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Old 06-04-2009, 07:17 PM   #81
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I think the SP500 "mantra" grew from the fact that it was the original index fund. Now that we have TSM, All World ex USA and more recently the Total World Index they are the funds of choice. Another reason for its persistence may be because it is the only cheap index fund available- this is true for my 403b plan currently.

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Exactly right. The philosophy around indexing came from the efficient market hypothesis and modern portfolio theory. MPT uses various allocations of "The Market Portfolio" (which theoretically includes everything from stocks to stamp collections) and risk free bills to create the optimal portfolio for a given level of risk. However, investing in "The Market Portfolio" is impossible because it includes every conceivable asset. Originally the S&P 500 Index was as close as you could get so that is what people suggested investors use. Now we have many more options and can get much closer to "The Market Portfolio" . . . so that is what some of us try to do.
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Old 06-04-2009, 07:30 PM   #82
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It is sometimes the lack of knowledge, not the crystal ball that keeps us from making an better-informed decision. We did not get to see the balance sheets of the financial stocks to decide to stay or to flee. I decided to flee and I am glad. Maybe I was just lucky. Who knows?
I know.

And I'll say you were just lucky. The things that spooked you out of the market were already known, and were therefore already priced into the market. For stocks to continue to fall from that point not only did all the bad things everyone was afraid of have to happen, but things actually had to be worse than that.

Over the past couple of months we've seen the market rally powerfully on really BAD news. Stocks are up 35% because the news just wasn't as bad as everyone expected. How will you ever know when the market is pricing in more bad news than will actually arrive?
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Old 06-05-2009, 02:20 PM   #83
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I know.

And I'll say you were just lucky. The things that spooked you out of the market were already known, and were therefore already priced into the market.

Oh, contrary to some people who claim credit for all their hard work, I will readily agree that luck always plays a certain part of my quite modest successes in life so far. However, as it is often quoted,

“I find that the harder I work, the more luck I seem to have” - Thomas Jefferson.

It was by chance that our economists in Malkiel's joke walked across the $20 bill that they refused to pick up. They could easily be too engaged in their discussion and failed to notice it too. I feel that luck is often a necessary component of success, but not the sufficient one.

I will continue to try hard, although success is never guaranteed.

In his "Black Swan" book, Taleb mentioned Buffet and said that Buffet's success may due to mere luck. Despite what else I might have agreed with Taleb, that statement did really take me aback. Now, if the world most well-known billionaire did not get credit, who am I to say that my minuscule portfolio isn't the result of some random pull of the slot machine lever?

Back to the contention that the market always prices things according to the best information available, that has been always been the argument of the market efficiency purists. In fact, some even go as far as to argue that there has never been any bubble in anything in history. A certain thing costs so much because the buyer and seller agree at that price. A tulip bulb cost as much as a house during the tulip mania in Holland in the 1600s because the sellers and buyers both said that the price simply had to be so.

A couple of years ago, a 1200 sqft condo in South San Diego went for $400-500K. That was the prevailing price, set between buyers and sellers of free will. Why did anyone call it a mania? I would not argue with these buyers and sellers, but I still refuse to participate in that market as a buyer. Whether their market was efficient or not and according to whose definition will not sway me.

I have read about all the market efficiency arguments in Malkiel's book, although he did admit that he has softened his stance to say that although the market is efficient in the long run, it can be inefficient in the short-term. Now, who could disagree with that? One would need skills, and yes luck, to obtain economic gains during these inefficiency periods, but they do exist.

We all heard of the phrase "reversion to the mean". That implies that there is a "reasonable" exchange ratio between assets, however fuzzy and evolving that can be, and if the exchange ratio gets too out-of-whack it will return to a more neutral state. How could that happen if the market is always efficient? The price should be what it is!

About the market instantly prices everything to the latest information, we tend to forget that the "market" composes of human beings. It is human nature to remember the prices that we paid for something and it is difficult to admit that we overpaid for junk. It takes time for us to readjust ourselves to the reality, to get out of our denial mode. It is also the human psychology that causes the pendulum to overswing in the other side, causing the formerly inflated asset to become underpriced. Predicting where the pendulum is in its trajectory is tough, but one cannot deny that it does swing.

In my field of work, we would say that the price of a stock is not a random walk. It is rather a Markov process of a higher order. Determining its stochastic properties is tough, as it is a not a stationary process. How can it be, if it can cease to exist (bankruptcy)? A random walk, it is not.

Anyway, I had to get out of town after my last post. As addictive as this forum is, I had to check in but have to leave again soon.
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Old 06-05-2009, 03:02 PM   #84
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“I find that the harder I work, the more luck I seem to have” - Thomas Jefferson.
Except in the case of beating the market countless studies have shown that the "hard work" of entire teams of highly educated, highly specialized, highly motivated, individuals working 80 hour weeks on nothing else, with direct access to company managements, trading flows, the work and insights of other analysts, and the all-important rumor mill has repeatedly proven unable to accomplish what you're attempting to do by yourself on your spare time.

So once again . . . good luck.
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Old 06-05-2009, 03:12 PM   #85
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Here's one mutual fund manager who apparently agrees with you:

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One of the best-known mutual fund managers minced no words with his industry colleagues, criticizing their poor performance last year. Managers should learn from their mistakes and adjust accordingly, or face losing clients and possibly going out of business, said Bob Rodriguez, manager of FPA Capital Fund.
......
"Let's be frank about last year's performance," Rodriguez said. "In a word, we stunk."
......
"If portfolio managers and analysts cannot recognize the greatest credit blow-off in the last 80 years, when will they?" asked Rodriguez.
We stunk - MarketWatch.com
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Old 06-05-2009, 03:22 PM   #86
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Just checked Morningstar. Vanguard's SP500 index fund beat 51% of funds in it's category over the last year. This is despite the fact that the typical actively managed fund has around 10% or so in cash reserves at any given time. So that cash drag should have given actively managed funds a huge advantage when the whole market was down 30-40%. Heck, the simple ability to change asset classes and change amounts invested in stocks versus cash should give actively managed funds a huge lead.

Other funds I checked did even better in their categories than the SP500 index (total international, emerging markets, total US market, etc). If teams of managers can't do it, how can we??

Edited to add: these index funds are like wine - they just get better with age. 1 year returns are not the appropriate comparison period for long term investments. Looking at 5 and 10 year investment results shows index funds doing even better relative to their peers than 1 yr results in general.
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Old 06-05-2009, 03:49 PM   #87
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Warren Buffet <-- efficient market theory killer
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Old 06-05-2009, 04:24 PM   #88
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Warren Buffet <-- efficient market theory killer
Nope. Buffet often buys the companies and picks people to run them. (Even the most rabid EMT adherent doesn't believe that all corporate leadership is equally adept). Buffet gets special deals that are not available to you and me (that GE perpetual preferred stock with a 10% yield he bought in October--not available to others). Buffet does a lot more than pick stocks, he frequently adds value to companies.
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Old 06-05-2009, 04:29 PM   #89
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Buffet often buys the companies and picks people to run them.
Actually, Buffett very seldom does this. He generally only buys businesses with solid management that he trusts, and leaves their management in place. If he doesn't like the management already in place in a company, he won't buy it.

This is stated each year in the "Acquisition Criteria" in Berkshire's annual reports:

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We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a
transaction when price is unknown).
But you are certainly correct that he and Berkshire are often the first to be given a crack at a certain deal, largely because he's not a corporate raider type who breaks up businesses and lays a bunch of people off. A lot of owners of private businesses who would still like to manage (but not own) their company find this a particularly good reason for wanting to sell to Berkshire.
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Old 06-05-2009, 05:12 PM   #90
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Actually, Buffett very seldom does this.
Thanks, I stand corrected. He did step in and actually run Salomon Brothers for several years, but that was an unusual circumstance.
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Old 06-05-2009, 08:27 PM   #91
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But you are certainly correct that he and Berkshire are often the first to be given a crack at a certain deal
He actually specializes in this. He keeps a large hoard of cash on hand so that when everyone else is scrambling for cash, Uncle Warren is sitting on a pile ready to rip your face off. He did it in 2001 and he did it again just in 2008/9.

His most recent "victim" was Constellation Energy (CEG). CEG had a liquidity problem but plenty of valuable assets. Warren agreed to buy CEG for a song, and put in $1B in cash to keep the company afloat while merger approvals were pending. But the $1B had plenty of strings attached. Ultimately a French utility came in with a better offer and CEG broke off the merger agreement with Berksire. One might think that Warren got beat, here, but no. When you tallied up the interest on the original $1B, the break-up fee, stock warrents, and other associated payments, Berksire walked away with ~$2.1B in value on its original $1B investment. The whole process took about 6 months.
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Old 06-05-2009, 08:31 PM   #92
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Warren Buffet <-- efficient market theory killer
Except when you have millions of monkeys flipping coins, one of them is going to achieve the unlikely outcome of flipping heads one hundred times in a row. And when he does, all the other monkeys will anoint him as the most skillful coin flipping monkey in the world.
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Old 06-06-2009, 08:11 PM   #93
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I think there are two questions issues surrounding the efficient market theory (EMT). The first is stock picking simply random activity with no skill involved. I think this is bunk. The second is there is any practical way for the average purchasers of mutual funds to identify superior stock pickers? I believe the answer is probably not.

It isn't just Warren Buffett that is a superior stock picker. In Warren's famous debate with EMT proponents he talks about a champion coin flippers. He wonders if academics would wonder if this was a random activity if all of the champion coin flippers came from one small village GrahamVille. He then goes on to show the superior stock picking performance over many decades of many of his fellow classmates of Ben Graham. (This story is well told in the Buffett bio Snowball)

The problem is that virtually every academic study focus on the performance of mutual funds and I have never seen a single study that measured the performance of individual managers, the actual stock pickers. I think if we had measurements of the lifetime performance of mutual fund managers we would see a group of folks who clearly delivered superior performance. But this is to much work for Academics so they measure one thing mutual fund performance and conclude a different thing, it is useless to pick stocks.

Let me try an analogy. Imagine that mutual funds are like professional sports franchises. Players are like stocks, studied extensively and who's market value is constantly changing, and can be traded with relatively low cost. There is even an IPO market i.e the draft.

Imagine if Academics studied the professional sport world. Now obviously in any given year on average a sports franchise wins 50% of its games and loses 50% (ignore ties). They would discover that even dominate franchises like the Yankees, Celtics, and Lakers have a win percentage of 60-61% and the NFL has achieved parity with 3 teams at 57% and only 2 under 40%. I think statistically this is to be expected.

The academics then concluded that that picking players is pointless exercise and suggest that to minimize expense, they should eliminate the general manager and coaches should not be involved with players selection. Instead they should index picking players, getting a couple of superstars with the highest salary, and bunch of solid players with middling salaries, and few rookies in the hopes that some of the grow into valuable players.

Does anybody think that this study would be embraced by sports fans much less taking seriously by pro sport owners?. I suspect it would be treated with derision, because it didn't measure the performance of individual coaches or general managers.

If we look at the best professional coaches we find that a number of them have lifetime winning percentages in the 70% range e.g. Lombardi 74%, Madden 76%, Phil Jackson 71%. Not surprisingly these coaches are household names. I suspect that it statistically very improbable that these results are matter of luck and not skill. Clearly, if the objective of owning a pro sports franchise is to win championship rings these coaches are worth their pay. In fact we could reasonably conclude that the superior performance of a few franchises is due to the presence of the great coaches and not the other way around.

Unfortunately as mutual fund investors we only know the performance of the franchises and not the coaches records. There are a couple of exception Lynch, Miller, Bill Gross. However, by the time these guys records are known they funds they operate are either closed to new investors or are so large that their future performance is hampered by their size.

But much like rabid players of fantasy sports leagues, we don't have to depend on General managers/mutual funds to do the work. We are free to pick individual players (stocks). Now some say this is a fools errand and perhaps they are right. My view is I simply need to better than 55% (since trading cost are now so low) of active investors in order to come out ahead. I know plenty of people that buy and sells stocks that know less than I do. After reading this board, I also "know" many who are better.
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Old 06-06-2009, 08:42 PM   #94
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Well, I'd take exception to several points, but here's just one:
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My view is I simply need to better than 55% (since trading cost are now so low) of active investors in order to come out ahead.
You don't need to "do better" than 55% of active investors. You need to "do better" than the people who make the purchasing decisions regarding 55% of the stock. That's quite a difference--the pikers and weekend "experts" are buying a few dozen to a few hundred shares at a time, the folks who spend their lives studying the companies, interviewing the presidents of the companies and looking over the books, studying competitive companies, etc are the ones directly advising/doing the purchasing of millions of dollars of stock at a time. You need to beat more than Joe Sixpack, you need to beat these full-timers at their own game. It's surely possible, just as I might beat Michael Jordan in a game of Horse--but it's unlikely.
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Old 06-06-2009, 09:59 PM   #95
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Well, I'd take exception to several points, but here's just one:


You don't need to "do better" than 55% of active investors. You need to "do better" than the people who make the purchasing decisions regarding 55% of the stock. That's quite a difference--the pikers and weekend "experts" are buying a few dozen to a few hundred shares at a time, the folks who spend their lives studying the companies, interviewing the presidents of the companies and looking over the books, studying competitive companies, etc are the ones directly advising/doing the purchasing of millions of dollars of stock at a time. You need to beat more than Joe Sixpack, you need to beat these full-timers at their own game. It's surely possible, just as I might beat Michael Jordan in a game of Horse--but it's unlikely.
I agree with you that it isn't 55% of the people but rather 55% of the Net Assets under active management.

However, you don't need to beat Michael Jordan, ain't ever going to happen unless you were college shoot guard all star in former life.

Remember players are stocks, some are rightly more valuable than others. The correct analogy you do need to do is beat a Phil Jackson coached basketball team. I submit that task isn't all that hard given that you both had a salary cap and you could hire the best assistant coaches to do the actual tactical coaching during the game. Your task is simply to evaluate which players represent the best value for the money. Now realistically Phil Jackson is a terrific coach and you probably could beat his team in one game possibly in a series but very unlikely over the course of a season. Now neither you nor I maybe good at evaluating player talent, but I won't be at all surprised if out in fantasy sport league land there are number of people who are better than the average professional coach.

Small investor have significant advantages over institutional investors. First there are certain things I can invest that a mutual fund can't. One example is Master Limited Partnerships which have provided excellent total returns in recent years, and can't be purchased by most mutual funds. Another example is micro cap stocks. Any normally mutual fund can't realistically buy a micro cap (<100 Million in market) because a purchase of several million or more will cause the price to go up too much. I can purchase $10K or so without a big change in the price. Although it took me a month to purchase $10K of one micro cap late last year. The reason for purchasing this stock is that companies book values was about $12.50 and the stock was trading for $1.50 a share and had $1/share in net cash. Close End funds which trade a discount to NAV is third area mutual funds can't buy that I as individual can.

Finally, individually unlike institutional investor are under no pressure (other than from the spouse) to do window dressing at the end of quarter or year, rush to buy or sell a stock because it has been added or dropped from an index etc.

I have modestly outperformed my target index 75%/25 Vanguard total stock/bond index AND paid for my living expense YTD, and over the last couple of years. I bet a couple of other folks on the board have similar or better records.
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Old 06-07-2009, 12:17 AM   #96
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Another example is micro cap stocks. Any normally mutual fund can't realistically buy a micro cap (<100 Million in market) because a purchase of several million or more will cause the price to go up too much.
Another advantage of the small investors is that they rarely become large investors.

I think every successful fund manager or investor of the last half century has suffered from bloat-- Lynch, Miller, Ruane, Ross, Kerkorian, even Soros & Buffett. They get good at their game but then they get too big to play it any more, and it's a matter of time before they learn whether they're any good at the next order of magnitude.

And for fund managers it's especially nasty, because it takes 15 years just to get past the other coin-flipping monkeys.
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Old 06-07-2009, 10:55 AM   #97
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He actually specializes in this. He keeps a large hoard of cash on hand so that when everyone else is scrambling for cash, Uncle Warren is sitting on a pile ready to rip your face off. He did it in 2001 and he did it again just in 2008/9.
Sooo, the market is not that efficient, and not all players are the same. How else was Uncle Warren able to score such good deals? I am just trying to do the same but at a smaller scale, scooping up bargain stocks while the other coin-flipping monkeys ran out of coins to flip. Yes, yes, and I need luck too. One can always use all the luck he can get.

Regarding mutual funds, I have learned that it is absolutely true one should not go chase the latest and hottest active mutual funds. If one wants to be an active investor, it is far better to spend that time picking stocks or sector ETFs yourself. And if an investor does not want to or think she can pick stocks, index investing with periodic rebalancing surely beats many "get rich quick" schemes.

I second what clifp and Nords said regarding the disavantages that a typical MF manager has. In fact, Peter Lynch was smart to quit while he was still on top. His Fidelity Magellan fund became unwieldy as investors kept piling in. His successor had a tough time maneuvering, and failed to beat the S&P. That fund has shriveled to a fraction of its former size. Berkshire's size is getting a bit cumbersome, but I still have trust in Buffet to know what to do.

Following is a post I made a while back to elaborate on the difficulties in execution for a MF manager.

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Stock prices have been so volatile that last week it was one thing, and today it's something else. Both 1.9% and 2.2% are correct, depending on the price when they computed it. And by the way, the future dividend is going to drop, but I'll leave that to the stock analysts to predict.

Your two MF's are "value-oriented" (a good thing if they did not load up on financial stocks), hence their dividend is higher than the S&P500.

About individual stocks, you can get much higher yields, but of course you may not be as diversified as the MF managers want to be. Perhaps they are afraid to lose their "solid" record if they concentrate too much on a few that pay really high dividends.

By the way, there is an advantage to owning individual stocks compared to MFs. Say a good company is in trouble, and the bad news hit the press. Owning a few thousand shares at most, one mouse click and you are out. Compared that to a MF manager who owns several million shares. It takes him days to get out. If he dumps his 10M shares, the price is instantly down in the mud.

I once read about a manager of a not-so-big MF, an account of his daily activities, not unlike our own thread "what did you do today". After researching and finding a good company, he wanted to build a position in this stock. In order for the position to make a dent in his bottom line, he got to get several million shares. It took him 3 months buying slowly to build up that position. Buying too fast, and the price rose beyond what he wanted to pay. Similarly, it took that long to unwind.

MF managers often lament that their portfolio size makes it tough for them to jump in and out quick like small individual investors. If I sound like I am defending these MF managers, it is only because I try to explain the probable reason they are not getting you the dividend that you want.

I hope the above explains why your 2 MFs do not want to load up on just a few companies. You can, as owner of individual stocks, but at your own risk.
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Old 06-07-2009, 01:59 PM   #98
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Sooo, the market is not that efficient, and not all players are the same. How else was Uncle Warren able to score such good deals? I am just trying to do the same but at a smaller scale, scooping up bargain stocks while the other coin-flipping monkeys ran out of coins to flip.
The difference is that Warren effects the outcome, you do not. The $1B he put in to CEG saved the company, it changed the dynamic. He made that life saving loan at such egregious terms you could almost hear Marlon Brando whispering, "Someday - and that day may never come - I'll call upon you to do a service for me. But until that day, accept this justice as gift"
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Old 06-07-2009, 02:01 PM   #99
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The problem is that virtually every academic study focus on the performance of mutual funds and I have never seen a single study that measured the performance of individual managers, the actual stock pickers.
You'll have to walk me through the difference between the performance of a stock picking fund manager and the performance of the fund for which he picks stocks.
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Old 06-07-2009, 03:08 PM   #100
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The difference is that Warren effects the outcome, you do not. The $1B he put in to CEG saved the company, it changed the dynamic. He made that life saving loan at such egregious terms you could almost hear Marlon Brando whispering, "Someday - and that day may never come - I'll call upon you to do a service for me. But until that day, accept this justice as gift"
The idea of "being fearful when others are greedy and being greedy when others are fearful" applies to large as well as to small investors. In other words, there are market inefficiencies one can take advantage of. One cannot predict when that will happen. One can be ready to recognize it and has the gumption to take the chance. There are of course never certainties, only probabilities.

Now, instead of saying that passive investing beats active investing, let's hear the passive investors define their passiveness. From the earlier posts, I have learned that Bogle's disciples have branched off from just S&P500 to different flavors. Some prefer small caps and foreign stocks which Mr. Bogle still does not recommend (I read the article linked in the OP). Others like value-oriented or dividend-paying stocks.

It is easy to say "stay the course" but it appears these passive investors are running off in all different courses. How do these passive investors chose their individual courses? Will they ever change their courses, like adding some foreign ETFs which they did not have access to before? It appears that many of these passive investors applauded the advent of these new-fangled investments. Is it the same course that Bogle preaches? It appears to me they are not all marching to the same drum beat.

About rebalancing, different investors use different triggering criteria. I believe only Trombone-Al choses Jan 2 as an unconditional date to rebalance. Nearly everyone else uses a certain percent threshold, a different rebalance period, or has entertained the idea of using S&P P/E ratio, etc... The choices are numerous. It is easy to say "index investing", but there are now so many indices to chose from, and one can practically build her own MF with a custom blend.

It seems to me that the above differences in style between passive investors can cause a large difference between individual portfolio performances. Being ignorant and always trying to find my own way, I now learn that even in "indexing investing", there are as many approaches as there are passive investors. Certainly, not all of them will beat the S&P 500.

So in short, passive investors, please describe your approach and your definition of passiveness.
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