Anti-Index Fund Literature

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Mister Imperceptible
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Anti-Index Fund Literature

Post by Mister Imperceptible » Thu Feb 01, 2018 2:04 pm

I’m an early accumulator who sees the value of index funds not in their infallibility, but in their so-called ability to capture average market returns while I focus on income and expenses. Active management seems like something I should get involved with as I get closer to or after FIRE.

Given my level of ignorance compared to the wise minds here, can someone point me to a source of information that details the inherent risks associated with index funds? I know such information won’t be found within the dominant discourse these days, but the advice from luminaries such as Buffett regarding concentration and active management isn’t entirely useful or convincing either, as for them, investing is life.

I work 60+ hours a week in a job that has nothing to do with economics or finance. All of my research is on my own time.

IlliniDave
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Re: Anti-Index Fund Literature

Post by IlliniDave » Thu Feb 01, 2018 2:52 pm

I'd recommend going over to bogleheads.org and perusing the Investing, Theory, News, and General sub-forum. A large number non-indexing or anti-indexing approaches/opinions in the literature get brought up there. Of course some of the membership will be anti-anti-indexing in their views/opinions, but there's usually links/references where you can go to find source material for all kinds of approaches/opinions. There's a pretty strong active investing crowd there too, so asking questions about where to look will typically be successful.

suomalainen
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Re: Anti-Index Fund Literature

Post by suomalainen » Thu Feb 01, 2018 5:48 pm

Best finance writer out there is Matt Levine over at Bloomberg. Been reading him for years. He is NOT a personal finance writer, but covers esoterica in institutional finance (was a lawyer and then a derivatives-structurer for Goldman Sachs before becoming a blogger/writer). Anyway, he has this bent for off-the-wall happenings and theories and whatnot, one of which is that index funds should be illegal. Not that he agrees with the theory, but he takes a humorous look at it.

https://www.bloomberg.com/view/articles ... e-too-well
https://www.bloomberg.com/view/articles ... e-illegal-

I'm absolutely certain this is not what you're looking for, but...I dunno, I throw it out there as some of you may enjoy his writings.

The worst thing about index funds, IMHO, is the market cap weighting aspect of it. You can find equal-weighted ETFs, but the indexes themselves are all market cap weighted IIRC.

ThisDinosaur
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Re: Anti-Index Fund Literature

Post by ThisDinosaur » Thu Feb 01, 2018 6:35 pm

@suomalainen
There are Fundamental Weighted Indexes as well. The problem with funds based on them is the constant need for costly trades as the market caps drift independent of the "fundamentals." Market cap weighted indexes are better as passive, low cost, set and forget instruments.

James_0011
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Re: Anti-Index Fund Literature

Post by James_0011 » Thu Feb 01, 2018 7:58 pm

It not really anti index fund, but if you search “real estate vs index funds radical personal finance”, there is a really good podcast discussion comparing the two.

Personally, I’m pursuing a real estate strategy because it has clear advantages over index funds for my specific situation.

suomalainen
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Re: Anti-Index Fund Literature

Post by suomalainen » Thu Feb 01, 2018 11:34 pm

@tD yeah, there are a lot of "index funds" these days that aren't really that. Someone will create an "index" and then create a fund to "track" it. Or maybe it goes the other way around (smart beta and all the rest)! Either way, I'm a "Random Walk on Wall Street" kinda of guy, so I don't put too much effort/stress into my investment picks. Mix of stable value, stock index funds and bond index funds in my managed accounts and just random dividend stocks in my personal account - stocks that I don't mind owning for 30+ years. I don't recommend my personal account strategy for others tho. I always recommend index funds; you're guaranteed to get the market return (by definition) whereas active management (whether stock pickers, smart beta or funds otherwise cloaked as index funds) gives you a 50/50 chance of beating the market (before fees) and net-of-fees it actually gives you a greater chance of underperforming the market than outperforming, particularly on a consistent basis.

jacob
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Re: Anti-Index Fund Literature

Post by jacob » Tue Feb 06, 2018 3:00 pm

I think https://www.gurufocus.com/news/489700 lays out the differences between the two approaches rather well. Instead of seeing the issue as X and anti-X, that is, since we have some strategy, we must also argue and define something that is against that strategy, it's better to realize that each and every trade has a buyer and a seller and that it is the relationship between those two that creates the two camps. At least, this is how it works in the market and the linked article does a good job of illustrating that relationship.

Of course, on the internet, it's more about cheering for one's own camp and explaining to others how wrong they are. The good thing about the market is that the more people you think are wrong, the easier it is for you to find someone to take the other side of your trade.

Mister Imperceptible
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Re: Anti-Index Fund Literature

Post by Mister Imperceptible » Tue Feb 06, 2018 3:19 pm

The point taken is pretty intuitive. The question is whether I should spend my time reading 10-K’s to make individual value picks, or continue to crush overtime and dump the extra money mindlessly into index funds. The latter option is exactly what the “system” wants, which is why I’m so hesitant. If I were FIRE already, I already know what I would be doing. Maybe I’m making out value investing to be harder than it seems.

I could forgo both options for now and save for a down payment on an affordable rental property. The market could crash between now and when I’m ready to buy, then suddenly index funds AND individual securities are attractive.

blackbird
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Re: Anti-Index Fund Literature

Post by blackbird » Tue Feb 06, 2018 4:09 pm

Mister Imperceptible wrote:
Tue Feb 06, 2018 3:19 pm
The latter option is exactly what the “system” wants, which is why I’m so hesitant.
I'm curious why you say this. Indexing certainly has become more and more popular over the last decade, but I think an argument can be made that the system very much wants you to NOT index. If we surveyed 100 finance professionals (stock brokers, investment bankers, people who make a living off of the trading of funds) wouldn't the majority of responses be against indexing because it removes a large slice of their income (the cost of churning funds)?

Indexing definitely seems frowned on here, which has always confused me a little, but it seems logical to expect the finance system (excepting those orgs who have staked their name on indexing, e.g. Vanguard) to prefer investment strategies that favor active management.

But then again, what do I know?

ThisDinosaur
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Re: Anti-Index Fund Literature

Post by ThisDinosaur » Tue Feb 06, 2018 4:17 pm

If the only reason you're not digging into 10k s is time, why not passively invest until you're closer to FI? You can switch up your strategy once you have more time to learn.

Mister Imperceptible
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Re: Anti-Index Fund Literature

Post by Mister Imperceptible » Tue Feb 06, 2018 4:38 pm

When I see episodes like yesterday’s drop, part of me wonders if it’s even real panic, or if some major player decided he was going to trigger a bunch of stop-losses and soak smaller active managers.

My philosophy is to be skeptical of both sides and first figure out what NOT to do. I know that I know nothing.

suomalainen
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Re: Anti-Index Fund Literature

Post by suomalainen » Tue Feb 06, 2018 4:50 pm

Mister Imperceptible wrote:
Tue Feb 06, 2018 3:19 pm
The point taken is pretty intuitive. The question is whether I should spend my time reading 10-K’s to make individual value picks, or continue to crush overtime and dump the extra money mindlessly into index funds.
To me, this comes across as a question of your personal ROI. Is your time better spent doing your overtime work or stock-picking? Which is more profitable to you?

To answer that question, ask yourself these: Do you have any expertise in stock picking? Do you have any expectation of being able to consistently outperform the market? If the answer is no, spend your time in profitable overtime endeavors and put your money to work in an index fund. If the answer is yes, what’s the name of your hedge fund and are you accepting outside investors?!

jacob
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Re: Anti-Index Fund Literature

Post by jacob » Tue Feb 06, 2018 5:19 pm

Beating or not beating the market is a false dichotomy. The main goal as a FIRE-investor is to have enough cash on a day to day basis and not run out of it. Doing relatively better than the market (by which people usually mean the s&p500 proxy) is insufficient if the market itself is not doing well enough on an absolute basis to fulfill this requirement.

As demonstrated recently in another thread, there are some practical concerns with buy&hold total return total market strategies that people don't really think about when they're dollar cost averaging during the accumulation phase. Here they can tell themselves that they're "in it for the long haul" and "they're buying at a discount" and "stocks always go up". During the withdrawal face, the long haul is now no longer long but rather today or tomorrow; they're no longer buying, but selling, and if stocks go down a few percent over a couple of days, they get cold sweats because they stand to lose a few hundred bucks permanently (relative to last week) by cashing out---there's no longer any "in the long run" to make up for it. Clearly "tracking" the market is an incomplete description of the total strategy and therefore "beating the market" is incomplete too.

There seems to be a lot of indexers who have not given more thought to the entire process than perhaps reading a simple book and a few blog posts. Whereas those who have dabbled with deliberate investing at least have some experience that goes beyond "because the internet told me".

That's not to say there's something wrong with indexing (the strategy). It's just that this particular strategy seems to attract a lot of people who don't want to think about investing at all or at least as little as possible even if they eventually depend on it.

As for the ROI calculation itself ... the difference between capital income and working (so-called "earned") income is that the former is paid in percentages according to how much money you put in and the latter in dollars according to how many hours you put in. 5% is 5% and takes the same amount of time no matter what ... and $100 is $100 and the time it takes is dependent on hourly wage ... but 5% of $100 is $5 whereas whereas 5% of $1,000,000 is $50,000 ... all for the same effort of getting or losing that 5%.

suomalainen
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Re: Anti-Index Fund Literature

Post by suomalainen » Tue Feb 06, 2018 6:26 pm

@Jacob I disagree. The market return is sort of your BATNA. You can use a "sufficient return to provide for my needs" benchmark, as well, but in either case, the future return of the market or a selective basket of stocks is not knowable. As a result, the question then becomes what is my *best* option given my skillset, interests, etc in order to generate a sufficient return to provide for my needs. For the vast majority of humans, there is very little chance of them having the consistent skill to outperform the market, the BATNA. Without that unique skill, what would be the reasons a hobbiest investor should choose to go it alone? (Leaving aside the derivative question of whether said hobbiest investor has the skill to select an active manager who will consistently outperform the market.)

As to your timing considerations, there too, everyone is in it for the long-haul, statistically speaking. Perhaps this dynamic changes once you approach your life expectancy, but for an "ERE" person, that is 20, 30, 40 years out. You are structurally long the market. Regardless, if you're in an asset class (say stocks), whether you own "the market" via an index fund or a selective basket of stocks, any downturn will be equally 1) unforeseeable and 2) painful. Again, if you think you can foresee market downturns and expertly time the market and/or only buy/sell selective assets at the perfect prices and times...can I invest my money in your hedge fund?

Finally, as to your ROI calculation, I was specifically referring to the OP's ROI of his/her time - should s/he invest it in 10K reading or in overtime? S/he has to take into account two scenarios: 1) time is spent accumulating earned income which then earns a market return or 2) time is spent accumulating market skill to earn a higher-than-market return while leaving less earned income to invest. So, two variables - a) his/her "alpha" (market beating returns) and b) his/her capital. Only if the alpha is great enough or the capital great enough should s/he foray into 10K reading.

And FWIW, my recollection of the academic literature on alpha is that it is essentially extremely small, even for professional investors. As I recall, Cliff Asness has some good writings on this. https://www.aqr.com/cliffs-perspective For hobbiest investors...well, the statistics are worse. And again, if you're that good, please for the love of god, start an ERE hedge fund and allow us all to invest.

And finally^2, in full disclosure, I am a hobbiest investor in my personal account and an index investor in my managed accounts. But I accept the fact that my personal account will in all likelihood underperform the market and I'm okay with that. The "fun" of doing it myself and the gambling aspect of maybe hitting a homerun is sufficient compensation for the negative alpha I generate.

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Re: Anti-Index Fund Literature

Post by jacob » Tue Feb 06, 2018 9:01 pm

Well, seeing this is a market matter, I'm glad you disagree. Hehehe ;) ;) ;)

Similarly, I'd say that for the vast majority of humans wanting to install the sink in their new bathroom, there's very little chance that they can do it better than a professional plumber. But then again, the vast majority of humans aren't interested in plumbing and so even if they get the impression that they should know a thing or two about plumbing, at most they're going to read "A simple guide to plumbing", then give up, and call a professional because there's no way they could ever learn all that ABS plastic grout stuff. But that's not the ERE way... I don't know about your definition of "very little chance" but I've done better work than plumbers, electricians, and investment professionals in selective cases... by taking what they've done and adding what I know to improve it, because I knew enough to tell when they did a good job and when they did a bad job.

What matters isn't what the market plumber is able to do. What matters is whether the sink drains. It's absolute, not relative. Also what it costs.

What would be the reason to actually know something about plumbing or investing or any field, really? I mean, as long as one can just punt and call a random professional. Or an average professional as it may be in this case.

Answer: Same as any other field.

The most important reason is being able to tell good work from shitty work. Indexing is not gonna work forever. Remember the first edition of YMOYL: All rolling long-bonds. It had all the ingredients of a good SWAN portfolio. A wise strategy for the 1960s through the early 1980s. Except interest rates started a perma-decline after that ... and now long-bonds are the shits. You'd need 100 years of expenses to implement that today. Context-free humans who read that book thinking that was enough---well, that didn't work. So now there's a second ediction of YMOYL telling people to invest in index funds. And some day, there'll be a third edition. And so on. Insofar that you go with the most recent best-selling investment strategy, you're probably looking at whatever has worked best for the recent past. Because humans are simple that way. Crypto, Index, Dotcom, CDs, Gold, Bonds, Nifty-Fifty, etc. going back decade by decade...

This is not to knock on YMOYL as much as it is to knock on people who think that "simple is best" or that reading a single book or asking "what should I do" on a forum or the internets is sufficient. I understand that's how things work for ordinary people, but I also know that it's possible to do much better than average with just a little effort.

Any professional in any field would like you to believe that their skill requires especially divine talents, etc. For investing, it's not the "vast majority" it's about 90% ... and that's out of the total population [sample] size. That means that about 10% of amateurs consistently beat the market (links in the FAQ on the blog), that is, the ones who has a sufficient combination of intelligence and effort. However, the average human has average intelligence and exhibits the average human's half-assed effort giving up after a year---that's the 90%. Investment success is similar to business success. Same thing. Most of your average cohorts are either clowns or not serious. Sorry, that sounds harsh. Please rephrase: Most people haven't done their homework! They do stupid shit being optimists or borrowing monies to realize their dreams. They don't study. Sorry, that also sounds harsh. Hmm...

So this means that someone who takes an interest and the time, then at best, there's a 10% chance they will "beat the market" and at worst, they'll know enough to recognize when a strategy is going by the wayside. Then they can switch from popular bonds to popular CDs .. or from popular CDs to popular dotcom .. or onto popular index funds... and the next popular thing after that. That'll work. Point being, there's a small chance, you'll beat the makret, but what's more important is that by studying you'll actually have a clue of what's going on. That's the point I tried to make in the ERE book.

Yet most people seem strangely complacent to make less effort than that. I suppose it depends on whether they habitually think a little effort is enough to beat the average or not.

And no, you can NOT invest your monies in my personal hedge fund. That argument misses a few important points. I have eventually learned that most are looking for short-term mental shortcuts yet have no desire to take long-term responsibility for their choices. Most want quick&easy tips. They don't want to read ten 300 page books of portfolio theory. They don't want to make the effort to understand the underlying mechanics of the strategy. Previously I've occasionally hinted at investments I've made. I've even given out my entire portfolio once. Then several years later, I was contacted with a full analysis of my individual positions and how they had performed. I told them that ... yeah, I sold almost all of that portfolio years ago. Wait what?!? Thing is .. if you run something like that, there'll be people questioning (all the @#$@#$ time) how you haven't outperformed the market over the past two days .. or why ditto over the past week ... past month .. past year ... 3years ... and so on. You might have done spectacularly over the past 3 years, but you'll be hassled by noobs with a shorter time horizon asking you why you're down 6% today when the market was only down 4%. Or whatever their personal event horizon is.

This is why the best mamagers tend to go with limited/private equity portfolios. Also why I try to curb my enthusiasm when it comes to recommending individual positions. IIRC, the last time I made a specific public rec. was CMI when it was around 80-something a couple of years ago.

Clarice
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Re: Anti-Index Fund Literature

Post by Clarice » Tue Feb 06, 2018 10:10 pm

jacob wrote:
Tue Feb 06, 2018 9:01 pm
Point being, there's a small chance, you'll beat the makret, but what's more important is that by studying you'll actually have a clue of what's going on. That's the point I tried to make in the ERE book.
Yet most people seem strangely complacent to make less effort than that. I suppose it depends on whether they habitually think a little effort is enough to beat the average or not.
@jacob:
Would you be able to recommend a couple of books to start someone off on acquiring "a clue of what's going on"?
Are there other methods of acquiring "a clue" that you would recommend?
Am I asking the right questions?

suomalainen
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Re: Anti-Index Fund Literature

Post by suomalainen » Tue Feb 06, 2018 10:38 pm

10% chance of beating the market means a 90% chance of...not...Totally unrelatedly, there's a funny statistic that something like 90% of people believe they are above average.

I think the core of my disagreement is that plumbing /= investing. Investing in some sense is about predicting an uncertain future whereas plumbing is more follow the instructions. Yes, you can make some intelligent guesses so that you are positioned in companies that are more likely than others to do well over the future [time span], but to believe that you will be in that 10% minority who can consistently make the "correct" bet...I dunno. I guess my point is know your strengths. If you're a fantastic, market-beating investor, congratulations, that's awesome! But for most people (and just waving it away by saying the 90% who are not market beating investors are just lazy is itself somewhat of a lazy argument), that will not be the case. For those starting out, go into it with your eyes wide open.

EDIT: PS, I didn't see any links in the FAQ on the blog.

Fish
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Re: Anti-Index Fund Literature

Post by Fish » Tue Feb 06, 2018 11:04 pm

@Clarice - There is an ERE blog post on the subject, see link below:
P_K wrote:
Fri Jun 16, 2017 6:23 am
@Fish
Probably you found this already, but the books Jacob recommends for a startup background on finance/investing can be found here:

http://earlyretirementextreme.com/start ... sting.html

The order he suggests reading them in the comments is: 3, 2, 7, 4, 1, 6, 5

P_K
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Re: Anti-Index Fund Literature

Post by P_K » Tue Feb 06, 2018 11:14 pm

@jacob

This has got to be approaching climate change in terms of a misconception/lack of understanding you’re tiring of refuting. I have to laugh every time someone says “If professionals can’t beat the market better than average, do you really think you can!?” Has anyone saying this ever worked with any “professionals” in any field, ever? I can’t imagine they have. Because my experience has taught me that the answer is “Yes,” and, also, “Duh.” The other equally common “argument” has also got to be getting old: “Well if you’re so good why don’t you open up a hedge fund and get rich??” Never mind that investing $500k or $1M is categorically different than 100M, than 10B. Never mind that starting a hedge fund requires marketing, hiring, lawyer-ing, in short business running that is also categorically different than just handling your own investments. But no, if you could REALLY beat the market you’d have started a fund and made billions so obviously you’re lying and it’s not possible. QED.

I do think you added a nice piece with this explanation though, with respect to:
jacob wrote:
Tue Feb 06, 2018 9:01 pm
The most important reason is being able to tell good work from shitty work.
While it was definitely more of an issue in the past, a big problem with the laissez faire approach to investing nowadays is that it runs the risk of buying a product you don’t understand, and have no way of evaluating. Maybe the plumber you hired knew what he was doing, he seemed to talk a good game, all your friends recommended him, what could go wrong? Then a few weeks go by and you find yourself ankle deep in 5h17 and you realize that probably you should’ve done a little research first. Maybe the index fund you bought was a good strategy, all the personal finance bloggers recommend it, your friends all do it, what could go wrong…

The point is that if you don’t know what you’re getting, or how to evaluate what you've received to make sure that you’re getting what you're supposed to get, you’re not really setting yourself up for long term success. For an EREer who plans to live off of or at least support themselves to some degree by investment income for 40+ years this kind of knowledge is even more important. Maybe you aren’t capable of being the 10%, but at least you can be aware enough of what’s available and what’s not and how that relates to what you’re currently buying, as opposed to getting whatever you’re sold.

Sclass
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Re: Anti-Index Fund Literature

Post by Sclass » Wed Feb 07, 2018 12:51 am

Good points here. I have to agree with soumalainen that if you don’t know WTH you are doing buying the index isn’t the worst option. The market is a powerful tool...like a gun. It can hurt you badly if you don’t know what you’re doing. Afterwords you’ll be wishing you bought the index.

We all cannot be stock gurus. Most people won’t do what it takes to beat the average joe - who happens to be a loser.

:lol: edit - and I actually bought CMI after Jacob mentioned it. I delayed a bit and got it at 91. Thanks man!

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