elharo comments on Solved Problems Repository - Less Wrong

25 Post author: Qiaochu_Yuan 27 March 2013 04:51AM

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Comment author: elharo 15 May 2013 10:24:42PM * 17 points [-]

I didn't think of this until the recent munchkin post, but one solved problem is what financial instruments to invest in. The answer is index funds with low fees in a tax advantaged account. Vanguard has some good funds with fees as low as 0.1%. Unless you're a professional investor (and maybe not even then) your chance of beating index fund performance over the long term is tiny. Not quite winning the lottery tiny, but maybe winning a big stuffed animal at a rigged carnival game tiny.

Comment author: FrameBenignly 25 January 2015 03:52:54AM 2 points [-]

The technical term for "low fees" is expense ratio.

Comment author: MTGandP 18 August 2013 10:47:58PM 2 points [-]

your chance of beating index fund performance over the long term is tiny.

Isn't it more like 50%?

Comment author: gwern 18 August 2013 11:42:09PM 11 points [-]

No; you are incurring extra fees due to your likely extra trading, diseconomies of scale, and uncompensated risk due to less diversification.

Comment author: diegocaleiro 03 September 2013 03:04:45PM 1 point [-]

How about index funds in countries that have an obviously larger growth potential instead of one's own country.

I don't mean to brag, but I'll bet none of you rich country folk have seen rates we've seen in Brazil in the last many years.

Comment author: elharo 18 September 2013 10:11:28AM * 7 points [-]

That's the Vanguard Emerging Markets Stock Index Fund and indeed I own some of that. However it's a relatively small part of my portfolio. The risk and variance are much higher, and the risk and variance of a single country index fund would be higher still. This fund dropped more than 75% during the 2008 crash and still hasn't recovered. The expense ratio ranges from about 0.2% to 0.33%, higher though not hugely so than domestic and total international index funds.

Most investors, especially those with smaller portfolios or who have a shorter time horizon, are probably better off with something like the Vanguard Total International Stock Index Fund which includes a developing markets component, but also includes Asia and Europe, or the Vanguard Total World Stock Index which adds the United States to the mix.

Comment author: FrameBenignly 25 January 2015 03:55:49AM 0 points [-]

At least in the US, generally expense ratios on foreign index funds are higher than on domestic index funds. They're still a better deal than actively managed mutual funds.

Comment author: Lumifer comment score below threshold [+] (10 children)

Comment author: elharo 25 September 2013 10:26:40AM 1 point [-]

That only changes which index funds to invest in, particularly the mix of stocks vs bonds. Unless your goal is to lose money, the answer is still index funds.

Comment author: Lumifer 25 September 2013 02:44:58PM 0 points [-]

Can you provide an unfolded argument as to why index funds are the right investment vehicles for everyone on this planet?

Comment author: elharo 25 September 2013 04:06:45PM 0 points [-]

Index funds outperform all other investments over a reasonably long time horizon.

Even over a short time horizon while certain stocks and funds may outperform some index funds, it is not possible to pick what those stocks are in advance. While you may get lucky with an individual stock pick, you are more likely to get unlucky. The expected return on the index fund is higher.

Comment author: Lumifer 25 September 2013 04:39:12PM 0 points [-]

Index funds outperform all other investments over a reasonably long time horizon.

Really? Surely you will be able to provide data to support this rather amazing claim. It certainly does not look true to me.

...it is not possible

Why is that? How do you know what's possible and what's not?

Comment author: elharo 27 September 2013 11:47:17AM * 2 points [-]

Many intelligent, rational folks have written about this at great length with lots of charts and numbers. Instead of rehashing the same material, let me just point you at Eric Tyson's Personal Finance for Dummies. as a good starting point.

As to why it's not possible, the short answer is the weak efficient market hypothesis, which has been well proven by 100+ years of experience. I don't personally hold the stronger version--that is, I believe it may be possible to beat the market given insider information--but unless you have such insider information, the expected return of an index fund is greater than any other investment you can make in the same sector.

To bring this back on topic for LessWrong, keep in mind that when evaluating investor performance, you have to avoid survivorship bias. I.e. you need to consider the class of investors as a whole, not merely the ones who got lucky and shout their performance from the rooftops, but also the much larger class of investors who underperformed the market. This alone may be enough to account for the Peter Lynch's and Warren Buffet's of the world.

And of course we also need to account for hindsight bias. I.e. in 2013 investing in Magellan or Berkshire Hathaway circa 1983 is a no-brainer, but how could you pick those in 1983 amongst all the others that looked equally good at the time? Magellan's actually a really interesting case. When I first started paying attention to mutual funds about 15 years, it was the poster child for an actively managed fund that could outperform the indexes. However over the last 10 years or so, it's significantly underperformed the S&P 500. If I had bought it back then instead of the index fund I did buy, I'd have less money today.

Comment author: Lumifer 27 September 2013 02:34:41PM -1 points [-]

Many intelligent, rational folks have written about this at great length with lots of charts and numbers.

Let me remind you what we are talking about. You said "Index funds outperform all other investments over a reasonably long time horizon." I believe this statement to be false. The general handwaving in the direction of "many intelligent, rational folks" does not look convincing.

Perhaps you could expand that statement a bit? What exactly do you call index fund, what are all other investments and what's a reasonably long time horizon? Does the concept of risk enter this claim at all?

let me just point you...

Can we move the discussion a couple of levels higher? I am reasonably well-acquainted with finance and not much interested in explanations for dummies.

the short answer is the weak efficient market hypothesis, which has been well proven by 100+ years of experience.

First, I do not believe EMH, even in the weak form, has been "proven". I also do not think it is correct (at least in a falsifiable form -- you can make it unfalsifiable easily enough by saying that the "long term" isn't here yet).

Second, weak EMH claims that it's not possible to predict future prices solely from past prices. Your claim -- "it is not possible to pick what those stocks are in advance" -- looks like semi-strong EMH and that one is pretty certain to be wrong.

Oh, and I am well aware of both survivorship bias and hindsight bias.

Comment author: elharo 29 September 2013 01:08:26PM 1 point [-]

A few months ago I proposed writing a book that would answer all your questions in detail, but there wasn't enough interest to make it worth doing. There are many good books out there already that address these issues. I get that "Dummies" books are too low-status for you. I'll try to dig up some equally well-written, correct references that are higher status and explain things like "what an index fund is?" "what's a reasonably long time horizon?", and "what other investments are possible?" For starters, I've heard good things about Suze Orman's books, though I haven't read them myself.

Your formulation of the weak efficient market hypothesis is incorrect. The weak EMH is not based solely on past prices, but on all publicly available information.

Comment author: Lumifer 30 September 2013 04:45:00PM 0 points [-]

are too low-status for you

No, it's not an issue of status. They are too simplified and do not reflect reality to the degree that I consider necessary. It's like telling a competitive athlete "Oh, physical fitness is solved, just go to the gym".

I don't want references, anyway. You are claiming that investing is solved. You are saying that the only correct investment is into an index fund. Well then, tell me what's an index fund. Is it just any passive diversified investment? There are a great many indices, are all of them equally good? How diversified is diversified enough? Is "long term" a year? five year? ten? fifty? Should commodities be part of a well-diversified portfolio? should currency? real estate? sovereign bonds? volatility?

Your formulation of the weak efficient market hypothesis is incorrect. The weak EMH is not based solely on past prices, but on all publicly available information.

Let's see... Wikipedia: "In weak-form efficiency, future prices cannot be predicted by analyzing prices from the past. ... Share prices exhibit no serial dependencies, meaning that there are no "patterns" to asset prices. This implies that future price movements are determined entirely by information not contained in the price series. Hence, prices must follow a random walk."

Investopedia: "The weak-form EMH implies that the market is efficient, reflecting all market information. ... The semi-strong form EMH implies that the market is efficient, reflecting all publicly available information."

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