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Re: Is indexing good?
Old 12-07-2005, 09:13 PM   #61
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Re: Is indexing good?

Quote:
Originally Posted by Apocalypse . . .um . . .SOON
My final hypothetical example (maybe):* Let's say that the S&P 500 is up 3% ytd.* Let's say that Vanguard's S&P index was worth $50 billion at the beginning of the year.* Say it's worth $51 1/2 today.* *What if $500 million of new money (net of withdrawals) was put into their fund by investors.* That new money was put into the underlieing shares immediately as the money came in.* *To my mind, this new money drove up the prices of stocks in the index.* So $500* million/1500 million = 1/3 of the increase in the price of the fund.* *That--to me--is a large macro-misallocation of retirement money--33% of the gain or 1% of the total value of the fund.* I don't think my numbers are too far off, but it's a pure guess on net increases to Vanguard's S&P fund.* Ok, does anybody have a 'compounding' calculator?
I think your whole argument hinges on the misconception that the market is driven by index fund inflows. There are, however, legions of people and vast sums of money dedicated to exploiting miss-priced securities. Besides, if your example were true, wouldn't the components of the S&P 500 move more or less in lock step as new index money comes into the market?? Try selling that notion to the owners of GM stock! How does your world view account for the fact that individual securities within the index outperform / under perform the average? Clearly there are other forces at work that offset the influences of index fund flows. No?

If you have evidence that index funds are causing a "macro-misallocation" of capital please share it. It appears, however, that you have taken a simple hypothesis that "index investing mindlessly misallocates capital" and extrapolated that hypothesis into an unsupported conclusion that the entire equity market is being driven by some kind of ponzi scheme (hyperbole intended).
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Re: Is indexing good?
Old 12-07-2005, 11:19 PM   #62
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Re: Is indexing good?

Quote:
Originally Posted by . . . Yrs to Go
I think your whole argument hinges on the misconception that the market is driven by index fund inflows. There are, however, legions of people and vast sums of money dedicated to exploiting miss-priced securities. Besides, if your example were true, wouldn't the components of the S&P 500 move more or less in lock step as new index money comes into the market?? Try selling that notion to the owners of GM stock! How does your world view account for the fact that individual securities within the index outperform / under perform the average? Clearly there are other forces at work that offset the influences of index fund flows. No?

If you have evidence that index funds are causing a "macro-misallocation" of capital please share it. It appears, however, that you have taken a simple hypothesis that "index investing mindlessly misallocates capital" and extrapolated that hypothesis into an unsupported conclusion that the entire equity market is being driven by some kind of ponzi scheme (hyperbole intended).
YTG: I offered a hypothetical example about the the Vanguard S&P 500 Fund. The only number I was sure about was the 3% ytd gain, which is actually 3.1% according to this week's BusinessWeek. In a very real sense, the market (all financial products), the prices of individual stocks, bonds, etc., after they are aggregated, are driven up or down by money flow into and out of them. When the DOW is up 80 points on the day, then a certain amount of money flowed in--net gain 80 points. And although not mentioned directly before, yes I believe vast sums of money are being added to the system, much of it created out of thin air from the Fed. Start watching the money flow charts in the back of The Economist if you want to see some eye popping numbers.

In housing, the numbers are much easier to see and trace: When the economy tanked a few years back, the Fed did two things. First, it lowered interest rates to stimulate the economy. Then it created digital money and loaned it to the banks at a low rate. Banks of course borrowed at low rates and made mortgages at higher rates, making some of their money on the spread. This newly created money entered the economy as debt--held by mortgagees. This process initiated our current housing bubble as I see it. Mortgage rates are low so people can buy more house for the same amount of money. Sooner of later, this drives up the pricees of housing. Some people liked where they live, but after getting their house appraised at a much higher rate, they take out home equity loans. All this new found money stimulates the economy. Saying "it's a bubble" or a little frothiness is just one way of masking inflation. But it may just be "a short-term inflation if a recession occurs.

Price inflation is always a lagging indicator of true inflation, which is an increase of the money supply greater than the population growth. I believe it's the grease that has made the economy work so well over the past 20-30 years. (I said grease, there are many other major components) Grease when "correctly applied" is almost invisble to the naked eye. My belief is that first, Allen Greenspan, blew the tech bubble of 2000 with overly easy credit to everyone and liberal margin rates. After that fall, he blew the housing bubble. Did he purposely blow a housing bubble? No. He just eased credit and the bubble ended up there--thru market forces. The US$ is worth half of what it was when Greenspan took his current position at the Fed.

I never said that the market was driven by index flows--but it is probably true to a very small degree and maybe I did. I am saying that I believe markets taken in total are driven by money flows. And when driven by macro-misallocation eventually give rise to sector bubbles and a general bubble that everyone together rides up without realizing they are on the bubble. I am saying that the S&P 500 index funds prices are partially driven by misallocated capital coming in, new money that cares not one wit about finding any efficiency of the underlieing stocks--but only follows a black box model . If the numbers in my example were correct, then there is a correlation (maybe 33%, maybe only 1%--I'm not a number cruncher. One would have to call Vanguard for the exact numbers and do the computing and statistical modeling. I've made my decision.

My thoughts on hedge funds (but I offer zero evidence for this idea): I think the early hedge funds did exactly what was originally intended by them--found inefficiencies and took advantage. I believe now that so many of them have piled into that mess, many of the advantages of looking for inefficiencies in the market place have gone away. Finding inefficiencies has become harder and harder as more hedgies pile in to search for ever decreasing possible returns. But, just as in the housing market, where all the houses have risen in price in unison, the true inefficiencies are harder to see. One way of finding inefficiencies is to look at comparables: If all the value stocks now have a PE close to 15, then finding one with a PE of 13 or lower may be the goal--and the way to make money. But if the PE for value stocks has historically been 10, then perhaps a misallocation of resources my be occuring without any of the participants being aware of it. They may see tiny lateral or micro-misallocations between specific products and fail to see any macro-misallocations. I also think many hedge funds have begun doing "the pile on" and are chasing the same things in packs--playing a sort of herd game, lemming-like.

Pile ons, positive feedback loops, macro-misallocations have many different cycles and play small but very important roles in many asset classes to my mind. . It is a ponzi scheme to me. I've drawn a couple of lines from money to bubble. I can explain the lines a little better, but most of it will just be repetition. I can add more lines though if you desire. See Mauldin for better numbers. You say "potato," and I say "potato." Good luck and skill with your investing.
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The Numbers
Old 12-08-2005, 12:10 AM   #63
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The Numbers

Interesting discussion guys. Just my couple of cents into it, how about we look at the numbers. I poked around a bunch of good websites. Check out the following:

www.ici.org
http://www.standardandpoors.com/
http://www.nasdaq.com/reference/IndexDescriptions.stm
& also
http://www.ifa.com/

Btw this is the data I collected for S&P 500 since that is the biggest Index - I think this is for 2004.

1.* $626 billion is indexed to the S&P 500.
1a. $255 billion of S&P 500 indexing is by Mutual Funds - the rest is all the Institutional money not in mutual funds by indexed.
2.* Float Adj Market Cap of S&P 500 is $11,000 billion

That's 6% guys not that high.

Also 10% of individual investors hold Index funds & 30% of Institutional Funds do so.

I agree it would be a problem if everyone indexed, but I don't think we are there yet!

-h
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Re: The Numbers
Old 12-08-2005, 12:33 AM   #64
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Re: The Numbers

Quote:
Originally Posted by lswswein
. . .
I agree it would be a problem if everyone indexed, but I don't think we are there yet!

-h
Kinda like Greg's toilet problem, huh?
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Re: Is indexing good?
Old 12-08-2005, 12:37 AM   #65
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Re: Is indexing good?


Get the mind out of the gutter gentlemen.


-h
I Hope there were enough winks in there
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Re: Is indexing good?
Old 12-08-2005, 02:02 PM   #66
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Re: Is indexing good?

Quote:
Originally Posted by ((^+^)) SG
What if everyone in Minnesota comes over to your house and uses your toilet? . . . It will back up and overflow.

So does that mean that you should stop using your toilet?

Make this a little less abstract. What if everyone listened to (pick your favorite radio or TV investment show) and bought every stock that was mentioned? Does that mean you should never own a stock that gets mentioned on an investment show?

Hypothesizing that some effect could become important and could result in a bad impact is a long way from proving that it is important or that the result you hypothesize is the primary effect. The empirical data shows that indexers still do better than most and that their performance advantage gets larger with increasing time. That pretty much disproves the hypothesis.
SG: I 'honest to God' did not think about your toilet question enough before answering. The thought process went like this: Oh boy, toilet talk! This could never happen in Minnesota. All the Minnesotans, 4 million of them, are nice people. In fact, they would line up in single file and wait their turn. I don't think Minnesotans would go two at a time, so to speak, although a mother might bring her child in with her. Could they stack up, one sitting on the other's lap. Not in Minnesota is my guess. So, how could we get the toilet to overflow if everyone behaved themselves the way Minnesotans always do? I know, I could go down to a bar and offer all the drinkers free liquor if they all piled into my bathroom at once. But they would need EX-Lax to make that work--out. I don't think this is possible without using Non-Minnesotans. I wonder if Texans would do that? Naaa! I'm running out of ways to make my toilet overflow. Oh yeah! If all 4 million Minnesotans were about 1/4 inch tall, I could fit them into the bathroom all at once . . . . But then, I have to worry about the proportions of other things too. Dang! I'm running out of ideas. I just can't get that toilet full using SG's analogy. I'll just tell SG "yes." and move to his other questions So, the real answer is different.

EDIT: Moderator screwed up and hit modify instead of quote...luckily original was open in another window and is now restored as poster wrote it. -BMJ
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Re: Is indexing good?
Old 12-08-2005, 03:42 PM   #67
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Re: Is indexing good?

CRUD! I messed up again and modified Greg's post instead of quoting it...working on fixing it now as I have the original post in another window...

EDIT: Fixed. Luckily I had his original post in a different window and was able to reconstruct it. Now if I can remember what my reply was....something about Greg not having a sceptic tank and city sewer systems having limits, but it doesn't seem worth the effort now.
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Re: Is indexing good?
Old 12-08-2005, 06:38 PM   #68
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Re: Is indexing good?

It’s time again . . . .for a longer one.

SG (& Nords): By the middle of the tech bust of ’01, I (we) had lost a significant amount of money, and I knew something had to be done to change the situation, to prevent that from ever happening again. Rather than ask “How can I repair the damage to this retirement portfolio?,” I asked myself “What went wrong here?, How did this happen?, Why?” My thoughts were that if I could find the answers to these questions then the solutions would flow automatically—just don’t do the things that create hell for the portfolio in a down market. In a sense and in a roundabout manner, I went on the quest for the perfect portfolio or, to be a wag about it, the perfect toilet. Just like the discovery of a “unified field theory” would complete science, although not flesh it out, I think I can find it. That is always the goal in the back of my mind. In a weird manner I’m an optimist. I enjoy the walk whether I reach the goal or not.

So, while I don’t really think I’m a bear, I do think that I’m a negativity aggregator, collecting all the data that cause financial instruments to go down so that I can figure things out. When Uncle Mick listed out his retirement portfolio principles, I thought I hit the jackpot: Norwegian Widow, Trust Charles De Gaulle, and be agile, mobile and hostile. He had clarified many of the assumptions that were not previously clear in my mind.

In one very broad sense (pun intended), the Norwegian Widow principle is a distilled value investor’s guide to investing, especially as detailed by Graham & Dodd. I don’t see how anyone can seriously invest with out understanding the components of “value.” When the talking heads of CNBC or financial planners tell you that things have changed and PEs of 20 are an opportunity, you have something to weigh that against, a set of timeless tools that help you make a better judgement.

Value investors are essentially always looking for low PE ratios that also have a sustainability to provide long-term dividends. Providing steady, secure dividends is the ultimate guide that every business buyer also looks for when they are making a purchase decision. Almost everything revolves around this steady generation of income. Where are the bucks and how quickly can I get’em? This is as close as I can get to security and stability without running a hands-on business myself. It is the most important principle of all and will always remain at the foundation of my portfolio. So I seek out the highest, safest, and immediate return for the bulk of the portfolio.

Growth investments are a subset of value investments to my mind. Investors decide that they are willing to forgo immediate returns so that reinvestment can enhance the future E of P/E. To me, growth investing sets up too many possibilities of misallocation and manipulation. It is hard to judge, although Warren Buffet has done an excellent job of growing the price of Berkshire Hathaway with value investments. Lots of possibilities out there. But show me the money.

An historical/political aside related to Ponzi: Throughout history (and I know I’m simplifying here), retirement portfolios primarily consisted of children, sons and daughters, and/or some small means of production such as a farm, shop, or trade. Some settler would come in staking out his or her claim to some land. The building and shaping began. The first generation cleared rocks, built fences, bought cows, etc. When the second generation matured they were handed an improved property with value pre- added, with known instructions that they were to provide for the care of the elders with what they were given. This process was to be repeated until it couldn’t be any more, with each generation improving things a little more for each succeeding generation, adding value to the means of earning. Today, this process has been turned on its ear. It’s become the opposite of itself. Not only do we run a deficit during bad times, we now run them during good times also. Businesses pony up to the debt trough so that, oftentimes, increasing amounts of earnings simply go to repaying debt. Leverage rules. We run a balance of payments deficit so that we can consume now, expecting our children to pay it off. Much of this current behavior is rationalized away or trivialized. But, right now, it’s like we are getting ready to hand our children and grandchildren a farm with so much debt attached that it may be impossible to even feed themselves with the earnings—all because of the debt service presently attaching itself to our retirement income sources.

It gets worse when you look at the new first world-emerging market problem. We see the Asian counties spending huge amounts of money on education and means of production assets. We cut back on merit scholarships and loans. We focus on zero interest loans to entice buyers. We have major industries that are in serious decline and have been for thirty years. The American car companies provided all the technology and methodologies for the Japanese. They followed our advice; we didn’t. These types of American-run companies can’t see the future. They can only manage from one crisis to the next. These are the types of companies that need to support our retirement, pay off the bonds owned by retirement portfolios with taxes on wages or profits, etc. But there are lots of good companies around too, but I don’t think there are as many as CNBC thinks or W. thinks. I see a weird type of corrosive manipulation going on, mainly surrounding debts and real, sustainable profits.

The Ponzi scheme has worked well for thousands of years, a couple hundred in our country. It’s a good thing when used properly—smoothing out and building great civilizations. It works as long as each generation adds some extra value to what they started with and not actually drained it. GM is a drain at this point in its cycle.

Agile, mobile and hostile: You shouldn’t hang around something that has a high likelihood of going down in value. Agile to me means being alert to both dangers and opportunities. It means studying what is going on and being ready to move. Agile means being able to turn one’s head in a different direction if there is a forboding or menacing sound—maybe a big bust or boom coming. It’s the most mental part of the investment game. Mobile means the ability to get there, having readily accessible cash is the first step, a reserve of funds that can be at the ready if the opportunity arises—if real value shows its face. Complacency is not a good mental characteristic for safe investing. Because when market conditions change, you need to change and move on that new knowledge. Hostile coming in with guns blazing, it means you know what to do and when to do it. It mean you have gathered enough information, that your skills are developed and usable, that you are confident of it. Then you go for it. If it’s a contrarian play, you need to understand the flows of the other bodies; if it’s a dividend play, you need to understand and have used value investment skills under stress before so that you behave correctly at the correct times. Timid aggression that comes from a lack of knowledge and courage breeds panic and confusion. This is my understanding of Uncle Mick’s principle.

De Gaulle? Uncle Mick is an optimist about this country. I’m not (at this point), and I won’t be until this current administration is gone—if then. Strong property rights are a founding principle of this country, deeply imbedded in the culture. When Dick Cheney said “Deficits don’t matter,” that the debt owed by this country is unimportant (because I think this really is his attitude), I knew the jig was up. I watch debt because I think Cheney is wrong and that is where the fall will be coming from. I currently see this as a true contrarian play. The rest of the portfolio money is playing the government’s stupidities—I think it’s easy money. But sometimes my timing is off.

--Greg
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Re: Is indexing good?
Old 12-08-2005, 07:02 PM   #69
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Re: Is indexing good?

Quote:
Originally Posted by Apocalypse . . .um . . .SOON
Hostile coming in with guns blazing, it means you know what to do and when to do it.*
Okay. So where exactly is your money these days, Greg? Sounds like cash and gold bullion. These "safe" investments have there own risks too.

Quote:
Value investors are essentially always looking for low PE ratios that also have a sustainability to provide long-term dividends.
To my mind value investing isn't necessarily about low PEs or any other specific metric. Investing, in general, is an exercise in "relative value" where the expected risks and returns of one investment choice are weighed against all of its competing alternatives (including holding cash and gold bullion). At 4.5% interest rates treasuries have a PE of 22 with a zero % growth rate. Given that alternative, one might think a 20 PE for a fairly-stable, slow but positive growth, dividend-paying company looks like a pretty good, if not a very good, value.

Cash at negative real rates of returns is an expensive "safe" investment alternative.
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Re: Is indexing good?
Old 12-08-2005, 08:17 PM   #70
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Re: Is indexing good?

Don' ever become a pessimist, Ira; a pessimist is correct oftener than an optimist, but an optimist has more fun--and neither can stop the march of events.

-Lazarus Long
-- Robert Heinlein

I think that says it all .........
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Re: Is indexing good?
Old 12-08-2005, 09:44 PM   #71
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Re: Is indexing good?

YTG:

58% is burrowed in mostly short-term AAA. 38% is running wild. RE estate, my former safe money, is now in the wild catagory, but it pays dividends. Here's another active managers take on things:

http://www.hussmanfunds.com/wmc/wmc051205.htm
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Re: Is indexing good?
Old 12-08-2005, 09:48 PM   #72
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Re: Is indexing good?

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Rather than ask “How can I repair the damage to this retirement portfolio?,” I asked myself “What went wrong here?, *How did this happen?, Why?” *My thoughts were that if I could find the answers to these questions then the solutions would flow automatically—just don’t do the things that create hell for the portfolio in a down market. *In a sense and in a roundabout manner, I went on the quest for the perfect portfolio or, to be a wag about it, the perfect toilet. *Just like the discovery of a “unified field theory” would complete science, although not flesh it out, I think I can find it. *That is always the goal in the back of my mind.
Greg,

Don't you think a broadly diversified portfolio is about as close to the "perfect" portfolio? *I know it is difficult to make an accurate observation but it seems like you torment yourself over the "quest" and become your own worst enemy. *Set something up and let it ride. *It is nice to be well informed but it can also work against you.

As Yrs said, a portfolio invested in gold/cash/TIPs comes with plenty risk, possibly even more than a broadly diversified portfolio including equities. *If things really go to crap it won't matter what you have, it will drop in value or become a victim to inflation - eats away at those stable, low return assets.







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Re: Is indexing good?
Old 12-08-2005, 10:01 PM   #73
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Re: Is indexing good?

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Originally Posted by wildcat
Greg,

Don't you think a broadly diversified portfolio is about as close to the "perfect" portfolio? I know it is difficult to make an accurate observation but it seems like you torment yourself over the "quest" and become your own worst enemy. Set something up and let it ride. It is nice to be well informed but it can also work against you.

As Yrs said, a portfolio invested in gold/cash/TIPs comes with plenty risk, possibly even more than a broadly diversified portfolio including equities. If things really go to crap it won't matter what you have, it will drop in value or become a victim to inflation - eats away at those stable, low return assets.
I guess we see risk pretty differently.
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Re: Is indexing good?
Old 12-08-2005, 10:12 PM   #74
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Re: Is indexing good?

Yeah I see it in risk adjusted returns as I think many investors would - I guess I would go for the highest as some would be happy with the lowest
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Re: Is indexing good?
Old 12-08-2005, 10:15 PM   #75
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Re: Is indexing good?

Quote:
Originally Posted by BigMoneyJim
CRUD! I messed up again and modified Greg's post instead of quoting it...working on fixing it now as I have the original post in another window...

EDIT: Fixed. Luckily I had his original post in a different window and was able to reconstruct it. Now if I can remember what my reply was....something about Greg not having a sceptic tank and city sewer systems having limits, but it doesn't seem worth the effort now.
I saw our sewer pipe a few years back. It's about two feet in diameter. It also drops about 500 feet in elevation Man oh man, I figure if you put about a hundred thousand non-bean eating Texans in all, you know the skinny ones, on top of every toilet in the city and flushed simultaniously, the suction would take them all down. Still wouldn't plug the system.
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Re: Is indexing good?
Old 12-08-2005, 10:25 PM   #76
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Re: Is indexing good?

Quote:
Originally Posted by Apocalypse . . .um . . .SOON
I saw our sewer pipe a few years back. It's about two feet in diameter. It also drops about 500 feet in elevation Man oh man, I figure if you put about a hundred thousand non-bean eating Texans in all, you know the skinny ones, on top of every toilet in the city and flushed simultaniously, the suction would take them all down. Still wouldn't plug the system.
Greg, I think I can safely speak for all non-bean eating (in chili, that is) Texans when I say, "You're full of crap".

Oh yes, I forgot:

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Re: Is indexing good?
Old 12-08-2005, 10:33 PM   #77
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Re: Is indexing good?

Wahoooooo:

Thanks, I deserve needed that.
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Re: Is indexing good?
Old 12-08-2005, 10:59 PM   #78
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Re: Is indexing good?

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Originally Posted by wildcat
Yeah I see it in risk adjusted returns as I think many investors would - I guess I would go for the highest as some would be happy with the lowest
Let's see, the S&P 500 is doing 3% so far this year. The gov't says that inflation is running about the same (maybe higher). 3-3=0. I'm taking volitility risk with a few of my positions though.

Here's one for you straight from Richard Russell: There is a synthetic short on the US$ of about $40-$50 trillion dolars: $2-3 tillion of misc. consumer debt, $7 trillion in mortgages, $30-40 trillion (I am not going to look this stuff up so discount it as much as you want) in as yet, in many cases, unfunded liabilities such as future medicaide and medicare payments, social security, municipal pensions, etc.

Synthetic short: Normally when someone buys a house he/she plans to pay it off in cheaper dollars, either from the known 2-3% inflation and from increasing wages. Payments get easier over time. In a real sense, you borrow more expensive dollars and pay back with cheaper dollars. This is the way our economy runs smoothly and one of the main reasons Bernanke (helicopter man) and Bush are absolutely petrified of deflation. If you make less money, if dollars are harder to get, or if things get more expensive, it's harder to pay off your mortgage or spend at retail. If a greater percentage of your income goes to debt, a smaller amount must go into consumer goods. The entire country is neck deep in a short play. Let's hope there's no squeeze.
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Re: Is indexing good?
Old 12-09-2005, 12:57 AM   #79
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Re: Is indexing good?

Quote:
Originally Posted by Apocalypse . . .um . . .SOON
Let's see, the S&P 500 is doing 3% so far this year.* The gov't says that inflation is running about the same (maybe higher).* 3-3=0.* I'm taking volitility risk with a few of my positions* though.*

. . .
Hey, the most important thing to consider when you are investing is what are you most comfortable with. If you don't believe in and understand an investment when you buy it, you are likely to sell it at the worst possible time. So, Greg, by all means, do what you believe in.

But if you are going to attempt to debunk a long term index strategy with 11 month returns data, the least you could do is get the numbers right. S&P is running just under 6% for the year. Total Stock Market is over 7%. Inflation is just under 3%. Even if it were a bad year for indexes, one year out of decades is not the way to evaluate the strategy.
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Re: Is indexing good?
Old 12-09-2005, 01:39 AM   #80
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Re: Is indexing good?

Greg, aka Conan the Contrarian................

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