Index funds beat most active funds

[saluki9]

"Active investing is therefore a zero-sum game. The only way for one active investor to do better than average is for another active investor to do worse than average" Fortune's Formula (Page 170) by Willian Poundstone

It's actually worse than that. All investors divy up the market return MINUS EXPENSES.

 

[Patrick]

"Active investing is therefore a zero-sum game. The only way for one active investor to do better than average is for another active investor to do worse than average" Fortune's Formula (Page 170) by Willian Poundstone

This is true for non-active investors too, since they don't actually make any money until they sell, and someone has to be on the "buy" side of the equation at that time.

 

[Nords]

Not disputing your overall point, but ... if the SP500 index is lower (or equal to) what it was in 2000, and overall return has averaged 6.8%, doesn't that imply that the dividend yield was 6.8% or more ? What am I missing ?

I think that's a total return of 6.8% over the last five-six years, not an average annual return.

"Active investing is therefore a zero-sum game. The only way for one active investor to do better than average is for another active investor to do worse than average" Fortune's Formula (Page 170) by Willian Poundstone

Luckily it's not hard to find those worse-than-average active investors... and their fund managers.

 

[JustCurious]

Your analysis is well thought out, but your info on the S&P 500 Index fund is inaccuarate:

[url]http://www.beaconequityresearch.com/resource-ind_sp500.php [/url]

You are correct that the SP500 is not limited to the 500 largest stocks, and that is why I used the modifier "generally" when I said the SP500 generally tracks the largest 500 stocks. According to Standard and Poor's, a publicly traded company must have a market capitalization of at least 4 billion dollars to be considered for inclusion in the 500 index (among other criteria), and they also state that the 500 index focuses on the large cap segment of the US stock market. So my point that the SP500 is a good benchmark for large cap mutual funds is valid.

 

[JustCurious]

I think that's a total return of 6.8% over the last five-six years, not an average annual return.
Luckily it's not hard to find those worse-than-average active investors... and their fund managers.

Nords, actually, 6.8 percent does reflect the average annual return, not the total return, of Vanguard's SP500 index fund for the last 5 years, up to Sep. 30, 2006. Go to vanguard.com, and look at the performance for VFINX.

 

[FinanceDude]

You are correct that the SP500 is not limited to the 500 largest stocks, and that is why I used the modifier "generally" when I said the SP500 generally tracks the largest 500 stocks. According to Standard and Poor's, a publicly traded company must have a market capitalization of at least 4 billion dollars to be considered for inclusion in the 500 index (among other criteria), and they also state that the 500 index focuses on the large cap segment of the US stock market. So my point that the SP500 is a good benchmark for large cap mutual funds is valid.

Good point.............the only real problem I have with the S&P is the market cap weighted approach...........i.e. the blue chips will dominate the index, and I feel that is not as broad-based as one would think. MSFT comes to mind, it's in ALL THREE major indexes.......ergo it is hard to get away from..............

I had a Wall Street trader tell me that a $1.00 move in MSFT would raise the Dow 93 points by itself.....................

 

[JustCurious]

Good point.............the only real problem I have with the S&P is the market cap weighted approach...........i.e. the blue chips will dominate the index, and I feel that is not as broad-based as one would think. MSFT comes to mind, it's in ALL THREE major indexes.......ergo it is hard to get away from..............

I had a Wall Street trader tell me that a $1.00 move in MSFT would raise the Dow 93 points by itself.....................

You raise another good point, that many people use the S&P 500 index as a barometer of the entire US market, when it is far, far from that! In my opinion, the best index to reflect the whole of the U.S. stock market is the Dow Jones Wilshire 5000 index (^DWC).

 

[MasterBlaster]

You raise another good point, that many people use the S&P 500 index as a barometer of the entire US market, when it is far, far from that! In my opinion, the best index to reflect the whole of the U.S. stock market is the Dow Jones Wilshire 5000 index (^DWC).

The Wilshire 5000 is also market cap weighted and suffers from the same issues that the S&P500 does

 

[JustCurious]

To illustrate the difference between the S&P 500 index, as compared to the total US market consider this:

The five year average annual return of VFINX (Vanguard's S&P500 index fund) is 6.85 percent.

The five year average annual return of SWTIX (Schwab's total stock index fund which tracks the Wilshire 5000 index) is 8.40 percent.

The difference is attributable to the fact that the total stock market fund benefited from the relatively good performance of small and mid cap stocks over the last 5 years, as compared to large cap stocks. And consider that the person who invested in the total stock market fund over the last 5 years earned 1.55 percent more each year with LESS RISK. (they were more diversified)

 

[MasterBlaster]

JC: Nobody refutes your figures.

However, because the S&P500 and the Wilshire 5000 indices are dominated by a relatively few large cap stocks the relative movement of the index (or indices) is not always indicative of the relative movement of the US economy.

That was the point made. That both of these indices suffer from that issue not just the S&P500.

 

[JustCurious]

JC: Nobody refutes your figures.

However, because the S&P500 and the Wilshire 5000 indices are dominated by a relatively few large cap stocks the relative movement of the index (or indices) is not always indicative of the relative movement of the US economy.

That was the point made. That both of these indices suffer from that issue not just the S&P500.

MB, I did not suggest that the Wilshire 5000 index is "indicative of the relative movement of the US economy." I suggested that it is a very good indicator of the US stock market.

 

[mickeyd]

" A passive investor is defined as anyone sensiable enough to realize you can't beat the market. The passive investor puts all his money into a market portfolio of every stock in existance.

An active investor is anyone who suffers from the delusion that he can beat the market. The active investor puts his money into anything except a market portfolio." Fortune's Formula

 

[SecondCor521]

However, because the S&P500 and the Wilshire 5000 indices are dominated by a relatively few large cap stocks the relative movement of the index (or indices) is not always indicative of the relative movement of the US economy.

MB, I'd like to understand this point better. What would you suggest is the best proxy for "the relative movement of the US economy"? If a person is just discussing stocks, I think that ^DWC (and mutual funds like SWTIX and VTSMX) does a pretty swell job. Clearly they don't reflect the performance of bonds, real estate, commodities, collectibles, or cash. Please clarify, thanks.

Edit: I see JC has made a similar point.

2Cor521

 

[MasterBlaster]

JC:

Well that is only true if your portfolio or "the stock market" reflects the market cap distribution of the indices.

If like many people you hold a portfolio of individul stocks then your premise is probably invalid.

Again, the indices move up or down based largely on the heavy weighting of those few large cap stocks. The market as a whole may do otherwise.

 

[MasterBlaster]

SC521, MickD, JC:

I was just making a point about the cap weighted issues of the indices.

The optimal weighted portfolio is up for discussion. John Bogle of Vanguard believes (like you) that the market cap weighted approach is best. There are others that beleive that your portfolio should be in as many un-correlated buckets as possible and that the market cap weighted approach is sub-optimal.

 

[JustCurious]

JC:

Well that is only true if your portfolio or "the stock market" reflects the market cap distribution of the indices.

If like many people you hold a portfolio of individul stocks then your premise is probably invalid.

Again, the indices move up or down based largely on the heavy weighting of those few large cap stocks. The market as a whole may do otherwise.

I agree to a point, that if you hold one of each of the 5,000 stocks in the market (a ball park figure) that the Wilshire 5000 index will move slightly differently than your portfolio because the movement of the large market cap stocks will more heavily influence the index than your portfolio.

However, I respectfully disagree that the Wilshire 5000 index does not reflect "the market as a whole." The value of the entire market is, itself, weighted more heavily toward the large capitalization stocks in greater proportions than simply the number of large cap stocks would indicate. (Stated differently, the market value of Microsoft is far far greater than the market value of Sears, so it is fair that a change in the value of Microsoft stock should have a greater influence on the index) Thus, the market weighted index accurately reflects the market weighted market.

 

[JustCurious]

SC521, MickD, JC:

I was just making a point about the cap weighted issues of the indices.

The optimal weighted portfolio is up for discussion. John Bogle of Vanguard believes (like you) that the market cap weighted approach is best. There are others that beleive that your portfolio should be in as many un-correlated buckets as possible and that the market cap weighted approach is sub-optimal.

MB, you are mixing issues together. I NEVER said that a market weighted portfolio is best. I said that the Wilshire 5000 is probably the best index to track the performance of the entire US stock market.

Whether you should invest your portfolio in the same weight as the US Stock market is a different discussion.

 

[MasterBlaster]

JC:

I believe that we are all on the same page here.

 

[mickeyd]

the Wilshire 5000 is probably the best index to track the performance of the entire US stock market.

Vanguard disagrees as they use the MSCI US Broad Market Index for the Total Stock Market Index Fund as it better reflects the stocks that are available for trade (all regularly traded US stocks).

 

[Mr._johngalt]

I can't understand how after over 7,000 posts here you still can't figure out how to 1) post with a quote and 2) go back and fix the original mistake without posting a second post on the same topic. It really isn't that difficult is it?

Nope. Not difficult. I just don't want to. How's that smart guy?

JG

 

[mathjak107]

5 years is to short a time to really see whats going on, asset classes havent had a chance to even get a good run.

the last 5 years my average annual is about 6.8% but if you pull out any 10 year time frames of my annual returns they all seem to smooth out at about 12.8 % annual average . What makes it so amazing is most of the time im no more than 80% in stock and as little as 65-70%...

as of last year i toned it down and run around 60% stock and 40% everything else.

 

[mickeyd]

I'm sure that MF companies will be glad to get rid of 2001 and 2002 in their 5 Year #. This will make their 5 yr total look better however, it will still influence the 10 year # for quite a while.

This is why you need to keep a perspective when looking at your total returns. It's all very relative.

 

[JustCurious]

5 years is to short a time to really see whats going on, asset classes havent had a chance to even get a good run.

the last 5 years my average annual is about 6.8% but if you pull out any 10 year time frames of my annual returns they all seem to smooth out at about 12.8 % annual average . What makes it so amazing is most of the time im no more than 80% in stock and as little as 65-70%...

as of last year i toned it down and run around 60% stock and 40% everything else.

I agree that it's better to look at 10 year returns. The 10 year return for VFINX right now is 8.51 percent. I hope your right that the returns "smooth out" to about 12.8 percent, but only time will tell.

 

[mathjak107]

remember also indexes for some crazy reason never include dividends which to me dosnt make sense.

 

[rmark]

The advantage of the cap weighted index fund is that no rebalancing transactions are needed as the values of the individual stocks in the index change. Early attempts to equal weight an index incurred high rebalancing transaction costs.

Comparing passive index funds and active management is really making no comparison at all, other than expenses. You need to specify which active trading stratgey will beat the passive index. (head & shoulders patterns, momentum, value, fibonacci numbers, phases of the moon)