As somewhat of a libertarian, I tend to fall into that last group. I have to keep reminding myself that if nobody could outguess the market, then there’d be no money in trying to outguess the market, so only fools would enter it, and it would be easy to outguess.
I have to keep reminding myself that if nobody could outguess the market, then there’d be no money in trying to outguess the market, so only fools would enter it, and it would be easy to outguess.
There is the old joke about a student and a professor of economics walking on campus. The student notices a $20 bill lying on the sidewalk and starts to pick it up when the professor stops him. “Don’t bother,” the professor says, “it’s fake. If it were real someone already would have picked it up”.
But it’s an equilibrium, right? Lumifer’s joke may be funny, but as an empirical matter, you don’t see a lot of $20 bills lying on the ground. There’s no easy pickings to be had in that manner. So the only people who can “outguess” the market (and I think that framing is seriously misleading, but let’s put that aside for now) are individuals and organizations with hard-to-reproduce advantages in doing so—in the same way that Microsoft is profitable, but it doesn’t follow that just anyone can make a profit through an arbitrage of buying developer time and selling software.
Because when it’s easy to outguess the market, the people who are good at it get richer and invest more money in it until it gets hard again.
It’s not in perfect equilibrium constantly. I’ve heard of someone working out some new method that made it easy which took off over the course of a few years until enough people used it that outguessing the market was hard again.
Because when it’s easy to outguess the market, the people who are good at it get richer and invest more money in it until it gets hard again.
This is an extremely impoverished framework for thinking about financial markets.
Let’s introduce uncertainty. Can Alice outguess the market? Um, I don’t know. And you don’t know. And Alice doesn’t know. All people involved can have opinions and guesses, but no one knows.
Okay then, so let’s move into the realm of random variables and probability distributions. Say, Alice has come up with strategy Z. What’s the expected return of implementing strategy Z? Well, it’s a probability distribution conditional on great many things. We have to make estimates, likely not very precise estimates.
Alice, of course, can empirically test her strategy Z. But there is a catch—testing strategies can be costly. It can be costly in terms of real money, opportunity costs, time, etc.
Moreover, the world is not stationary so even if strategy Z made money this year whether it will make money next year is still a random variable, the distribution parameters of which you can estimate only so well.
This is an extremely impoverished framework for thinking about financial markets.
It’s good enough.
Knowing about things like risk will tell you about the costs and benefits with higher precision. It will explain somewhat why there’s lots of people involved in a market, and not just a couple of people that control the entire thing and work out the prices using other methods.
All that uncertainty makes the market difficult to predict. But all you really need to know is that regardless of how easy or hard it is to guess how a business will do, the market will ensure that you’re competing with other people who are really good at that sort of thing, and outguessing them is hard.
But all you really need to know is that regardless of how easy or hard it is to guess how a business will do, the market will ensure that you’re competing with other people who are really good
This can be applied to anything from looking for a job to dating.
You wouldn’t expect to be able to do job X better than a professional if you don’t have any training, would you?
Also, economists say the same about the job market. If you don’t have any particular advantage for any given job, you can’t easily beat the market and make more money by picking a high-paying job. If a job made more money without some kind of cost attached, people would keep going into it until it stops working.
I guess there is more to the market. It’s something that scales well, so doing it on a small scale is especially bad. It takes exactly as much work to by $100 in stocks as $10,000. If you’re dealing with tiny companies where someone trying to make trades on that scale would mess around with the price of the stock, that won’t apply, but in general trying to make money on small investments would be like playing poker against someone who normally plays high stakes. They’re the ones good enough to make huge amounts of money. The market won’t support many of them, so they must be good.
I have a weird feeling that a bunch of people on LW have decided that there’s nothing to be done in financial markets (except invest in index funds), fully committed to this belief, and actively resist any attempts to think about it… :-/
Isn’t this optimal? The case for index funds by ordinary investors is extremely strong, and if there exists good evidence to the contrary it will be of the form that is almost certainly beyond the ability of most LW people to properly evaluate.
Is it? Which specific index funds are you talking about and how do you define optimality here?
good evidence to the contrary it will be of the form that is almost certainly beyond the ability of most LW people to properly evaluate.
So, it’s completely fine for most LW people to evaluate the chances of a Singularity, details of AI design, or the MWI of quantum mechanics, but real-life financial markets, noooo, they are way too complicated? X-D
So, it’s completely fine for most LW people to evaluate the chances of a Singularity, details of AI design, or the MWI of quantum mechanics, but real-life financial markets, noooo, they are way too complicated? X-D
Good reply, but there are different types of complexity and looking at financial market data isn’t a type of complexity LW tends to deal with.
Let’s take our friends Alice and Bob. They come to you and ask you where should they invest their pennies. You tell them “low cost broad based index funds”. They blink at you and say “Could you please give us the names of the funds?”
And I still have no idea what do you mean by “optimal”.
there are different types of complexity and looking at financial market data isn’t a type of complexity LW tends to deal with.
That is true as a matter of empirical observation. But the real question is about capability: can LW types deal with the financial-markets type of complexity? Why or why not?
Most Americans invest in mutual funds via their firm’s pension plan and have limited choices. I have index funds with Vanguard and Fidelity on the S&P 500.
can LW types deal with the financial-markets type of complexity? Why or why not?
Even for those who could, it wouldn’t be worth the time cost for those of us who don’t work in finance since you would likely conclude after lengthy study that yes, one should just buy index funds.
How do you know? Isn’t that rather blatantly begging the question..?
I have a PhD in economics from the University of Chicago.
So, in which sense having a long-only portfolio of large-cap US equities is optimal?
The S&P 500 is effectively international since big U.S. companies do lots of business in foreign countries. For diversification reasons you might also want to own bonds and invest some in smaller cap stocks.
I have a PhD in economics from the University of Chicago.
First, appeal to authority is a classic fallacy.
Second, if you’re doing the Ghostbusters bit, live up to your billing. Instead of vaguely regurgitating HuffPo-level platitudes, formulate a claim, provide the necessary tight definitions, outline the reasoning why your claim is true, provide links to empirical data supporting your position.
I suspect we have differences in two areas: the credibility of the EMH, and the approach to the problem of asset allocation.
Let’s keep the EMH debate out of this thread—it’s a beast of its own—but even under EMH the asset allocation issue is far from trivial. In fact, it’s quite complicated. However this complexity is NOT a good reason to just give up and point to a suboptimal solution which does have the twin advantages of being (a) simple; and (b) not the worst; but is NOT “best for everyone” which is what it’s sold as.
It’s rude to ask someone how they came to believe something, and then dismiss their experience out of hand.
formulate a claim, provide the necessary tight definitions, outline the reasoning why your claim is true, provide links to empirical data supporting your position.
It’s rude to ask someone how they came to believe something, and then dismiss their experience out of hand.
I am not asking about personal experience—“how did you find your path to Jesus” kind of thing. I am asking to provide supporting evidence and arguments for a claim about empirical reality. “I have a PhD” is neither supporting evidence nor an argument.
Step up your own game.
My claim is negative: there is NO investment optimal for everyone; optimality is hard to define and even harder to estimate; equity index funds are just an asset class, one among many; etc.
I see the advice “you should just invest in index funds” as similar to advice “you should just eat whole grains”. Yes, it’s progress if your baseline is coke and twinkies. Yes, it’s not the worst thing you can do. No, it’s not nearly an adequate answer to the question of what should you eat.
My claim is negative: there is NO investment optimal for everyone; optimality is hard to define and even harder to estimate; equity index funds are just an asset class, one among many; etc.
This comes nowhere near the standard you’ve tried to impose on your interlocutor.
You are either willfully or autistically not parsing English as an English speaker would normally intend it. “Is not evidence” normally means “is not good evidence”. The speaker does not have to insert the word “good” for it to have that meaning.
I’m sorry, but are you projecting? I’ve outlined how much evidence I ascribe to this situation, and Lumifer has been clear that he ascribes much less. This isn’t a debate over omitted modifiers.
Either you think that “I have a PhD” is evidence but not good evidence, in which case you are indeed complaining about the omitted modifier, or else you think that “I have a PhD” is good evidence, which is a claim I find astonishing.
Furthermore, you just got finished saying that logical fallacies are (possibly weak) evidence, as if being weak evidence would be relevant, and you linked to a post which says that evidence that is not good is still evidence. These support the interpretation that you were talking about PhDs being evidence at all, not about PhDs being good evidence.
No, it depends on the authority. Being rational means giving appropriate weight to the opinions of other people and these peoples’ education has some impact on the optimal weights. Also, you did ask the personal question “How do you know?” and I interpreted this as your wondering how I, James Miller, acquired my knowledge of financial markets.
you did ask the personal question “How do you know?” and I interpreted this as your wondering how I, James Miller, acquired my knowledge of financial markets.
A bit of miscommunication, then, my question referred to the quote directly preceding it which is
since you would likely conclude after lengthy study that yes, one should just buy index funds
I meant “How do you know that I would likely conclude after lengthy study that yes, one should just buy index funds?”
If you read LW you are likely the kind of person who, after massive study, would agree with economists on microeconomic issues on which most economists agree because microeconomics is really math and logical reasoning applied to human behavior and economists are, relative even to the LW population, good at these things.
If you read LW you are likely the kind of person who, after massive study, would agree with economists on microeconomic issues
Let me provide a data point for you: I have studied this issue sufficiently well. I have NOT come to the conclusions which you expect.
microeconomics is really math and logical reasoning applied to human behavior
Yes, but badly applied :-D Economics is only starting to realize that actual live humans are not Homo economicus and that equilibrium models of systems with omniscient fully rational agents driven solely by the desire to have more money are not much like the real world.
Once economists leave the rarefied atmosphere of DSGE models and such and have to deal with the reality-provided empirical data, they can hardly agree on anything. A recent case in point—the Piketty book.
Could I suggest that you actually read the article? Authorities aren’t necessarily correct, and so it would be fallacy to appeal to an authority as necessarily correct… (but what , for a Bayesian, would be necessarily correct...?) …even so, “authorities can be correct in their field of reasoning” (and are more likely to be than non authorities....to state, in theory, what everyone does in practice)
I tend to think that the current markets are efficient enough that putting my money in index funds is about the best I can do from a time/opportunity cost perspective.
The professionals I know working for hedge funds do routinely find small inefficiencies, but in order to make them profitable enough to be worth the time investment, they generally have to exploit quantities of leverage I don’t have access to as an individual.
If you enjoy pouring over the market looking for details to exploit, then it can be a use of leisure time I guess. I pour over enough data at work that spending free time pouring over more in order to achieve fairly small gain just doesn’t seem worth it.
Whether it’s worth picking up a $20 bill depends on
The chance that you are the first person to notice it and pick it up, if it’s an actual $20 bill
The ratio of real $20 bills to fake ones
The gain in finding a real $20 bill, compared to the loss in picking up a fake one.
The odds for #2 and #3 are pretty high compared to the odds of similar activities when playing the market. The odds of #1 vary depending on how well travelled the place is but are generally a lot higher than for whether you’re the first person to notice an opportunity in the market.
Of course, #1 is also affected by how many people use this entire chain of reasoning and conclude it;’s not worth picking up the bill, but the other factors are so important that this hardly matters.
The way I see it, in practical terms, it’s always worth picking up. I’ve picked up a number of fake bills. I keep them. It’s better than leaving them to torment each successive person who picks it up until someone else does it instead.
On the contrary, there are very many profitable software companies of all sizes. Writing software is a huge market that has grown very quickly and still provides large profit margins to many companies.
You might make an argument that Microsoft’s real advantage is the customer lock-in they achieve through control of a huge installed base of software and files. Even there there are many software companies in the same position. It’s hard to reproduce the advantage of having a large share of a large market. But that doesn’t necessarily make it unprofitable to acquire even a small share of the market.
I think you misunderstand my point. Of course there are many profitable software companies (I work for one of them!), in the same way that there are also many banks, hedge funds, etc. But all of these have hard-to-reproduce advantages (“moats” in the lingo). The reason Microsoft (or any other software company) is able to buy developer time and sell software at a profit is because they have social and organisational capital, because they have synergy between that capital and their intellectual property rights, because they have customer relationships, etc etc. It is not an arbitrage and it’s not true that just anyone can do it. Microsoft themselves are in fact a fine example of this; throwing resources in the fight against Google has not proven successful.
A lot of the thread descending from here is covered by the whole of the quoted essay. I’d quote more, but I don’t want to make it easy for people to just read another quote.
There is a great deal of money to be made by entering the market and not trying to outguess it. This is what index funds are about. Thus many non-fools enter the market.
As somewhat of a libertarian, I tend to fall into that last group. I have to keep reminding myself that if nobody could outguess the market, then there’d be no money in trying to outguess the market, so only fools would enter it, and it would be easy to outguess.
There is the old joke about a student and a professor of economics walking on campus. The student notices a $20 bill lying on the sidewalk and starts to pick it up when the professor stops him. “Don’t bother,” the professor says, “it’s fake. If it were real someone already would have picked it up”.
That joke got less funny the first time I picked up a Christian tract disguised as a $20 bill. It got a lot less funny the second.
But it’s an equilibrium, right? Lumifer’s joke may be funny, but as an empirical matter, you don’t see a lot of $20 bills lying on the ground. There’s no easy pickings to be had in that manner. So the only people who can “outguess” the market (and I think that framing is seriously misleading, but let’s put that aside for now) are individuals and organizations with hard-to-reproduce advantages in doing so—in the same way that Microsoft is profitable, but it doesn’t follow that just anyone can make a profit through an arbitrage of buying developer time and selling software.
No, why would it be?
Equilibrium is a convenient mapping tool that lets you assume away a lot of difficult issues. Reality is not in equilibrium.
Because when it’s easy to outguess the market, the people who are good at it get richer and invest more money in it until it gets hard again.
It’s not in perfect equilibrium constantly. I’ve heard of someone working out some new method that made it easy which took off over the course of a few years until enough people used it that outguessing the market was hard again.
This is an extremely impoverished framework for thinking about financial markets.
Let’s introduce uncertainty. Can Alice outguess the market? Um, I don’t know. And you don’t know. And Alice doesn’t know. All people involved can have opinions and guesses, but no one knows.
Okay then, so let’s move into the realm of random variables and probability distributions. Say, Alice has come up with strategy Z. What’s the expected return of implementing strategy Z? Well, it’s a probability distribution conditional on great many things. We have to make estimates, likely not very precise estimates.
Alice, of course, can empirically test her strategy Z. But there is a catch—testing strategies can be costly. It can be costly in terms of real money, opportunity costs, time, etc.
Moreover, the world is not stationary so even if strategy Z made money this year whether it will make money next year is still a random variable, the distribution parameters of which you can estimate only so well.
It’s good enough.
Knowing about things like risk will tell you about the costs and benefits with higher precision. It will explain somewhat why there’s lots of people involved in a market, and not just a couple of people that control the entire thing and work out the prices using other methods.
All that uncertainty makes the market difficult to predict. But all you really need to know is that regardless of how easy or hard it is to guess how a business will do, the market will ensure that you’re competing with other people who are really good at that sort of thing, and outguessing them is hard.
No, I don’t think so.
This can be applied to anything from looking for a job to dating.
So, no, that’s not all you really need to know.
You wouldn’t expect to be able to do job X better than a professional if you don’t have any training, would you?
Also, economists say the same about the job market. If you don’t have any particular advantage for any given job, you can’t easily beat the market and make more money by picking a high-paying job. If a job made more money without some kind of cost attached, people would keep going into it until it stops working.
I guess there is more to the market. It’s something that scales well, so doing it on a small scale is especially bad. It takes exactly as much work to by $100 in stocks as $10,000. If you’re dealing with tiny companies where someone trying to make trades on that scale would mess around with the price of the stock, that won’t apply, but in general trying to make money on small investments would be like playing poker against someone who normally plays high stakes. They’re the ones good enough to make huge amounts of money. The market won’t support many of them, so they must be good.
I have a weird feeling that a bunch of people on LW have decided that there’s nothing to be done in financial markets (except invest in index funds), fully committed to this belief, and actively resist any attempts to think about it… :-/
Isn’t this optimal? The case for index funds by ordinary investors is extremely strong, and if there exists good evidence to the contrary it will be of the form that is almost certainly beyond the ability of most LW people to properly evaluate.
Is it? Which specific index funds are you talking about and how do you define optimality here?
So, it’s completely fine for most LW people to evaluate the chances of a Singularity, details of AI design, or the MWI of quantum mechanics, but real-life financial markets, noooo, they are way too complicated? X-D
Low cost, broad based index funds.
Good reply, but there are different types of complexity and looking at financial market data isn’t a type of complexity LW tends to deal with.
That’s still very VERY non-specific.
Let’s take our friends Alice and Bob. They come to you and ask you where should they invest their pennies. You tell them “low cost broad based index funds”. They blink at you and say “Could you please give us the names of the funds?”
And I still have no idea what do you mean by “optimal”.
That is true as a matter of empirical observation. But the real question is about capability: can LW types deal with the financial-markets type of complexity? Why or why not?
Most Americans invest in mutual funds via their firm’s pension plan and have limited choices. I have index funds with Vanguard and Fidelity on the S&P 500.
Even for those who could, it wouldn’t be worth the time cost for those of us who don’t work in finance since you would likely conclude after lengthy study that yes, one should just buy index funds.
So, in which sense having a long-only portfolio of large-cap US equities is optimal?
How do you know? Isn’t that rather blatantly begging the question..?
I have a PhD in economics from the University of Chicago.
The S&P 500 is effectively international since big U.S. companies do lots of business in foreign countries. For diversification reasons you might also want to own bonds and invest some in smaller cap stocks.
First, appeal to authority is a classic fallacy.
Second, if you’re doing the Ghostbusters bit, live up to your billing. Instead of vaguely regurgitating HuffPo-level platitudes, formulate a claim, provide the necessary tight definitions, outline the reasoning why your claim is true, provide links to empirical data supporting your position.
I suspect we have differences in two areas: the credibility of the EMH, and the approach to the problem of asset allocation.
Let’s keep the EMH debate out of this thread—it’s a beast of its own—but even under EMH the asset allocation issue is far from trivial. In fact, it’s quite complicated. However this complexity is NOT a good reason to just give up and point to a suboptimal solution which does have the twin advantages of being (a) simple; and (b) not the worst; but is NOT “best for everyone” which is what it’s sold as.
Logical fallacies are still (possibly weak) evidence.
It’s rude to ask someone how they came to believe something, and then dismiss their experience out of hand.
Step up your own game.
I am not asking about personal experience—“how did you find your path to Jesus” kind of thing. I am asking to provide supporting evidence and arguments for a claim about empirical reality. “I have a PhD” is neither supporting evidence nor an argument.
My claim is negative: there is NO investment optimal for everyone; optimality is hard to define and even harder to estimate; equity index funds are just an asset class, one among many; etc.
I see the advice “you should just invest in index funds” as similar to advice “you should just eat whole grains”. Yes, it’s progress if your baseline is coke and twinkies. Yes, it’s not the worst thing you can do. No, it’s not nearly an adequate answer to the question of what should you eat.
You’re simply wrong. It is evidence.
This comes nowhere near the standard you’ve tried to impose on your interlocutor.
Obviously, I disagree.
That’s because I don’t go around telling people that the problem of investment allocation is solved and all you need to do is invest in index funds.
Have you read this?
You are either willfully or autistically not parsing English as an English speaker would normally intend it. “Is not evidence” normally means “is not good evidence”. The speaker does not have to insert the word “good” for it to have that meaning.
I’m sorry, but are you projecting? I’ve outlined how much evidence I ascribe to this situation, and Lumifer has been clear that he ascribes much less. This isn’t a debate over omitted modifiers.
Either you think that “I have a PhD” is evidence but not good evidence, in which case you are indeed complaining about the omitted modifier, or else you think that “I have a PhD” is good evidence, which is a claim I find astonishing.
Furthermore, you just got finished saying that logical fallacies are (possibly weak) evidence, as if being weak evidence would be relevant, and you linked to a post which says that evidence that is not good is still evidence. These support the interpretation that you were talking about PhDs being evidence at all, not about PhDs being good evidence.
No, it depends on the authority. Being rational means giving appropriate weight to the opinions of other people and these peoples’ education has some impact on the optimal weights. Also, you did ask the personal question “How do you know?” and I interpreted this as your wondering how I, James Miller, acquired my knowledge of financial markets.
A bit of miscommunication, then, my question referred to the quote directly preceding it which is
I meant “How do you know that I would likely conclude after lengthy study that yes, one should just buy index funds?”
If you read LW you are likely the kind of person who, after massive study, would agree with economists on microeconomic issues on which most economists agree because microeconomics is really math and logical reasoning applied to human behavior and economists are, relative even to the LW population, good at these things.
Let me provide a data point for you: I have studied this issue sufficiently well. I have NOT come to the conclusions which you expect.
Yes, but badly applied :-D Economics is only starting to realize that actual live humans are not Homo economicus and that equilibrium models of systems with omniscient fully rational agents driven solely by the desire to have more money are not much like the real world.
Once economists leave the rarefied atmosphere of DSGE models and such and have to deal with the reality-provided empirical data, they can hardly agree on anything. A recent case in point—the Piketty book.
The fallacy is appeal to inappropriate authority....
No it isn’t. For support I appeal to Wikipedia.
Could I suggest that you actually read the article? Authorities aren’t necessarily correct, and so it would be fallacy to appeal to an authority as necessarily correct… (but what , for a Bayesian, would be necessarily correct...?) …even so, “authorities can be correct in their field of reasoning” (and are more likely to be than non authorities....to state, in theory, what everyone does in practice)
I think I just misunderstood the referent of “the fallacy” in the great-grandparent, i.e., the fallacy in general / the alleged fallacy above...
Anyway, cheerfully withdrawn.
I tend to think that the current markets are efficient enough that putting my money in index funds is about the best I can do from a time/opportunity cost perspective.
The professionals I know working for hedge funds do routinely find small inefficiencies, but in order to make them profitable enough to be worth the time investment, they generally have to exploit quantities of leverage I don’t have access to as an individual.
If you enjoy pouring over the market looking for details to exploit, then it can be a use of leisure time I guess. I pour over enough data at work that spending free time pouring over more in order to achieve fairly small gain just doesn’t seem worth it.
Whether it’s worth picking up a $20 bill depends on
The chance that you are the first person to notice it and pick it up, if it’s an actual $20 bill
The ratio of real $20 bills to fake ones
The gain in finding a real $20 bill, compared to the loss in picking up a fake one.
The odds for #2 and #3 are pretty high compared to the odds of similar activities when playing the market. The odds of #1 vary depending on how well travelled the place is but are generally a lot higher than for whether you’re the first person to notice an opportunity in the market.
Of course, #1 is also affected by how many people use this entire chain of reasoning and conclude it;’s not worth picking up the bill, but the other factors are so important that this hardly matters.
The way I see it, in practical terms, it’s always worth picking up. I’ve picked up a number of fake bills. I keep them. It’s better than leaving them to torment each successive person who picks it up until someone else does it instead.
On the contrary, there are very many profitable software companies of all sizes. Writing software is a huge market that has grown very quickly and still provides large profit margins to many companies.
You might make an argument that Microsoft’s real advantage is the customer lock-in they achieve through control of a huge installed base of software and files. Even there there are many software companies in the same position. It’s hard to reproduce the advantage of having a large share of a large market. But that doesn’t necessarily make it unprofitable to acquire even a small share of the market.
I think you misunderstand my point. Of course there are many profitable software companies (I work for one of them!), in the same way that there are also many banks, hedge funds, etc. But all of these have hard-to-reproduce advantages (“moats” in the lingo). The reason Microsoft (or any other software company) is able to buy developer time and sell software at a profit is because they have social and organisational capital, because they have synergy between that capital and their intellectual property rights, because they have customer relationships, etc etc. It is not an arbitrage and it’s not true that just anyone can do it. Microsoft themselves are in fact a fine example of this; throwing resources in the fight against Google has not proven successful.
Yeah, but it’s an equilibrium that it’s really hard to outguess the market, not impossible.
A lot of the thread descending from here is covered by the whole of the quoted essay. I’d quote more, but I don’t want to make it easy for people to just read another quote.
There is a great deal of money to be made by entering the market and not trying to outguess it. This is what index funds are about. Thus many non-fools enter the market.
By “enter”, I meant try to outguess.
If everyone bought stocks randomly, it would be easy to outguess.