Why Index Funds Are Like Subprime CDOs

Ask your investment, budget, and other money related questions here
Jason
Posts: 2210
Joined: Mon Jan 30, 2017 8:37 am

Re: Why Index Funds Are Like Subprime CDOs

Post by Jason » Sat Sep 07, 2019 11:43 am

Ted Williams was arguably the person most proficient at hitting a baseball that ever lived. As good as he was at hitting a baseball, he was as poor at teaching people to hit a baseball. Why? Because he possessed gifts - fast twitch reflexes, better than 20/20 eyesight etc. - that could not be taught and being kind of an asshole, he grew impatient and decided to become the greatest fly fisherman that ever lived. He wrote a book "The Science of Hitting" that remains the pre-eminent book on how to hit a baseball.

If I read Ted William's book, I would no doubt become a more informed hitter. I would no doubt become a better hitter. But, ultimately, I would still suck at hitting a baseball. Is it perfectly analogous to investing? No. But there are corollaries. Uninformed vs Informed cannot be atomized as though we are all capable of being informed at the same level. It is also subjective. I am an informed investor? Depends on the audience. I have reached the point that any type of free or community college level course is redundant to me but I'm not going to be hired by hedge fund to trade oil futures. Are there unnecessary, self-imposed psychological barriers that I deal with? Yes. What does that mean? I have no idea. Sorry if you wasted time reading that. That being said, JLF reminds me of a bit of Ted Williams sans being an asshole.

From a practical standpoint, Seppia offers a workable solution. I work with the 2% rule. No initial investment in an individual stock investment can exceed 2% of my entire portfolio. And I always ramp up in at least three stages. Big ass baby steps.

The Old Man
Posts: 385
Joined: Sat Jun 30, 2012 5:55 pm

Re: Why Index Funds Are Like Subprime CDOs

Post by The Old Man » Sat Sep 07, 2019 12:43 pm

@Jacob:
Rather than attacking index funds, it would be better if you attacked the other sacred cow of the FIRE movement – the 4% rule. Now, I will be the first to admit the 4% rule was a genuine contribution to the field, but like everything else people expect far more than what the “rule” can deliver.

(1) The 4% rule was not 100% successful, but based on a 95% success rate.
(2) The 4% rule when it failed did so during the 1960s-70s.
(3) The 1960s-70s were a period of increasing inflation as the government tried to end the business cycle through monetary measures. The end result was high inflation with high unemployment. In consequence, the bond and stock markets under performed; however, real estate and especially leveraged real estate did great.
(4) Portfolio composition for the 4% rule was a stock/bond combination.
(5) Since stocks/bonds are NOT an inflation hedge, the 4% rule failed.
(6) For the people retiring in the 1960s-70s using the 4% rule, the chance of failure was far greater than 5%.
(7) TLDR: The 4% rule is a statistical artifact. It does not offer predictive value for a SWR when the incidence of inflation cannot be predicted and the assets themselves provide no inflation protection.

Today we are dealing with a negative interest rate environment in much of the world. Due to the interconnectedness of the world economy, those negative interest rates will eventually arrive to the USA. What does that mean? It means the assumptions that underlie the 4% rule will not hold.

I’m not smart enough to figure out what is the best investment strategy in a negative interest rate environment. For those that want to think outside the box, this area will likely provide the largest payoff.

jacob
Site Admin
Posts: 11209
Joined: Fri Jun 28, 2013 8:38 pm
Location: USA, Zone 5b, Koppen Dfa, Elev. 620ft, Walkscore 73
Contact:

Re: Why Index Funds Are Like Subprime CDOs

Post by jacob » Sat Sep 07, 2019 1:27 pm

There's a story about a young samurai who once was offended by an old samurai and consequently challenged him to a duel to the death. The old samurai had served all his life in charge of the palace tea ceremony and had never faced battle or practiced much anyway. He would surely lose the duel and the young samurai expected as much, hence the challenge. The old samurai asked an expert swordsman if there was anything he could do. The swordsman told the old samurai to just adopt a stance of jodan no kamae and mentally treat the duel with the same deliberate state of mind as he would a tea ceremony. The next morning the old samurai very properly and calmly assumes jodan. After facing off for a few minutes the young samurai falls to his knees, apologizes, and asks forgiveness/mercy and for the duel to be cancelled.

What just happened? Jodan is a very aggressive stance. To win (live) you're either much much better than your opponent or you're willing to accept mutual suicide which is what this stance usually leads to. By entering jodan with calmness, the old samurai signaled that either a) he was a much better swordsman than generally believed; or b) he was ready to die and take the challenger with him. In any case, it was certain death for the young samurai who therefore lost his nerve.

What's the lesson here? What Jason is saying ... the most important thing to know in investing is yourself. This is why many traders spend time studying Musashi, Sun Tzu, or Jesse Livermore or other traders rather than the minutia of 10Ks, etc. I think most retail investors would be surprised to learn that the so-called professionals who are ascribed immense powers are often mid-twentysomethings with all kinds of backgrounds other than financial analysis. I guarantee you that some of them don't know what a P/E ratio is on their first day of work. They're more likely to be picked because they're good at poker or have an "interesting" background (like say maybe an expert violin player or an ex-Olympian).

There's a story about Joe Siegel who is a famous trader in "green lumber". The story goes that he had no idea what he was trading---thinking that green lumber was wood painted green---so obviously fundamentals are not crucial to the trading process. For pit-trading in particular, the psychology of himself and his "opponents" was more important. The best traders I know, know themselves extremely well. We're talking people who only have a few losing days per year. Yes, they exist ... but as has been alluded to above ... it's just about impossible to do this on a scale bigger than 7-8 figures... this is why these guys are not running mutual funds.

This is not to say that investment professionals are clueless. They definitely know or eventually learn the basics, but most know less about the technical details than the average academic. OTOH, they know far more about the practical experience of being an investor/trader than do those who spend all their time studying spreadsheets. Compare a military historian to a combat veteran.

I have in my lifetime done a deep 10K analysis of exactly one company (it was FAST back in 2006ish). That was enough for me to realize that I have no edge in that over the thousands of people on seeking alpha who pursue this as a hobby or as a way to get discovered for a job interview. DIY fundamental analysis plays no role in the way I invest. I leave that to others ... I just read the CFRA reports instead. Analyzing that one company was helpful in understanding where a given number in the analyst report comes from (e.g. what is a quick ratio) or whether 1.2 is "a lot". But nah, I have little interest in doing forensics and reading footnotes.

For the informed DIYer, I think it's a mistake to spend thousands of hours becoming a great fundamental analyst (unless you want to work in the field) ... But again, I also know some fundamental investors who do well for themselves in emerging market small caps ... why there? Because there's little to no competition.

The X-factor in proficient investing is not how many hours "one has served time" for. It doesn't take much time establishing the basics because fundamentally, it comes down to buying and selling securities. What sets people apart is how much time they spend thinking about the last two CCs of the CCCCCC chain. The first 4 should only require 1000 hours or about a year's worth of evenings to build a foundation.

That is insofar one wants to be an informed DIY'er. What do the best investors have in common? They read A LOT ... and they read widely. Why? Because they're looking for an edge in the last two CCs ... especially the final C. This is also why their annual reports are much more interesting/esoteric than the average fund manager's.

But I digress ...

Back to the retail problem. The issue as I see it as that there are a lot of newbie investors who don't know themselves and don't really know what they bought yet firmly believe that they have a great investment plan "for the long run" because their favorite blog told them so. This is why we see so much teeth gnashing when the market is down for the week or another week these days. Many younglings have only ever seen the current mega bull market. They don't know how they'll handle a sustained drop or even a small one. They don't know themselves because they have never bothered to find out. Indeed the reason that this thread exists is likely that many don't know the market either. I think "informed" people or what I count as informed have been aware of the OP issue for years. I first started talking about it about a decade ago and it's not like I'm the smartest person in the market. Rather it's that ... I think the problem is that instead of seeing insight as some kind of proportional graduation that Jason points out (not learning anything from community college anymore). The common belief now is that any personal effort is pointless(*) when one can just index or buy a robo-adviser app. IOW, a material fraction of market participants have lost their humility---like the young samurai above---and become rather certain of something that just ain't so.

(*) That is apparently the state of secondary math education in Denmark these days. Thanks to the internet and sites like wolfram alpha where you can just look up the answer to practically any mathematical problem, there are now students graduating from high school with passing grades (the ministry of education has had to start grading on a curve) in math despite not knowing what "10%" or 9/9 means.

This is what I mean by paying attention personally and perhaps paying someone else to help too. Another slogan that's frequently repeated is that nobody could have predicted the housing crisis and resulting credit crisis. Bullshit! Several people did and they didn't keep it a secret either. Anyone who paid attention would have known about it. I knew about it and started going into cash and safer stocks a full year before the market bottomed. However, the majority of people had invested their egos in the bubble. They just knew they couldn't be wrong because they were like smart :-P It's not that people didn't know or couldn't know. It's that they didn't want to know. That's an example of not knowing oneself; not knowing that one's thinking is unduly influenced by one's ego and the need to be right. Great traders/investors don't make mistakes like that. This, however, is much harder to learn than how to read a 10K.

Now to do what Burry did back then requires both the 1) independent analysis, 2) the insight to recognize it, 3) the skill to set up the trade, and 4) the perseverance/fortitude to go against everybody else using margin or leverage. That's why he's a multimillionaire today. However, it was within the capacity of mere mortals (as long as they knew themselves a bit and hadn't allowed their ego to buy in) to at least understand the public analysis and recognize the subprime bubble.---And then stay out of the way when the crash happened. Which is what I did at the time with only 5 years of experience.

Key lesson here is that I think FIRE investors need to be able to pay attention and understand what they're being told. The rest can be outsourced.

The Old Man
Posts: 385
Joined: Sat Jun 30, 2012 5:55 pm

Re: Why Index Funds Are Like Subprime CDOs

Post by The Old Man » Sat Sep 07, 2019 2:26 pm

Noob question: What is the "CCCCCC chain"?
Sorry, Googling was no help.

Nomad
Posts: 181
Joined: Wed May 16, 2018 5:23 pm
Location: UK

Re: Why Index Funds Are Like Subprime CDOs

Post by Nomad » Sat Sep 07, 2019 2:26 pm

Jin+Guice wrote:
Sat Sep 07, 2019 9:52 am

What I'm having trouble with is even figuring out how to develop a strategy. How do I sort through all of the conflicting advice? How do I figure out where my efforts are best allocated?

How does one get to the point where they feel like they know what they're doing?
Personally, I read a few random articles then jumped in with not much money to play with.
For individual stocks Stockopedia.com was very useful for screening out the things to avoid and for highlighting the success of various strategies.
However, I do not have the stomach for investing in individual stocks so I lean towards funds etc.

I used the https://portfoliocharts.com website and identified a good fixed asset portfolio of 20% US 20% Emerging Markets, 20% REIT, 20% Bonds and 20% Gold. Then I would identify funds and ETF's in those categories that out performed. However, this is essentially buy and hold with occasional rebalancing.

However, recently I have been using https://www.portfoliovisualizer.com/ to investigate timing models. I put money into asset classes that are doing
well for the proceeding 3 to 6 months and actively avoid ones that are not doing well.

The key thing is that there are now tools available to backtest investment strategies. I have a thread were I list my current funds.

jacob
Site Admin
Posts: 11209
Joined: Fri Jun 28, 2013 8:38 pm
Location: USA, Zone 5b, Koppen Dfa, Elev. 620ft, Walkscore 73
Contact:

Re: Why Index Funds Are Like Subprime CDOs

Post by jacob » Sat Sep 07, 2019 2:45 pm

@TheOldMan - It's in the ERE book under Gauging Mastery. Copying-comparing-compiling-calculating-coordinating-creating.

Each pair roughly corresponds to technician (can e.g. copy and compare), mechanic, and developer in this blog post but it's somewhat more elaborate in the book.

P_K
Posts: 39
Joined: Wed May 04, 2016 9:47 pm

Re: Why Index Funds Are Like Subprime CDOs

Post by P_K » Sat Sep 07, 2019 2:50 pm

@jacob

Thanks, as always, for your insights. So a corollary of already having an interesting background before becoming an investor might be that developing a significant degree of skill in a variety of areas could actually be used to improve one's investing ability more than additional 10K/fundamental analysis. E.g. "How can I apply my understanding of playing chess at the 1% level to investing?" Something for me to think on.

jacob
Site Admin
Posts: 11209
Joined: Fri Jun 28, 2013 8:38 pm
Location: USA, Zone 5b, Koppen Dfa, Elev. 620ft, Walkscore 73
Contact:

Re: Why Index Funds Are Like Subprime CDOs

Post by jacob » Sat Sep 07, 2019 3:15 pm

It's not coincidental that Buffett (value investor) is a bridge player. That day traders prefer poker. That quants are into handicapping and sportsbetting. Their avocations are aligned with their respective vocations. The way you see the world should ideally match the way you invest. And of course also the way that the world actually is or rather will be.

classical_Liberal
Posts: 939
Joined: Sun Mar 20, 2016 6:05 am

Re: Why Index Funds Are Like Subprime CDOs

Post by classical_Liberal » Sat Sep 07, 2019 5:22 pm

jacob wrote:
Sat Sep 07, 2019 10:42 am
Now imagine those who read the first edition and never bothered to check in again or deliberately decided not being convinced of the original arguments for risk free bonds.
This isn't the first time you've brought up this concern, and the fact a clustering of high risk behaviors (wrt FIRE) can occur. I'm just curious how broad you think the potential for this type of behavior really is. I mean, it seems to me "set it and forget it" wrt to life savings is insane. People in the FIRE movement are generally a bit more informed than average.

@anyone
Yes, I know other FI related sites encourage noobs to index. I've always assumed this is the "introductory" phase to investing. Frankly, it's not a bad introduction. I guess I haven't read J.L. Collins or the like. Are those sources actually encouraging a "set it and forget it" allocation for life? Or are they simply trying to encourage people to deal with their behavioral tendencies that could very negatively impact investing performance? Because the later seems like a good idea for newer investors. I'm just wondering if all this concern regarding FIRE movement being decimated because they are all 90% VTI for life is valid. Put another way, did anyone here actually retire based on YMOYL and still holds 100% Treasuries?

Seppia
Posts: 1048
Joined: Tue Aug 30, 2016 9:34 am
Location: Italy

Re: Why Index Funds Are Like Subprime CDOs

Post by Seppia » Sat Sep 07, 2019 9:49 pm

classical_Liberal wrote:
Sat Sep 07, 2019 5:22 pm
I'm just wondering if all this concern regarding FIRE movement being decimated because they are all 90% VTI for life is valid.
I am 100% convinced that more than half of the index mujahideens will not buy and hold, and instead panic and sell, whenever the next downturn hits.
Being 100% stocks is great (and easy to maintain) when there’s a 10 year bull market with historically low volatility.
What some underestimate is the mental toll that seeing your assets go down in value 20-30-40% in a few months with crazy volatility will take.

Seppia
Posts: 1048
Joined: Tue Aug 30, 2016 9:34 am
Location: Italy

Re: Why Index Funds Are Like Subprime CDOs

Post by Seppia » Sat Sep 07, 2019 9:51 pm

jacob wrote:
Sat Sep 07, 2019 1:27 pm
There's a story about a young samurai who once was offended by an old samurai and consequently challenged him to a duel to the death.
Fantastic post overall, thanks Jacob.
I know you guys are all INTJs and don’t need this kind of “thank you that was great” posts, but, really, thank you.

User avatar
jennypenny
Posts: 6239
Joined: Sun Jul 03, 2011 2:20 pm
Location: Stepford USA

Re: Why Index Funds Are Like Subprime CDOs

Post by jennypenny » Sun Sep 08, 2019 4:46 am

Seppia wrote:
Sat Sep 07, 2019 9:49 pm
I am 100% convinced that more than half of the index mujahideens will not buy and hold, and instead panic and sell, whenever the next downturn hits.
I wonder about this too. What's the average age of an index holder? If most are ten years closer to retirement than during the last downturn, that would make it mentally easier to justify pulling the plug. If it's mostly other funds holding those funds, then they'll all go down together (or stick their hands out at the same time, hence my question about Vanguard).

Serious Q: If most of the money flowing into stocks is buybacks because money is cheap, and money is going to stay cheap, is there any reason not to expect that to continue?

jacob
Site Admin
Posts: 11209
Joined: Fri Jun 28, 2013 8:38 pm
Location: USA, Zone 5b, Koppen Dfa, Elev. 620ft, Walkscore 73
Contact:

Re: Why Index Funds Are Like Subprime CDOs

Post by jacob » Sun Sep 08, 2019 9:06 am

@cL - It's my impression that the slogan-based beliefs/concentration is rather broad. This forum is somewhat of an exception to indexing in that there's a good level of tolerance towards not-indexing here. Put it another way, I have a hard time thinking of any big FIRE site that does not recommend either indexing or real estate investing as the one and only true way. But then again, I only regularly visit a few other sites.

The answer is both. As always, we should distinguish between the leaders (who tend to be more detailed) and the followers (who go to the quick&easy cafeteria), but the take-away in much of the FIRE sphere is exactly to eliminate behavioral mistakes with a "fire and forget"-state of mind. Collins recently put out a tongue-in-cheek meditation vid. His book has more caveats (like pointing out the virtues of a balanced portfolio as one nears retirement age albeit one that is still more aggressive than the bond%=age tradition) but if you want to look at the average (FIRE-sphere) user take-away, check out the reviews on amazon.

I also think that indexing is an excellent starting point ... it really does solve the "know thyself" problem to perfection. Perhaps the meditation, slogans, or social proof serves to help to stay the course. Where it becomes risky is that many stop there and don't think about knowing the market or their investments having largely replaced this with the belief that the ultimate bulletproof solution has been found! Returning to Mark Twain, this is what makes the situation particularly dangerous. Like subprime CDOs.
Sun Tzu wrote: If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.
The common belief is that "if you know yourself but not the enemy, you will still win in the long run", but that is only true if the tide keeps rising.

Incidentally, the general forgot one combination: "If you know the enemy but not yourself, ..." which is the bane of frenetic stock pickers, but I digress.

TL;DR - It's not that index funds are like subprime CDOs... it's that they are being treated as such.

@jp - The problem with buybacks is that money needs to become increasingly cheaper (or economic growth needs to become stronger to compensate). Here's the chain of effects. A company borrows money. This debt increases debt service and normally it is used to increase growth so the debt can be paid. Instead it is used to buy back stocks. This reduces the share count and even if there's no growth and earnings stay the same, the earnings-per-share goes up. Multiply that with the P/E, and this is how buybacks cause share prices to go up. Recall that this money was not actually invested in capital(*) to increase earnings... it went to buy shares. What has happened is that the balance sheet has been rearranged. A higher share price has resulted in a higher [P/E] multiple at the cost of a higher debt service cost.

As a result organic growth must be able to pay for that debt service. Otherwise cash flow goes down. This makes it harder to maintain earnings (insofar one can not borrow again) .. and if earnings go down, the price goes down due to the now higher multiplier effect, e.g. when the P/E is 30, a $2 drop in EPS costs $60 in the stock market instead of $30 when the P/E is 15.

This would be easier to draw in a diagram :-P

(*) New machines and new labor to run them. One of the complaints about the 2017 Trump tax cuts---I'm talking the corporate tax cuts---is that a) the elimination of the repat tax went into earnings as companies could write off what would otherwise be tax losses/purgatory; and b) the money itself went into buybacks. The economy itself didn't feel the effect directly. It was only good for the stock market.

This is the situation we're in now. This is why the Fed lowered interest rates to 2.25% despite claims about a "strong economy". (If an economy is strong, it should be able to sustain debt loads at 4-6% .. but this one sputters when pushing 2.25% .. so ... it's actually somewhat mediocre despite stock prices being high. Still better than Europe's though.)

This is also why the smart money is so concerned about the growth in BBB rated debt (one step above junk). Even if the companies can nominally afford refinancing, if their rating is downgraded into junk, then their cost of refinancing goes up. That eats the earnings which drop. Then the price drops potentially by a lot and equity gets wiped out. The second thing to go in such a company would be the dividends.

What happens if the Fed just keep lowering the funds rate instead? Then we can keep driving up the cost of debt service by borrowing more... but eventually the cost of the debt service will eat all the earnings. That puts a natural end to the multiple expansion. It doesn't matter how high P/E is, if EPS->0. In short, this can not go to infinity... UNLESS, lenders are willing to lend money at negative rates, effectively paying interest to the companies which would then use that for their dividends and further buybacks. This situation would only happen when bond-holding is mandatory for some market participants. This is why Europe can sustain some level of negative interest rates.

TL;DR - Even companies can't live above their means forever. Even if the "credit card company" drops the rate to 0.00%, borrowers will still hit their credit limit eventually. At that point their "lifestyle", that is, the stock price will take a hit proportional to how far above their means, they've been living. Last year, I sold all the companies in my non-REIT portfolio with above-average debt holdings (except T) for that reason.

User avatar
Ego
Posts: 4208
Joined: Wed Nov 23, 2011 12:42 am

Re: Why Index Funds Are Like Subprime CDOs

Post by Ego » Sun Sep 08, 2019 9:20 am

Let's say Bogle's kids go on 60 Minutes tonight and collectively admit that they believe Burry is right. Boomers across the country panic, login to their Vanguard accounts and transfer everything to the cash-equivalent fund. So, what happens?

jacob
Site Admin
Posts: 11209
Joined: Fri Jun 28, 2013 8:38 pm
Location: USA, Zone 5b, Koppen Dfa, Elev. 620ft, Walkscore 73
Contact:

Re: Why Index Funds Are Like Subprime CDOs

Post by jacob » Sun Sep 08, 2019 9:44 am

@Ego - The stock market would be closed tomorrow and probably remain so for several days while the Fed, Mnuchin, various bank CEOs, and the representatives of the big fund companies like Vanguard, Fidelity, Blackrock, ... try to work out how to finagle this giant transfer of wealth behind the scenes.

Also see,
https://www.amazon.com/Too-Big-Fail-Was ... 670021253/
https://www.thebalance.com/2008-financi ... ne-3305540

If it was "only" one of them instead of all of them, it would look more like when the quant funds folded in the fall of 2008 with large drops in the market resulting because of lack of liquidity on the other side (also see liquidity discussion in the link further back in the thread). Back then, there weren't (m)any circuit breakers, today, you'd see trading in large numbers of stocks halted for 10 minutes, restarted, then halted again. It would be very hard to push limit orders through as a retail investor insofar you were hoping to "buy on sale". These are the situations where you see the difference between brokers.

7Wannabe5
Posts: 5003
Joined: Fri Oct 18, 2013 9:03 am

Re: Why Index Funds Are Like Subprime CDOs

Post by 7Wannabe5 » Sun Sep 08, 2019 11:10 am

@Ego:

Already happened. Ish.

https://www.wsj.com/articles/bogle-soun ... 1543504551

I believe that it now is hovering above 50%.

Meanwhile, overall participation in stock market in any way (inclusive of retirement accounts) is down to 52% of U.S. adults, and only 5% of adults say that they know what "stock option" means. So, it's not like you have to be able to derive your own version of Black-Scholes- Merton in order to pull ahead of the pack.

One book I am currently reading which I highly recommend for those who prefer intelligent words over intelligent numbers is "How to Speak Money: What the Money People Say- and What it Really Means" by John Lanchester (also an excellent novelist, son of mid-century British/Hong Kong banker.)
" I am going, with apologies, to introduce a newly coined term of my own. That term is "reversification." I mean by it a process in which words come, through a evolution and innovation, to have a meaning that is opposite to, or at least very different from, their initial sense. Take the term "Chinese wall," much used in the world of finance. This is a classic example of reservification. In real life, a Chinese Wall is a very big, very real physical wall in China...In the world of money, though, the term "Chinese wall" means an invisible dividing line inside a financial institution that prevents people from sharing information across it, in order to avert conflicts of interest. In theory, banks are full of Chinese walls...In practice, Chinese walls tend to be highly permeable, especially in times of stress or opportunity, In other words, it is the opposite of the actual Chinese wall. In considering the financial use of the term, we would all do well to bear in mind something said by the investor Vincent Daniel, in speaking to Michael Lewis: "When I hear 'Chinese wall,' I think, "You're a fucking liar.' "
Interesting mental exercise might be to imagine that you are in the current economic environment, but you are 25 years old (physically vigorous with many years ahead of you) version of you, inclusive of current knowledge/experience/skill base, with zero net worth (no debt/no assets), and somebody just offered you a loan of $400,000 at 1.5% on the basis of appraisal of your human capital. What would you do?

Jason
Posts: 2210
Joined: Mon Jan 30, 2017 8:37 am

Re: Why Index Funds Are Like Subprime CDOs

Post by Jason » Sun Sep 08, 2019 11:58 am

The retail brokerage firms have established a narrative of degradation of risk between financial instruments - broadly based index funds/mutual funds/ETF's are the safest, sector based index funds are safe but less safe, individual stocks will not only cause eventual financial ruin, but sexual impotency, baldness and death of your dog, commodities and precious metals well, you will be immediately smited by God. I went to see a Fidelity advisor a few years back and they wanted me to sell a sector Fidelity fund and put the proceeds into a broader Fidelity fund. I ignored their advice. Of course they wanted me to sell all my individual stock holdings. I refused that as well. In retrospect, I was being told that any and all predication/prognostication is detrimental to my financial health. Just DCA. That's the message. For those of us in the US, we live in one of the most dynamic capitalistic societies that ever existed but are told not to think upon it when it comes to our personal financial life - what we read, see, hear, encounter in our existential lives will only hurt us when it comes to thinking about our money. That's Hannah Arendt shit right there that makes John Bogel a financial Nazi. OK. Maybe not. But I have stepped out - Brexit comes to mind. I played that shit mad dope. I realize I'm not so much a bad stock picker, I am a bad stock seller - I sell too early. And being someone who is typically late for the party, I have started to train myself to see who's getting their ass beat now and will eventually pick themselves up. I'm not sure it's a take the training wheels off thing, but more of a you can start riding down some roads not in your neighborhood type of thing.

User avatar
Ego
Posts: 4208
Joined: Wed Nov 23, 2011 12:42 am

Re: Why Index Funds Are Like Subprime CDOs

Post by Ego » Sun Sep 08, 2019 12:11 pm

So, TARP 2?

Divided congress. Millennials are now old enough to vote and only 20% own stocks. They're pissed at the boomers for the environment and student loans. Here's their chance to kick the boomers where it hurts. Would it pass?

Warren and Sanders were outspokenly critical of TARP 1. Could make things interesting.

jacob
Site Admin
Posts: 11209
Joined: Fri Jun 28, 2013 8:38 pm
Location: USA, Zone 5b, Koppen Dfa, Elev. 620ft, Walkscore 73
Contact:

Re: Why Index Funds Are Like Subprime CDOs

Post by jacob » Sun Sep 08, 2019 12:48 pm

@Ego - Central banks buying stocks directly is a possibility. Some foreign national banks already buy US stocks (the Fed is not allowed ... or at least wasn't last time I checked some years ago). Another option is the nationalization of various companies. I highly recommend the book in the link above to get an idea of how big problems in high finance are solved once the market breaks down. I'll note that such bailout deals happen at fire sale prices. AIG is an example of a company that was de facto nationalized in 2008. It went from a reverse split adjusted value of ~$1400/sh to some $20 bucks depending on which day you looked ... it's trading at ~$55 today.

In reality, short of a nuclear war, it's a near impossibility that all retail investors would do a simultaneous "bank run" on their self-directed funds. Insofar they do it over time (several weeks or months like last time), it's more likely to look like the liquidity issues described in the other thread.

How many congress members are currently representing Millenials again? But seriously, once there's a material faction representing people currently under 40, the main game-changer would be a change in the capital tax structure seeking some generational equity.

Jin+Guice
Posts: 383
Joined: Sat Jun 30, 2018 8:15 am

Re: Why Index Funds Are Like Subprime CDOs

Post by Jin+Guice » Sun Sep 08, 2019 1:52 pm

Thanks everyone for all the responses. I was feeling lost and discouraged about investing, but now I'm feeling reinvigorated and have developed a plan.

If you're in this thread for the OP you can pretty much skip this post, it's a personal response to everyone who commented on my frustration.

I still need to spend some time learning about the fundamentals of investing. I've read several books by successful investors and I know what a lot of the very basic terminology means, but a lot of what's said on the investing forums here is still Greek to me. I'm going to dedicate some time over the next year or two to doing the curriculum and then reading some of the auxiliary material suggested.

I'm also relieved to hear that most of you aren't spending forever reading company annual reports. Things like "knowing yourself and others better" and "learning other interesting things" are something I'm more interested in putting time towards than reading annual reports. I understand that I can't totally side-step doing this, but it's relieving to hear that the confident among you are mostly not spending 10-20 hours a week on this.

I also appreciate the reminder that I don't have to be all or nothing in paper assets and can start investing in stocks slowly, with relatively easy criteria. I also needed to be reminded that sitting in 100% cash equivalents, even if I am able to match inflation (which I understand is not guaranteed) is not a wise move. The goal is to have that money make money, which will always involve risk (just like staying in cash). Looking at the numbers on a screen without using them is a failure.


In thinking about my own current investor psychology, I've identified some weaknesses and areas I need to explore. After crossing into six figures of net worth, I went from being risk prone to becoming risk averse. I went from "eh, fuck it, I would've just blown this money on guitars before" to "I have all this money and it is my stash and I CANNOT LOSE IT." I also started worrying about old age retirement. I do still plan to accumulate enough money to retire before "traditional" retirement age, but it's worth remembering that I don't ever want to retire fully and that making the majority of my moves based on what I and the world might be like in 40 years, is not how I want to operate.

From 2015-2018 I indexed. I sold my index funds in 2018 because I wanted to understand what I was doing before investing and I've been in analysis paralysis since then. I was still thinking about the money from a religious index investor stand point, which is to say a large 3-4% interest bearing savings account. I have some outside the stock market investing opportunities that I've been reluctant to take because I didn't want to lose out on this "safe" return rate. It's weird how strongly this mentality persisted even after my beliefs changed.

I also need to think more about how to withdrawal in semi-ERE. When am I o.k. with drawing down? When am I o.k. with not saving as much? When do I feel I need to save more? I've been operating under the accumulation -> retirement paradigm, but this isn't really what I want to do.

@c_L: My experience inside the FIRE community is that index investing is a religion. I'd consider dogmatic index investing THE investing advice of the FIRE movement. Part of the dogma is that it is IMPOSSIBLE to beat the index, which includes periods where the index is losing, so don't even bother learning about investing, it's a waste of time (and potentially dangerous, because you might think you know better than indexing, you dumb fat idiot). Statements like "o.k., I get the reasoning behind this, but, maybe index investing is not the best thing for every single person throughout all future time periods on earth," are treated as an attack.

Post Reply