Sunday, 7 September 2014

Empirical Evidence Required

As I had a feeling he might, Prabhat / Emp had a comment on my post about index funds and the improbability of the man in the street beating them over the long-term, and I do agree with him on one thing, although I didn't mean what he infers:

Before I say anything else, I am offended by being classed with 'Sultan'. I am not seeking anyone to 'invest' in me or to fund my activities or buy advice or any such thing, I'm not selling anything and am not self-promoting with an agenda.
What I actually wrote was meant to distinguish two types who could ignore the advice - wealthier clients (e.g The Sultan) and experts (e.g Emp):
Wealthier clients such as the Sultan, and those like Emp for whom beating the market is so easy, it's amazing that not everyone is above average, can obviously ignore academic research and this advice, but for mere mortals like most of us, it’s pretty solid.
It was certainly not my intention to lump Emp, or anyone else for that matter, in with the Sultan. That would have been very rude. And I don't mean to suggest that Emp / Prabhat is not wealthy by the way. He may well be, but obviously not in the same league as the Sultan.

Emp's comment has been published, but as usual, he fails to give any reasons or evidence why he feels that Mr. Average should ignore the advice of academic research and try to beat the market. Yes, it is always possible, and being optimistic is a good thing, but optimism has to be tempered by reality, especially when it comes to investing for your future. How can Mr Man-in-the-Street realistically expect to beat the insiders of the financial institutions?
Finally, I am not making any advice as to what anyone should do with their money; just pointing out the fact that you won't become truly rich doing what everyone else is, so if that is one's goal than they had better try and be smarter than everyone else.
I'm not sure what he definition of 'truly rich' is here (the Sultan can probably help), but the point is that 'everyone else' isn't investing in index funds. More people are investing in index funds now than have done in the past, but as anyone trading sports knows, discipline is key, and the man in the street tends not to be too disciplined and reacts poorly. I know plenty of people personally who are not making optimal decisions for various reasons.

"Average returns" sounds a little wishy-washy, but the term means market average returns, not that returns are average amongst individuals. I'm sure that anyone who has invested as suggested in my post for a few years is unlikely to run into anyone who has made more than them, save the individual who is over-invested in his own company which has been on a tear, or someone who got lucky.

The S&P 500 index is a broad (500 stocks as its name implies) index, and last year (2013) was up 32.42%. It's probably not recommended to ask your friends from outside the financial world what returns they achieved last year, but were you to do this, and were you to get an honest answer, not many would be close to that.

Prabs concludes with:
Also, while we are on the point, I have to note that all these guys who are saying 'you can't beat the market' of course have their own 'low cost index funds' that they want you to invest in...what do you think they are going to say, when their business depends on fund collection from the masses in a major bull market?
Not true, and a strange thing to say. "All these guys"? Academic research comes from academic institutions, not from Vanguard. These studies are reported on by writers, not by financial institutions. Vanguard and other Index Fund offering institutions might like what is being written, but that in no way invalidates the findings.

As I said earlier, if Prabhat can offer any reason why he thinks the average returns can consistently be beaten by the man in the street, I'd love to read it.  Saying that "in theory" long-term averages  can be beaten is just repeating what we all know.

In theory, climate change may not be the result of human activity.

In theory, Deepak Chopra makes perfect sense.

What we are missing here is some supporting evidence for this "theory" of Emp's, and on that, I expect to hear nothing.


Prabhat said...

I'm slightly puzzled, my comment explicitly stated that the average person (or fund) won't 'beat the market'. My point was that a) if someone wished to be excellent it's possible.

Secondly, and this might be more interesting, I think it's rather obvious that a passive indexing approach will perform exceedingly well in a long, low-volatility bull market. It may not do so well in volatile or bearish market conditions (which is traditionally when commodity traders and big hedge funds tend to better). Judging an index fund only on how it performs in an epic bull run is quite misleading because the chief advantage of alternative approaches is being able to avoid downside or profit from it by shorting.

You keep saying the average person has no self control etc., and here we are on common ground. I agree entirely that the average person lacks discipline, self-control and other attributes necessary to succeed. My point was if someone has those attributes or wishes to cultivate them, they have options better than an index fund. For that matter, judging by track records you yourself (not to imply you are average) would have done better investing in your football selections than the market.

Marty said...

When asked I always advise people to invest in low cost index funds and to drip feed investment, so I generally agree with Cassini's practice.

I disagree with this though:
"The S&P 500 last year (2013) was up 32.42% ... ask your friends from outside the financial world... not many would be close to that."
If they're holding US blue chips (a very common investment approach) then lots of them will likely have beaten the S&P, because they're holding the stocks the S&P is made up of and a fair proportion of stocks in that index will have outperformed the index.