= 27d567bc2d48d9f40e9ccc20ea370b15)
SaidAchmiz comments on Rationalists Are Less Credulous But Better At Taking Ideas Seriously - Less Wrong
You are viewing a comment permalink. View the original post to see all comments and the full post content.
= 783df68a0f980790206b9ea87794c5b6)
Loading…= b715d02e85f7b3b4ae65ca3d3e450868)
Subscribe to RSS Feed
Powered by Reddit
= f037147d6e6c911a85753b9abdedda8d)
You are viewing a comment permalink. View the original post to see all comments and the full post content.
Comments (285)
Thank you. A couple of follow-up questions, if you don't mind:
Do most ordinary investors not do this?
If not, do you know why? Do most people not know about the advantage of index funds? Or do they know, but don't use them anyway?
If the latter, why don't they? That seems strange. What makes index funds the "non-default" idea, so to speak? If index funds are known by financial experts to be superior to mutual funds (or other investing strategies), where would an ordinary person get the idea that they should be using anything other than index funds?
An index fund is intended to go up or down y the exact same amount as the entire exchange as a whole. For example, you might hear that the S&P 500 rose a total of 7% last year. If that happened, then your index fund would go up by 7%.
The main reason people don't invest in index funds is because they want to "beat the market." They see some stocks double or triple within a year and think "oh man, if only I'd bought that stock a bit earlier, I'd be rich!" So some people try to pick individual stocks, but the majority of laypeople want to let "experts" do it for them.
Mutual funds generally have a fund manager and tons of analysts working there trying to figure out how to beat the market (get a return greater than the market itself). They all claim to be able to do this and some have a record to point to to prove that they have done it in the past. For example, fund A may have beat the market in the previous 3 years, so investors think that by investing in Fund A over an Index fund, they will come out ahead.
But unfortunately, markets are anti-inductive so past success of individual stocks, mutual funds, and even index funds is no guarantee of future performance.
If you look at the performance of all funds over the past 20+ years and correct for survivorship bias (take into account all the funds that went out of business as well as the ones that are still around today), it becomes very clear that almost no mutual funds actually beat the market in terms of your ACTUAL RETURN when averaged over each year.
The final big problems with actively managed funds are fees and taxes. Actively managed funds charge higher percentage rates each year to cover their work. That's how they make money. They also tend to sell a percentage of your stocks each year and buy new ones in their attempt to beat the market. This gives a certain "portfolio turnover" percentage and the higher that is, the more you have to pay in taxes (capital gains), which lessens your return even more.
The bottom line is that mutual funds claim to be able to beat the market and many do in any given year. People chase the money and pay more in capital gains and fees to try to make a higher return. Over time though, the index fund beats all others in terms of total return over time.
But mutual funds are. I don't remember the citation, but I recall that mutual funds that do very poorly one year are more likely to do so in the future when you take into account fees and taxes.
Clearly, there are actively managed funds that do consistently worse than index funds, otherwise index funds wouldn't be able to make money, since financial markets are negative-sum.
Financial markets are positive-sum. If you just buy a bunch of stocks and hold onto them, on average you'll outperform cash.
Not necessarily. First, it depends on the market. Some are zero-sum, and about others one can say that they are NOT zero-sum, but that's it. They might be negative-sum or positive-sum, depending on the circumstances.
That also depends. Average over what? Which countries and what time periods?
If you buy a stock A at price X, somebody must be selling you stock A at price X.
If buying turns out to be a good deal (that is, the discounted dividends Y you collect from holding stock A are greater than X), then selling must turn out to be a bad deal: if the other party held stock A they would have collected the profit Y-X that they forfeited to you. Your gain is their lost profit, therefore the market is zero-sum between investors. Add transaction costs and it becomes negative-sum.
This analysis is simplified by the fact that I didn't take into account risk aversion and the fact that different parties can discount future utility in different ways (different discount rates or even hyperbolic discounting). But I suppose that when it comes to collective investors such as mutual funds or banks, these parameters can be considered to be roughly the same.
The stock market is not (necessarily) zero-sum or negative-sum as a whole, since money is transferred from companies to investors each time dividends are paid, but the way the investors slice the cake between them is negative-sum.
Survivorship bias means that most existing funds can have beating index funds in the past.
Yes, but taking into account survivorship bias, there are some actively managed funds that do do consistently worse than the market, and eventually fail (and are replaced by other funds that do so)
1) No but I'm doing my best as a columnist for Better Investing Magazine to tell them. Still, lots of money is in index funds.
2 and 3) Actively managed mutual funds put a lot of money into marketing, and the explanation for index funds is probably beyond most people. A huge number of financial experts would be out of jobs if all non-professional investors switched to index funds.
I don't know, the simple explanation for index funds is "on average, you will get the market average. So why not avoid the fees?", though it requires people being self-aware enough to recognize situations where they are, in fact, average.
But the actively managed mutual fund you are considering investing in has consistently outperformed the market even when taking into account taxes and fees.
Am I above average at picking actively-managed mutual funds?
What if you are the kind of person who is above average in most things. It's far from obvious why you shouldn't think you would be above average at picking stocks or mutual funds.
Why, thanks for noticing. ;) This is where the self-awareness comes in, and I agree if you can't rely on that then you do need to build up the argument that the financial advisors and active managers are not worth their cost.