasonably long period is both objectively false and rather absurd.

hibikir 2y ago
Read the GP carefully.Expect to beat is very different than beat. You don't expect to beat the casino in roulette, but some people will luck out. That doesn't mean they could expect to win in advance: They should expect a small loss, depending on the table, and be surprised when luck smiles upon them.
- qwytw 2y ago
  > You don't expect to beat the casino in roulette, Do you believe that investment is entirely random and there is absolutely no skill involved? Because if not, that's a nonsensical analogy. You should use a a both both luck and skill based game like poker (probably not the casino variety, though) etc. Otherwise if you can reasonably expect to beat 50% of all "players" (of course it takes much more time to verify that in the market) then you can expect to make more than the average.
  - ryandrake 2y ago
    > Do you believe that investment is entirely random and there is absolutely no skill involved? The skill involved is more just "best practices" that let you match the market: Buy-and-hold, diversify, basically, do what the index funds do and you will be roughly +0 to the market. Beyond that, it's a totally random distribution that adds between -X and +X which allows some participants to beat the market and causes some to underperform. You can't tell beforehand which participants will beat the market, even having full knowledge of their strategies and skill. If you think you can, please tell me which active funds will beat the market in the next 10 years based on their skills. I'll invest in them.