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Lumifer comments on Public Service Announcement Collection - Less Wrong
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True.
Not true. Or at least much more complicated.
The first problem (minor) is with the concept of an "index fund". Most people read it as an S&P500 index fund, that is, a fund that passively invests into US large-cap equity. At this point it's reasonable to ask, why US large-cap equity? Why not a US equity + US bonds passive fund? Why not add European stocks or bonds? Why not add emerging markets? Why not add commodities or real estate? The answer to what kind of a mix of asset classes do you want to hold is... complicated.
The second problem (major) is with the concept of "best return". It's pretty meaningless to talk about best returns without involving uncertainty, volatility, and individual risk tolerance. I don't think asserting that the risk-return profile of the S&P500 (again, US large cap equity) is just perfect for everyone is a defensible position.
Finance is a hard problem. There's no easy universal answer to "what should I do with my money" -- the answer is it depends. Sure, compared to investing in S&P500 there are a lot of worse things you can do -- but that doesn't mean buying the Vanguard index fund is the optimal choice.
The argument is that the added value of the "it depends" answer doesn't pay for the additional cost in calculating what it depends on. With perfect knowledge, not everyone would go for the Vanguard index fund, but that's not the situation we have, and with imperfect knowledge it's a solid choice for nearly every situation. Having it as a default choice (that you possibly move away from after doing research) is much better than not having it as a default choice.
I see no reason to believe so. Do you have evidence or arguments to support this naked assertion? What other choices are you comparing it against?
From Index Fund Advisors:
They have several recommendations by Nobel laureates on that page, and have a index of papers here. As a general comment, the Efficient Markets Hypothesis is relevant: unless your money manager is insider trading (and if you, as a customer, know about that, then probably so does the SEC), you should not expect them to do significantly better than the market as a whole. The EMH has holes; Buffet has famously outperformed the market and index funds by dint of superior rationality, but most people are not qualified to judge which money managers are rational enough to be better than index funds.
You don't think they might be a bit, um... biased? :-)
Marketing BS is not evidence.
And before we get into the EMH mess (by the way, how strong a version are you arguing for?) let me ask you, which market? There are a whole bunch of different markets -- what makes large-cap US equity special?
Possibly. I linked them because they're convenient. I know enough economics that index funds being optimal for investors without special knowledge is obvious to me; you can find more on wikipedia or Motley Fool.
I personally recommend VTSMX for investors in the US, because there are a handful of reasons to prefer investing in domestic funds (especially if you live in the US). There is advice out there targeted at low-load funds if you're interested in putting more thought into the choice. If you live elsewhere, there may be tax considerations that make other funds superior (google 'index fund [your country]', and you should probably find some useful advice), but if you live in a particularly small country investing only in domestic stocks will probably increase your volatility significantly over an American only investing in US stocks.
I suspect I know more economics than you and that optimality is not obvious to me at all.
Let me ask you again the question which you sidestepped -- which market? An "index fund" is a shortcut for "passively managed diversified portfolio" and that's a very large territory.
Let's even assume market efficiency. First, investors are different. Let's take a few: a 25-year-old grad student in Singapore with $5,000; a 65-year old Canadian with about $5m saved for retirement; a 40-year-old Indian who has ten lakhs rupees with which he intends to open a business in a couple of years. None of them have "special knowledge" -- is the same investment vehicle optimal for all of them?
Second, I've still seen no argument as to why large-cap US equity (aka S&P500) is the best. Why is it better than a stock-and-bond mix, for example? Should you throw emerging market equity in there, too? it will increase diversification. And what about commodities? Strategy-based ETFs? They are all different and they will all increase the diversification of your portfolio -- under the EMH assumptions that's the only way you can win. Theoretically your portfolio should consist of all investable assets available and yet the usual recommendation is to invest in the S&P500-based index fund? That doesn't look optimal to me at all.
Third, what about leverage? I can easily double my leverage or halve it (by leaving half of my money in cash). What's the optimal leverage? Why would you consider the default leverage of 1 to be optimal?
Finance is hard.
How is recommending a specific fund sidestepping the question? If you mean that I sidestepped the meta question of "which method do you use for selecting which market?", then yes, I did. I don't think the value gained from researching that sort of topic is very high once you subtract the costs of researching. I also don't think the question of how much of one's wealth should be invested is very sensitive to the asset class that you choose to invest in for most investors. (Yes, lower wealth investors should be more risk averse, and older investors should be more risk averse. But, for older investors at least, that suggests a passively managed fund with a targeted retirement date which they use to adjust their allocation between stocks and bonds, which still falls in the recommended class of index funds!)
Indeed, it might be better to treat the claim "invest in index funds" as a consequence of the broader claim that "treating finance as hard is a mistake." It looks to me like there are two sorts of people that consistently do well in personal finance:
The people that believe that finance is hard do not seem to consistently do well, and seem to be easy prey for financial parasites.
It's not clear to me what advice you're giving with the statement "Finance is hard." Is that a "become a financial advisor" or "hire a financial advisor"? If so, how do you square that with acknowledging that most of the industry is parasitic or deluded? On average, people have average financial advisors.
We seem to have a baseline disconnect with respect to how one goes about picking what to invest in, so I'll let the subject drop and not get into line-by-line argument.
However let's take a look at the broader claim "treating finance as hard is a mistake".
Um, evidence? It does not look to me like that, so where's the data?
The "finance is impossible" group is better known as passive long-only investors. They don't get "average" return on capital in any meaningful sense of the word "average" -- they are just willing to accept whatever returns the basket of assets (index) they chose will generate. And they still have to make decisions -- very meaningful decisions -- about which index to pick and how much leverage to deploy.
The "finance is easy" group is usually called value investors. Note that they are active investors, not passive. Given this I am not sure why do you think they consistently do well -- this seems to contradict your acceptance of EMH earlier. And, of course, "pricing assets" is very very hard.
The advice is: there are no good one-size-fits-all solutions. Investments should be custom-tailored to individual circumstances which include things like risk tolerance, expected use, expected time horizon, etc. That custom-tailoring is complex and there are no obvious ways to make it simple. Simple solutions exist but are typically sub-optimal. Generic advice (other than "don't fall for scams") is pretty worthless.
Who do you think consistently does well, and what data do you use to support that view? That'll help me determine if I have evidence you'll find convincing.
Similarly, what does "average" mean to you?
I said earlier:
I don't have a good explanation for why value investing works. The most charitable and plausible one I know is "most investors look for short-term mispricings instead of long-term mispricings, and so there are more opportunities where less people are looking."
Is there a short list of fairly unrelated components that cover almost all of what it depends on?
Off the cuff, I'd guess:
Any other broad category of consideration that I missed, or consolidation/elimination of those I listed?