On this blog Nick Bostrom once asked “What practical things does debiassing enable us to do?” Well, investors who overcome overconfidence bias and invest in index funds earn much higher average returns than investors who think they can beat the market by investing in actively managed mutual funds.
Read the prospectus & online for the fee adjusted return vs the benchmark. The YTD is always less, but look at the 5 yr,10 yr,etc..
Mutual funds are great just pick ones that outperform the index in the long run and don't be a squirrelly shorter. For avoiding taxes put your funds in a tax sheltered account. People say MOST funds =fail but that is the whole purpose..pick one that outperforms. I mean look at CWGIX/Dodge and Cox.
If you are going to be that simplistic then most new businesses fail..so investing in new business won't make you $?
investors who overcome overconfidence bias and invest in index funds earn much higher average returns than investors who think they can beat the market by investing in actively managed mutual funds.
You are really stretching the evidence to make this claim. Most active fund managers fail to beat their relevant benchmarks, but this says precisely nothing about the returns I see on my statement. My behavior has far more to do with it than which funds I'm investing in. Overconfidence might be a small part of it, but there is a veritable stew of biases which affect investor decision-making.
That's why there's, like, a whole academic field devoted to the topic.
Henry Blodget of Slate.com points out how the past performance of mutual funds says next to nothing about their future performance. Check figs. 5.2-5.4
isn’t it true that if a higher and higher percentage of the money invested in stocks goes into index funds, won’t the market for stocks at some point loose its mind and the managed money start to win.
Yes. The real point of the random walk hypothesis is that returns to speculative activity are competed down to the lowest wages of superintendence that the market will bear. This means that speculation is a very bad deal for casual traders.
There is a pretty good book which talks about how to overcome bias in financial decisions, it is a bit dated, but it was one of the first things I read about overcoming bias:
BTW Matthew C I have in the past shorted MCel and Bldp based on my belief that many MCel and Bldp investors seem to support those companies for charity reasons rather than value reasons. Also MCel and Bldp are what they call suckers bets very very long shots that cpuld pay out very big but if I use puts I limit the damage if the stock home runs but I win in most cases.
First I am a big fan of “A Random Walk Down Wall Street” and thus I am a cost minimizer, but isn’t it true that if a higher and higher percentage of the money invested in stocks goes into index funds, won’t the market for stocks at some point loose its mind and the managed money start to win. After all stock investing is all about dividends and future dividends (stock buy backs and liquidation being equal to dividends) they are the only real return on stocks so that it is possible to be right apart from what the market does.
I have an E*Trade account and I AM buying one stock at a time building up to 60 + stocks buying in approximate $5,000 chunks which I hold for 10s of years/indefinitely will I not end up with even lower costs ($5.00/trade = 5/5000 = 10 basis points over 10 years = less than 2 basis points expense) than index finds?
However, the market needs these researchers in order to keep it efficient. While the index fund does not bear the cost of researching, they certainly are receiving the benefit. This could turn out to be a problem if the amount invested in index funds becomes significantly larger than those invested in managed funds.
Ross Miller has a neat paper where he measures the active portfolio manager by his deviation from a benchmark like the S&P500. Thus one's position in IBM is the amount by which it differs from the S&P weights. As these differences are much less than the absolute position weights, and reflect the active part of the adviser's skill, he then figures the actual expense ratio by dollar is more like 5%! You pay a lot for a quasi index fund with a couple of anecdotes. Puts the hedge funds 2% of assets and 20% of profits in perspective.
I don't think its overconfidence. I think its more for the entertainment value. If it was really overconfidence people would have a much bigger allocation to active strategies in their portfolios than they really do. “professional” investors behave the same way. They really take very little active risk. They say they believe but they act like they don’t.
Another aspect of tangible reward--which doesn't get talked about often here--is in medical application. Many of us possess a myriad of strange biases toward science and technology; I can't tell you how many times I've gotten into an argument with someone over the expression "natural is better." (whatever that means)
Overcoming biases can help one pick the most beneficial medical treatment in times of need. (and avoid hack treatments)
The "fundamental indices" you describe, I consider strategies as opposed to indices. The advantage of a market-weight index is that there is no need to rebalance the portfolio whenever the price changes. The weightings of a fundamental index are constantly changing so it is impossible to truly track performance of the benchmark.
Not that there is anything wrong with the strategy, I just think the term index is as much a marketing ploy as anything else.
Funds that do well one year are not, however, more likely than average to do well the next.
As Harlow and Brown note, the question is not whether the average actively managed fund can outperform but whether those that will outperform can be identified in advance. Their research suggests the odds of doing so can be as high as 60%.
Kosowski et al have also found that there are more successful active managers than would be explained by random variation, supporting the notion that such managers have skill.
If people don't want to invest in companies that produce, say, tobacco or weapons for moral reasons, then, by definition, their stocks are undervalued relative to where they should be in a "rational" market. Remember: Evil will always triumph, because good is dumb!
I've read somewhere (maybe a link on MR) that a properly-designed market basket fund does even better -- the standard index funds are biased towards market cap, which means that they automatically buy more when a stock is overly expensive and less when it is a good deal.
Read the prospectus & online for the fee adjusted return vs the benchmark. The YTD is always less, but look at the 5 yr,10 yr,etc..
Mutual funds are great just pick ones that outperform the index in the long run and don't be a squirrelly shorter. For avoiding taxes put your funds in a tax sheltered account. People say MOST funds =fail but that is the whole purpose..pick one that outperforms. I mean look at CWGIX/Dodge and Cox.
If you are going to be that simplistic then most new businesses fail..so investing in new business won't make you $?
investors who overcome overconfidence bias and invest in index funds earn much higher average returns than investors who think they can beat the market by investing in actively managed mutual funds.
You are really stretching the evidence to make this claim. Most active fund managers fail to beat their relevant benchmarks, but this says precisely nothing about the returns I see on my statement. My behavior has far more to do with it than which funds I'm investing in. Overconfidence might be a small part of it, but there is a veritable stew of biases which affect investor decision-making.
That's why there's, like, a whole academic field devoted to the topic.
Henry Blodget of Slate.com points out how the past performance of mutual funds says next to nothing about their future performance. Check figs. 5.2-5.4
isn’t it true that if a higher and higher percentage of the money invested in stocks goes into index funds, won’t the market for stocks at some point loose its mind and the managed money start to win.
Yes. The real point of the random walk hypothesis is that returns to speculative activity are competed down to the lowest wages of superintendence that the market will bear. This means that speculation is a very bad deal for casual traders.
There is a pretty good book which talks about how to overcome bias in financial decisions, it is a bit dated, but it was one of the first things I read about overcoming bias:
http://www.amazon.com/Smart...
BTW Matthew C I have in the past shorted MCel and Bldp based on my belief that many MCel and Bldp investors seem to support those companies for charity reasons rather than value reasons. Also MCel and Bldp are what they call suckers bets very very long shots that cpuld pay out very big but if I use puts I limit the damage if the stock home runs but I win in most cases.
First I am a big fan of “A Random Walk Down Wall Street” and thus I am a cost minimizer, but isn’t it true that if a higher and higher percentage of the money invested in stocks goes into index funds, won’t the market for stocks at some point loose its mind and the managed money start to win. After all stock investing is all about dividends and future dividends (stock buy backs and liquidation being equal to dividends) they are the only real return on stocks so that it is possible to be right apart from what the market does.
I have an E*Trade account and I AM buying one stock at a time building up to 60 + stocks buying in approximate $5,000 chunks which I hold for 10s of years/indefinitely will I not end up with even lower costs ($5.00/trade = 5/5000 = 10 basis points over 10 years = less than 2 basis points expense) than index finds?
However, the market needs these researchers in order to keep it efficient. While the index fund does not bear the cost of researching, they certainly are receiving the benefit. This could turn out to be a problem if the amount invested in index funds becomes significantly larger than those invested in managed funds.
Ross Miller has a neat paper where he measures the active portfolio manager by his deviation from a benchmark like the S&P500. Thus one's position in IBM is the amount by which it differs from the S&P weights. As these differences are much less than the absolute position weights, and reflect the active part of the adviser's skill, he then figures the actual expense ratio by dollar is more like 5%! You pay a lot for a quasi index fund with a couple of anecdotes. Puts the hedge funds 2% of assets and 20% of profits in perspective.
see http://papers.ssrn.com/sol3...
I don't think its overconfidence. I think its more for the entertainment value. If it was really overconfidence people would have a much bigger allocation to active strategies in their portfolios than they really do. “professional” investors behave the same way. They really take very little active risk. They say they believe but they act like they don’t.
Another aspect of tangible reward--which doesn't get talked about often here--is in medical application. Many of us possess a myriad of strange biases toward science and technology; I can't tell you how many times I've gotten into an argument with someone over the expression "natural is better." (whatever that means)
Overcoming biases can help one pick the most beneficial medical treatment in times of need. (and avoid hack treatments)
Matthew-
The "fundamental indices" you describe, I consider strategies as opposed to indices. The advantage of a market-weight index is that there is no need to rebalance the portfolio whenever the price changes. The weightings of a fundamental index are constantly changing so it is impossible to truly track performance of the benchmark.
Not that there is anything wrong with the strategy, I just think the term index is as much a marketing ploy as anything else.
Funds that do well one year are not, however, more likely than average to do well the next.
As Harlow and Brown note, the question is not whether the average actively managed fund can outperform but whether those that will outperform can be identified in advance. Their research suggests the odds of doing so can be as high as 60%.
Kosowski et al have also found that there are more successful active managers than would be explained by random variation, supporting the notion that such managers have skill.
Here's a crazy idea: "Socially Irresponsible Investing."
http://www.youtube.com/watc...
If people don't want to invest in companies that produce, say, tobacco or weapons for moral reasons, then, by definition, their stocks are undervalued relative to where they should be in a "rational" market. Remember: Evil will always triumph, because good is dumb!
Oddly enough, there really is a fund that does something like this:http://www.vicefund.com/ind...
I've read somewhere (maybe a link on MR) that a properly-designed market basket fund does even better -- the standard index funds are biased towards market cap, which means that they automatically buy more when a stock is overly expensive and less when it is a good deal.