Jack Bogle warning on index fund investing

[Montecfo]

Quote:

Originally Posted by gerntz Eroding advantage doesn't mean active management has an advantage, just less of a disadvantage.

As with most things, it depends. Active management works best in less liquid markets and more specialized markets such as international, emerging markets and bonds.

Indexing works best in large highly liquid, less specialized markets.

I view indexing and active management as tools, and try to choose the right tool for the job.

[Fedup]

I have money in both. So either way, I'm doomed. Depends on which side you wake up on.

[mathjak107]

Quote:

Originally Posted by ERD50 Not sure what your point is. Which 9 stocks? Which 18 stocks? I don't think we know ahead of time, do we? That's why I like an index that holds lots of stocks. -ERD50

you can easily look up the stocks . the point is in a cap weighted index you are not very diversified . watch what would happen to the index if fang faltered .

[ERD50]

Quote:

Originally Posted by mathjak107 Quote: Originally Posted by ERD50 View Post Not sure what your point is. Which 9 stocks? Which 18 stocks? I don't think we know ahead of time, do we? That's why I like an index that holds lots of stocks. -ERD50 you can easily look up the stocks . the point is in a cap weighted index you are not very diversified . watch what would happen to the index if fang faltered .

Are you saying the 9 and 18 largest holdings? Sure, I can look those up easily enough. But you said something about the 9 and 18 accounting for 30% and 51% "of the moves".

I'm not sure that's the same list. Could be the middle/smaller stocks move more than the largest ones, and therefore make up "more of the move"?

-ERD50

[gerntz]

Quote:

Originally Posted by Nightcap Perhaps I'm missing something, but exactly how can you be more diversified than owning a tiny piece of the entire bloody market?

Not sure I understand. If you mean you have a tiny portion of assets in one index fund, probably too much cash. If you mean that all your assets are in tiny slivers of all markets thru indexes, I think 100% of assets in stocks is too risky - vs. some cash and hard tangible assets.

[gerntz]

Quote:

Originally Posted by foxfirev5 I am even more convinced that nobody knows nothing.

[gerntz]

Quote:

Originally Posted by Montecfo As with most things, it depends. Active management works best in less liquid markets and more specialized markets such as international, emerging markets and bonds. Indexing works best in large highly liquid, less specialized markets. I view indexing and active management as tools, and try to choose the right tool for the job.

Does that say active management of the less liquid markets is better than an index of those same markets? Or that it's closer to an index but not better?

[ERD50]

Quote:

Originally Posted by mathjak107 most popular index funds are weighted and not diversified at all . just 9 stocks account for 30% of the moves of all 500 in the s&p 500. 18 stocks represent 51% of the move of the s&p 500 . ... .

Tacking on to my previous post - if you meant weighting, that doesn't add up either. From:

SPDR® S&P 500 ETF (SPY) Top Portfolio Holdings

Quote:

1 Apple Inc 3.84% 2 Microsoft Corp 2.59% 3 Amazon.com Inc 1.89% 4 Facebook Inc A 1.71% 5 Johnson & Johnson 1.67% 6 Exxon Mobil Corp 1.60% 7 Berkshire Hathaway Inc B 1.52% 8 JPMorgan Chase & Co 1.42% 9 Alphabet Inc A 1.41% --------------------- 17.65% 10 Alphabet Inc C 1.37% 11 General Electric Co 1.16% 12 AT&T Inc 1.14% 13 Wells Fargo & Co 1.12% 14 Bank of America Corporation 1.09% 15 Procter & Gamble Co 1.08% 16 Chevron Corp 0.94% 17 Comcast Corp Class A 0.94% 18 Pfizer Inc 0.93% --------------------9.77% ------------------------------------------------------------27.42%

Columns get skewed, but that's ~ 18% and 27% for the top 9 and 18. Not 30% and 51%.

Is that what you mean, or something else?


ERD50

[OldShooter]

Quote:

Originally Posted by gerntz Does that say active management of the less liquid markets is better than an index of those same markets? Or that it's closer to an index but not better?

Actually, @Montecfo's statements are OWTs. If you study the original William Sharpe paper (easy/only three pages: https://web.stanford.edu/~wfsharpe/a...ive/active.htm) and/or carefully watch Kenneth French's 5-minute video explanation (https://famafrench.dimensional.com/v...investing.aspx) you will understand.

IMO where these statements come from is a misunderstanding. If an index contains all of the stocks that a group of active managers are trading, then their results will always be the index average less their costs. It is also very, very close to being true when the index contains substantially all of the stocks they are trading, as illustrated by the semiannual S&P SPIVA results.

I read one article the other day where the author was bashing indexing by pointing out that active managers would soundly beat the S&P whenever emerging market stocks were strong. Well, duh. The S&P is the wrong measuring stick for active investors who are not investing in the S&P. So that kind of thing is one source of the OWTs.

Another thing that is happening (the hucksters are endlessly clever) is the emergence of ETFs with "index" in their names but which are basically sector funds. Such a narrow "index" will outperform active managers who trade strictly using the stocks in the index (back to Sharpe!) but those managers are highly unlikely to limit themselves to a goofy little sector index. So when the active managers beat the South China Sea Emerging Markets Index ETF and start thumping their chests, you can be sure that they are not investing strictly in the stocks in that (fictional) index. So that is another source of the OWTs.

Mathematically speaking, Sharpe is precisely correct only if the "market average" is the average of all investable stock and the "active managers" list is all active managers. As people diverge from that it becomes easier and easier to find cases where the managers on average outperform an index simply by deliberately choosing the wrong index as a standard or by surreptitiously going off-reservation and trading in stocks that are not in the index.

So my takeaway is to use total market funds, Russell 3000, Wilshire 5000, ACWI, etc. and be confident that I will beat 90% of the active managers in the US or the world. That's good enough for me.

[Montecfo]

Quote:

Originally Posted by gerntz Does that say active management of the less liquid markets is better than an index of those same markets? Or that it's closer to an index but not better?

It depends on the market, and the manager. Obviously you want to choose managers with a solid track record. Indexes will generally beat poor managers even in less efficient markets.

[Montecfo]

Quote:

Originally Posted by OldShooter Actually, @Montecfo's statements are OWTs. If you study the original William Sharpe paper (easy/only three pages: https://web.stanford.edu/~wfsharpe/a...ive/active.htm) and/or carefully watch Kenneth French's 5-minute video explanation (https://famafrench.dimensional.com/v...investing.aspx) you will understand. IMO where these statements come from is a misunderstanding. If an index contains all of the stocks that a group of active managers are trading, then their results will always be the index average less their costs. It is also very, very close to being true when the index contains substantially all of the stocks they are trading, as illustrated by the semiannual S&P SPIVA results. I read one article the other day where the author was bashing indexing by pointing out that active managers would soundly beat the S&P whenever emerging market stocks were strong. Well, duh. The S&P is the wrong measuring stick for active investors who are not investing in the S&P. So that kind of thing is one source of the OWTs. Another thing that is happening (the hucksters are endlessly clever) is the emergence of ETFs with "index" in their names but which are basically sector funds. Such a narrow "index" will outperform active managers who trade strictly using the stocks in the index (back to Sharpe!) but those managers are highly unlikely to limit themselves to a goofy little sector index. So when the active managers beat the South China Sea Emerging Markets Index ETF and start thumping their chests, you can be sure that they are not investing strictly in the stocks in that (fictional) index. So that is another source of the OWTs. Mathematically speaking, Sharpe is precisely correct only if the "market average" is the average of all investable stock and the "active managers" list is all active managers. As people diverge from that it becomes easier and easier to find cases where the managers on average outperform an index simply by deliberately choosing the wrong index as a standard or by surreptitiously going off-reservation and trading in stocks that are not in the index. So my takeaway is to use total market funds, Russell 3000, Wilshire 5000, ACWI, etc. and be confident that I will beat 90% of the active managers in the US or the world. That's good enough for me.

I do not disagree with your statement, but you are making a different point than the point I made. The statement, "if two portfolios own the same stocks, the one with lower fees will win" is certainly not remarkable.

Further, to beat a market index, an active manager must hold different stocks than those comprising the index. This is just the definition. I do not recommend investing in every active manager's fund, as your statement suggests. Nor have I ever heard that suggested.

[Totoro]

Quote:

Originally Posted by OldShooter So my takeaway is to use total market funds, Russell 3000, Wilshire 5000, ACWI, etc. and be confident that I will beat 90% of the active managers in the US or the world. That's good enough for me.

A favorite quote of mine "accepting average performance gives you above average results".

[Closet_Gamer]

Its an interesting thought exercise:

Imagine a world where only 10 people are actively investing and everyone else was passively indexed. For simplicity, assume a perfectly common set of equities (no shifting from one index to another). Also assume that the 10 people have enough money to "make a market" unto themselves.

Indexing is actually about understanding that the majority of people in the market are at an information disadvantage on any given topic...you simply can't gain enough of an information edge to make more informed investing decisions than everyone else. Hence, if you're actively trading, you tend to be wrong and you kill yourself trading on inferior perspectives.

If you only had 10 people trading, those 10 folks now have the same problem. Any one of them is betting their knowledge against the other nine people. The 10 people will make different decisions than one another. Valuations will still move around as the active participants try to outfox one another on how the companies will actually perform.

The smaller knowledge base means everyone is harmed because in aggregate the money is invested less efficiently...but the index still functions and would still be likely to outperform any given one of our 10 active investors who is relying on his/her own wisdom vs. the collective wisdom of 10 people.

The index continues to match the moves of the collective wisdom of the "informed" part of the market -- its just indexed against a much smaller knowledge pool driving the active trading actions. In aggregate everyone is making less informed (worse) investing decisions than if you had 100 or 1000 people seeking an information edge in their trades. Performance for everyone but a handful of the active investors would suffer due a drop in efficient capital allocations. The handful that win are either really, really good (Buffett) or really, really lucky for a finite period of time (typical "winning" active fund manager).

There were also be a huge pull for one of the passive indexers to believe they can outfox the other 10 people trading. One indexer would almost certainly step off the sidelines to become the 11th active investor...and the index would get marginally more efficient once more because the knowledge pool went up.

So...I don't think indexing ever loses its relative advantage over an average individual taking actions in the market...though the whole market may become relatively less efficient if a preponderance of the money is passive and not contributing to the collective wisdom of the market.

Bottom Line: I'm an indexer for life.

[OldShooter]

Quote:

Originally Posted by Montecfo ... Obviously you want to choose managers with a solid track record. ...

Sounds intuitively obvious, but sometimes the world is counter-intuitive. The data says that track record is not predictive of future results. The technical term is "manager persistence" and there is little or none on the upside. Lousy managers, however, do slightly tend to persist usually due to high fees.

Here is a video: https://famafrench.dimensional.com/v...-managers.aspx It's only about 6 minutes; Kenneth French (of Fama/French fame) explains why your manager pick is always a random one.

This article (http://www.etf.com/sections/features...icroscope.html) includes a link to the paper that Ken French mentions, Luck Versus Skill in the Cross Section of Mutual Fund Returns. At 45 pages I admit that I have not read the whole thing, just the summary.

The proof is also in the S&P Manager Persistence scorecards that are published semiannually. The conclusion is always the same, past performance does not predict future performance. A quick web search will yield as many of these as you care to read. Here is a clip from the most recent one:

"According to the S&P Persistence Scorecard, relatively few funds can consistently stay at the top. Out of 631 domestic equity funds that were in the top quartile as of September 2014, only 2.85% managed to stay in the top quartile at the end of September 2016. Furthermore, 2.46% of the large-cap funds, 2.20% of the mid-cap funds, and 3.36% of the small-cap funds remained in the top quartile."

Basically, the overall conclusion is that achieving good manager results looks like luck, not skill. So, no surprise: The fact that someone got lucky in the past is not predictive. Said another way, a monkey who has flipped ten heads in a row is no more likely than 50/50 to flip heads on his next try.

One of the luckiest monkeys on record was Bill Miller of Legg Mason. He rolled fifteen heads in a row, beating the S&P for fifteen years. Then he spectacularly blew up and in two years lost far more money than he had gained for his investors. Market statisticians say that in a random market there was about a 7% probability that some manager, somewhere, at some time, would produce this result. Miller was the one.

[Totoro]

Quote:

Originally Posted by Closet_Gamer There were also be a huge pull for one of the passive indexers to believe they can outfox the other 10 people trading. One indexer would almost certainly step off the sidelines to become the 11th active investor...and the index would get marginally more efficient once more because the knowledge pool went up.

Interesting explanation, I'll be stealing that one for my live discussions

One thing: the 11th active investor may make the index more or less efficient, depending if he/she is on average better in capital allocation than the first 10, and outside pressures on Mr(s). 11 (irrational backers ..).

There is self-cleaning pressure: lower skills tends to get kicked out of the pool, but it's a very messy process because of the poor signal/noise. Luck or skill, hard to distinguish. So the question is: how many people do you need to get a relatively decent pool that drives rough efficiency?

[gerntz]

Quote:

Originally Posted by Montecfo It depends on the market, and the manager. Obviously you want to choose managers with a solid track record. Indexes will generally beat poor managers even in less efficient markets.

Actually, I prefer indexes for these markets unless it's known that the average manager beats the indexes. Don't want to bet on picking a good manager if odds less than 60/40 that I can.

[Texas Proud]

I mentioned it before and will again in a different way...

I am amazed how many people have posted to this thread about diversification that seem to not know what it really is when it comes to investing....

The person who said that the S&P 500 was 'one stock' and was not diversified is a prime example...

[OldShooter]

Quote:

Originally Posted by Texas Proud I mentioned it before and will again in a different way... I am amazed how many people have posted to this thread about diversification that seem to not know what it really is when it comes to investing.... The person who said that the S&P 500 was 'one stock' and was not diversified is a prime example...

Well, we're all ignorant to some degree. I am far too old to know everything.

So I view contributing to and reading discussions like this as a A Good Thing. Sure, there is a lot of misinformation around. (My favorite internet cartoon: https://en.wikipedia.org/wiki/On_the...ternet_dog.jpg) But most of it gets corrected. For example, I think @Closet_Gamer's little gedanken experiment on indexing is quite nice.

So when people don't seem to understand something like diversification, you can be here to help.

[Fedup]

Quote:

Originally Posted by Texas Proud I mentioned it before and will again in a different way... I am amazed how many people have posted to this thread about diversification that seem to not know what it really is when it comes to investing.... The person who said that the S&P 500 was 'one stock' and was not diversified is a prime example...

Well everybody made it easy on boggle head, what's there need to know. 3-fund portfolio. Follow the herd.

[Montecfo]

Quote:

Originally Posted by Texas Proud I mentioned it before and will again in a different way... I am amazed how many people have posted to this thread about diversification that seem to not know what it really is when it comes to investing.... The person who said that the S&P 500 was 'one stock' and was not diversified is a prime example...

Hmm. If you refer to a statement I made, then you misunderstood it.