It’s easy to think of trivial examples of one-time victories—for example, an early Bitcoin investor realizing that crypto-currency had potential and buying some when it was still worth fractions of a cent. But you can justly accuse me of cherry-picking here and demand repeatable examples.
Nothing guarantees that there will be repeatable examples—it could be that people are bad at taking ideas seriously until the ideas succeed once, at which point they realize they were wrong and jump on the bandwagon.
But in fact I think there are such examples. One such is investing in index funds rather than mutual funds/picking your own stocks. There are strong reasons to believe you’ll do better, most people know those reasons but don’t credit them, and some people do credit them and end up with more money.
Occasional use of modafinil might fall in this category as well, depending on whether we define people’s usual reasons for not taking it as irrational or rational-given-different-utility-functions.
I don’t think most of these examples will end out as “such obvious wins no one could possibly disagree with them”—with the possible exception of index funds it’s never as purely mathematical as the lottery example—but I think for most people the calculus is clear.
I seriously doubt most people know the the reasons they should be investing in index funds. Remember, the average American has an IQ of 100, doesn’t have a degree higher than a high school diploma, and rarely reads books. I’m not sure I’d know the reasons for buying index funds if not for spending a fair amount of time reading econ blogs.
Agreed: I have no idea why I should be investing in index funds (if, indeed, I were investing in anything). My skepticism about that example, though, actually comes from a slightly different place:
If I decided to do some investing, went to five financial experts, asked them what I should invest in, and they all said “Yep, index funds, definitely the way to go”, then I would invest in index funds. Right? Where would I even get the idea to do anything else?
And thus, why does “invest in index funds” qualify as a counterintuitive idea? Why is it a thing that some people might not take seriously? Wouldn’t it just be the default?
If I decided to do some investing, went to five financial experts, asked them what I should invest in, and they all said “Yep, index funds, definitely the way to go”, then I would invest in index funds
probably wouldn’t happen. If you asked uninvolved experts, it would, but the most accessible experts aren’t uninvolved. What is much more likely is that you (the average American with some money to invest) go to invest your money with an investment firm. And that investment firm pushes you toward actively-managed funds, since that’s where their incentives are. In order for the idea of investing solely in index funds to be available, you have to put in meaningful thought, if only enough to look for non-corporate advice on how to invest well.
I’m not an expert, but my impression is that most people don’t think about this kind of thing without prompting. Which means that they don’t think about it unless they, for example, see an ad for Charles Schwab and call them to look into investing. Getting to the point of considering whether the expert has an incentive to lie to you seems to mark you as of substantially above-average reasoning skills.
Isn’t it a little bit self-contradictory, to propose that smart people have beaten the market by investing in Bitcoin, and at the same time, that smart people invest in index funds rather than trying to beat the market? Or in other words, are those who got rich off Bitcoin really different from those who picked some lucky stocks in 1997 and cashed out in time?
That’s a good point but I’m going to argue against it anyway.
Unlike a lucky stock, Bitcoin wasn’t accounted for by mainstream markets at the time. An index fund amortizes the chances of lucky success and catastrophic failure across all the stocks into a single number, giving roughly the same expected value but with much lower variance. Bitcoin wasn’t something that could be indexed at that point, so there was no way you could have hedged your bet in the same way that an index fund would let you hedge.
It’s easy to think of trivial examples of one-time victories—for example, an early Bitcoin investor realizing that crypto-currency had potential and buying some when it was still worth fractions of a cent.
Actually, I’ve been working on a mini-essay on exactly this topic: because of my PredictionBook use, I have a long paper trail of explicit predictions on Bitcoin which implied major +EV at every time period, but I failed to meaningfully exploit my beliefs and so my gains have been far smaller than they could have been.
I think index funds are a good example of something that fits my criteria #s 1, 2, and 3. (Thank you to the commenters who’ve explained to me both why they are a good idea and why many/most people may not understand or believe this.)
Do index funds fit #s 4 and 5? It might be interesting to ask, in the next survey: do you invest? If so, in index funds, or otherwise? If the former, how much money have you made as a result? In the absence of survey data, is there other evidence that rationalists (or “rationalists”) invest in index funds more than the general population, and that they win thusly (i.e. make more money)?
I think modafinil is clearly a good example of my #s 2 and 3; I am not so sure about #1. I am still researching the matter. Gwern’s article, though very useful, has not convinced me. (Of course, whether it fits #s 4 and 5 also remains to be demonstrated.)
I remain unsure about whether the Bitcoin investment is a good example of anything. Again, if anyone cares to elucidate the matter, I would be grateful.
investing in index funds rather than mutual funds/picking your own stocks. There are strong reasons to believe you’ll do better, most people know those reasons but don’t credit them, and some people do credit them and end up with more money.
I’d like to hear this from a financial expert. Do we have any who’d like to speak on this?
Occasional use of modafinil might fall in this category as well, depending on whether we define people’s usual reasons for not taking it as irrational or rational-given-different-utility-functions.
Oh? What will modafinil do for me? (Will google and return to this thread, but if someone wants to recommend some links with concentrated useful info, it would be appreciated.)
I also have some objections to this sort of “obvious win” that do not depend on what modafinil’s specific effects are: namely, that “deciding to start taking a drug without the advice and supervision of a licensed medical professional is bad” seems to be a decent heuristic to live by. It’s not unalterable, but it seems good to a first approximation. Do you disagree?
an early Bitcoin investor realizing that crypto-currency had potential and buying some when it was still worth fractions of a cent.
Forgive me for my ignorance: so this guy has lots of Bitcoin now? What can you buy with Bitcoin? Can you just convert the Bitcoin into dollars? If so, how much money did this person make from this?
I don’t think most of these examples will end out as “such obvious wins no one could possibly disagree with them”—with the possible exception of index funds it’s never as purely mathematical as the lottery example—but I think for most people the calculus is clear.
My suspicion is that these examples are actually more like “it’s not clear whether these things are, in fact, even wins for the people who did them, never mind whether they will be wins for other people who are considering doing them”. I was really looking for something more unambiguous than that.
I will comment more when I’ve investigated / received clarifications on the examples you’ve provided. In the meantime I would love to see more examples.
Thank you. A couple of follow-up questions, if you don’t mind:
Do most ordinary investors not do this?
If not, do you know why? Do most people not know about the advantage of index funds? Or do they know, but don’t use them anyway?
If the latter, why don’t they? That seems strange. What makes index funds the “non-default” idea, so to speak? If index funds are known by financial experts to be superior to mutual funds (or other investing strategies), where would an ordinary person get the idea that they should be using anything other than index funds?
An index fund is intended to go up or down y the exact same amount as the entire exchange as a whole. For example, you might hear that the S&P 500 rose a total of 7% last year. If that happened, then your index fund would go up by 7%.
The main reason people don’t invest in index funds is because they want to “beat the market.” They see some stocks double or triple within a year and think “oh man, if only I’d bought that stock a bit earlier, I’d be rich!” So some people try to pick individual stocks, but the majority of laypeople want to let “experts” do it for them.
Mutual funds generally have a fund manager and tons of analysts working there trying to figure out how to beat the market (get a return greater than the market itself). They all claim to be able to do this and some have a record to point to to prove that they have done it in the past. For example, fund A may have beat the market in the previous 3 years, so investors think that by investing in Fund A over an Index fund, they will come out ahead.
But unfortunately, markets are anti-inductive so past success of individual stocks, mutual funds, and even index funds is no guarantee of future performance.
If you look at the performance of all funds over the past 20+ years and correct for survivorship bias (take into account all the funds that went out of business as well as the ones that are still around today), it becomes very clear that almost no mutual funds actually beat the market in terms of your ACTUAL RETURN when averaged over each year.
The final big problems with actively managed funds are fees and taxes. Actively managed funds charge higher percentage rates each year to cover their work. That’s how they make money. They also tend to sell a percentage of your stocks each year and buy new ones in their attempt to beat the market. This gives a certain “portfolio turnover” percentage and the higher that is, the more you have to pay in taxes (capital gains), which lessens your return even more.
The bottom line is that mutual funds claim to be able to beat the market and many do in any given year. People chase the money and pay more in capital gains and fees to try to make a higher return. Over time though, the index fund beats all others in terms of total return over time.
But mutual funds are. I don’t remember the citation, but I recall that mutual funds that do very poorly one year are more likely to do so in the future when you take into account fees and taxes.
Clearly, there are actively managed funds that do consistently worse than index funds, otherwise index funds wouldn’t be able to make money, since financial markets are negative-sum.
If you buy a stock A at price X, somebody must be selling you stock A at price X.
If buying turns out to be a good deal (that is, the discounted dividends Y you collect from holding stock A are greater than X), then selling must turn out to be a bad deal: if the other party held stock A they would have collected the profit Y-X that they forfeited to you. Your gain is their lost profit, therefore the market is zero-sum between investors. Add transaction costs and it becomes negative-sum.
This analysis is simplified by the fact that I didn’t take into account risk aversion and the fact that different parties can discount future utility in different ways (different discount rates or even hyperbolic discounting). But I suppose that when it comes to collective investors such as mutual funds or banks, these parameters can be considered to be roughly the same.
The stock market is not (necessarily) zero-sum or negative-sum as a whole, since money is transferred from companies to investors each time dividends are paid, but the way the investors slice the cake between them is negative-sum.
Not necessarily. First, it depends on the market. Some are zero-sum, and about others one can say that they are NOT zero-sum, but that’s it. They might be negative-sum or positive-sum, depending on the circumstances.
If you just buy a bunch of stocks and hold onto them, on average you’ll outperform cash.
That also depends. Average over what? Which countries and what time periods?
Yes, but taking into account survivorship bias, there are some actively managed funds that do do consistently worse than the market, and eventually fail (and are replaced by other funds that do so)
1) No but I’m doing my best as a columnist for Better Investing Magazine to tell them. Still, lots of money is in index funds.
2 and 3) Actively managed mutual funds put a lot of money into marketing, and the explanation for index funds is probably beyond most people. A huge number of financial experts would be out of jobs if all non-professional investors switched to index funds.
the explanation for index funds is probably beyond most people.
I don’t know, the simple explanation for index funds is “on average, you will get the market average. So why not avoid the fees?”, though it requires people being self-aware enough to recognize situations where they are, in fact, average.
But the actively managed mutual fund you are considering investing in has consistently outperformed the market even when taking into account taxes and fees.
But the actively managed mutual fund you are considering investing in has consistently outperformed the market even when taking into account taxes and fees.
Am I above average at picking actively-managed mutual funds?
What if you are the kind of person who is above average in most things. It’s far from obvious why you shouldn’t think you would be above average at picking stocks or mutual funds.
What if you are the kind of person who is above average in most things.
Why, thanks for noticing. ;) This is where the self-awareness comes in, and I agree if you can’t rely on that then you do need to build up the argument that the financial advisors and active managers are not worth their cost.
Not an economist or otherwise particularly qualified, but these are easy questions.
I’ll answer the second one first: This advice is exactly the same as advice to hold a diversified portfolio. The concept of an index fund is a tiny little piece of each and every thing that’s on the market. The reasoning behind buying index funds is exactly the reasoning behind holding a diversified portfolio.
For the second question, remember the idea is to buy a little bit of everything, to diversify. So go meta, and buy little bits of many different index funds. But actually, as this is considered a good idea, people have made such meta-index funds, that are indices of indices, that you can buy in order to get a little bit of each index fund.
But as an index is defined as “a little bit of everything”, the question of which one fades a lot in importance. There are indices of different markets, so one might ask which market to invest in, but even there you want to go meta and diversify. (Say, with one of those meta-indices.) And yes, you want to find one with low fees, which invests as widely as possible, etc. All the standard stuff. But while fiddling with the minueta may matter, it does pale when compared to the difference between buying indices and stupidly trying to pick stocks yourself.
The concept of an index fund is a tiny little piece of each and every thing that’s on the market.
This is not true. An index fund holds a particular index which generally does not represent “every thing that’s on the market”.
For a simple example, consider the most common index—the S&P 500. This index holds 500 largest-capitalization stocks in the US. If you invest in the S&P500 index you can be fairly described as investing into US large-cap stocks. The point is that you are NOT investing into small-cap stocks and neither you are investing in a large variety of other financial assets (e.g. bonds).
Yes. What I wrote was a summery, and not as perfectly detailed as one may wish. One can quibble about details: “the market”/”a market”, and those quibbles may be perfectly legitimate. Yes, one who buys S&P 500 indices is only buying shares in the large-cap market, not in all the many other things in the US (or world) economy. It would be silly to try to define a index fund as something that invests in every single thing on the face of the planet, and some indices are more diversified than others.
That said, the archetypal ideal of an index fund is that imaginary one piece of everything in the world. A fund is more “indexy” the more diversified it is. In other words, when one buys index funds, what one is buying is diversity. To a greater or lesser extent, of course, and one should buy not only the broadest index funds available, but of course also many different (non-overlapping?) index funds, if one wants to reap the full benifit of diversification.
the archetypal ideal of an index fund is that imaginary one piece of everything in the world.
Maybe in your mind. Not in mine. I think of indices (and index funds) as portfolios assembled under a particular set of rules. None of them tries to reach everything in the world, in fact a lot of them are designed to be quite narrow.
A fund is more “indexy” the more diversified it is.
I still disagree. An index fund’s most striking feature is that it invests passively, that is its managers generally don’t have to make any decisions, they just have to follow publicly announced rules. I don’t think a fund is more “indexy” if it owns more or more diverse assets.
In other words, when one buys index funds, what one is buying is diversity.
Sigh. Still no. You’re buying a portfolio composed under certain rules. Some of these portfolios (= index funds) are reasonably diversifed, some aren’t, and that depends on how do you think of diversification, too.
The “classic” index fund, one that invests into S&P500, is not diversified particularly well. It invests in only a single asset class in a single country.
An index fund’s most striking feature is that it invests passively, that is its managers generally don’t have to make any decisions, they just have to follow publicly announced rules. I don’t think a fund is more “indexy” if it owns more or more diverse assets.
Yup. Take an actively managed fund that seems to be indexy by ygert’s standards today. It might not be so indexy tomorrow.
Forgive me for my ignorance: so this guy has lots of Bitcoin now? What can you buy with Bitcoin? Can you just convert the Bitcoin into dollars? If so, how much money did this person make from this?
The hypothetical investor probably has the same amount of Bitcoins he always had, but Bitcoins are worth many more dollars now than previously, a difference of three orders of magnitude.
You can easily sell Bitcoins for US dollars on mtgox.com, but after mid-2013 you need a verified account (which IIRC requires sending them proof of residence) to transfer them to your bank account, which is a heck of a trivial inconvenience. (For all I know there might be an easier way, though.)
So—holding up Said, and for that matter my own memories, as evidence—most people simply haven’t considered these options.
Which … checks … does fit with the original criteria:
1.There is some opportunity for clear, unambiguous victory;
2.Taking advantage of it depends primarily on taking a strange/unconventional/etc. idea seriously (as distinct from e.g. not having the necessary resources/connections, being risk-averse, having a different utility function, etc.);
3.Most people / normal people / non-rationalists do not take the idea seriously, and as a consequence have not taken advantage of said opportunity;
4.Some people / smart people / rationalists take the idea seriously, and have gone for the opportunity;
5.And, most importantly, doing so has (not “will”! already has!) caused them to win, in a clear, unambiguous, significant way.
I don’t think it does, actually. The following are three distinct scenarios (as pertain to my point #2):
1. Being entirely unaware of what options/possibilities exist in some domain.
Example: I don’t do any investing, and so, prior to this thread, had no opinion on index funds whatsoever, nor on mutual funds, nor on anything related.
2. Being unaware of some particular (potentially counterintuitive) idea or option.
Example: I’d never had anyone recommend modafinil to me, or suggest that I should take it, or explain what benefits it might have.
3. Being aware of some idea or option, but not taking it seriously.
Example: I have no idea. Gaming poorly-designed lotteries? I suspect this example fails for other reasons, but it does fit the criterion #2.
The claim, as I understand it, was:
There are numerous cases like scenario 3 above, where the main thing that keeps people from taking advantage of an opportunity, and winning thusly, is not taking some idea seriously — despite being aware of that idea. Rationalists, on the other hand, do take the idea seriously, and win thusly.
Index funds are not a good example for people who have no knowledge of investing, because what kept me, for instance, from taking advantage of the profit opportunities offered by the idea “invest in index funds” was not having any knowledge of investing whatsoever, not some failure to take things seriously.
Modafinil is not a good example for people not aware of modafinil or its (alleged) positive effects, because what kept me, for instance, from taking advantage of the cognitive boosts offered by the idea “take modafinil” was not being aware of modafinil, not some failure to take things seriously.
I haven’t gotten a good response about Bitcoin, so I won’t comment on that.
Now, don’t get me wrong: I think index funds are a good example in general, based on the very helpful and clear comments I’ve gotten on that topic (thank you, commenters!). (Modafinil is not as clearly a good example. I’m still researching.) But my case, and similar others, are not good evidence for those examples.
Oh, indeed! Sorry, I didn’t mean to state that they proved his point or anything like that. I was just observing that they do seem to fit the criteria listed in the original comment Yvain was replying to.
Well… my point is that they do not, in fact, fit the criteria — specifically, criterion #2 — in the case of people who haven’t considered these ideas as options.
Unless they’re not considering them as options because they wouldn’t work for them (e.g. not having the necessary resources/connections, being risk-averse, having a different utility function, etc.), but rather because they’re unusual in some fashion...
I guess perhaps you weren’t clear on why, exactly, you wanted them to have been ignored?
I’m not claiming that a majority of the people who don’t do these options don’t do them because they’re aware of them but don’t take them seriously. I’m claiming a majority (or at least many) of the people who possess enough knowledge about them to be able to figure out that they should do them, don’t.
My source is mainly anecdotes from people I’ve talked to who know all the arguments for these but don’t do them.
A majority of the people who know enough about investing to know that they should invest in index funds rather than something else, do not do so, instead continuing to invest in other, less-optimal financial instruments.
I find this hard to believe. Do you really have anecdotes supporting this? (And a lack of a comparable or greater quantity of anecdotes to the contrary?)
A majority of the people who possess enough knowledge about nootropic drugs to be able to figure out that they should take modafinil, do not take modafinil.
I am entirely unconvinced that taking modafinil is a good idea, so you would have to first demonstrate that.
Something about Bitcoin. I don’t know what your claim even means in this case, honestly. Please explain.
I think your post would greatly benefit from the inclusion of some of those anecdotes you allude to. In other words, why do you believe this thing you believe? What has caused you to come to this conclusion? I would love to know!
There’s lots of modafinil info at gwern’s page. Wikipedia is also a pretty good source. The short (and only slightly inaccurate) version is that it gives you the good effects of caffeine, but stronger, and with no withdrawal or other drawbacks. It’s had positive effects on my mood and focus.
“deciding to start taking a drug without the advice and supervision of a licensed medical professional is bad” seems to be a decent heuristic to live by
Reasonable! Which is why I’m taking modafinil with the advice and supervision of a licensed medical professional. If you’re wary of self-medication, you might want to look into that route.
If you are so inclined, I would be interested in hearing how you approached the “advice of a medical professional” aspect; did you go to your GP and say “So I’m considering taking modafinil”? (If you’d prefer not to answer, I entirely understand, no need to even respond to say no; thank you in any case for your comment.)
I’d been seeing a psychiatrist to get treated for anhedonia. We tried a few different SSRIs, which didn’t help. Then I read about modafinil, and it seemed like it could plausibly help treat some of my symptoms (although not their causes), so I brought it up. He agreed it was a reasonable thing to try and prescribed it. I’ve been taking modafinil regularly for a year, now. It’s not a giant boost for me, but it is a boost, and the drawbacks are negligible.
That’s pretty remarkable, I would expect that most psychiatrists would be highly resistant to such a proposal. Also, having to try SSRIs first in order to maybe get them to agree is not an insignificant cost.
The example in the thread is real-life-ish—compare to the story of Voltaire and friends winning the French lottery. But if you want more:
It’s easy to think of trivial examples of one-time victories—for example, an early Bitcoin investor realizing that crypto-currency had potential and buying some when it was still worth fractions of a cent. But you can justly accuse me of cherry-picking here and demand repeatable examples.
Nothing guarantees that there will be repeatable examples—it could be that people are bad at taking ideas seriously until the ideas succeed once, at which point they realize they were wrong and jump on the bandwagon.
But in fact I think there are such examples. One such is investing in index funds rather than mutual funds/picking your own stocks. There are strong reasons to believe you’ll do better, most people know those reasons but don’t credit them, and some people do credit them and end up with more money.
Occasional use of modafinil might fall in this category as well, depending on whether we define people’s usual reasons for not taking it as irrational or rational-given-different-utility-functions.
I don’t think most of these examples will end out as “such obvious wins no one could possibly disagree with them”—with the possible exception of index funds it’s never as purely mathematical as the lottery example—but I think for most people the calculus is clear.
I seriously doubt most people know the the reasons they should be investing in index funds. Remember, the average American has an IQ of 100, doesn’t have a degree higher than a high school diploma, and rarely reads books. I’m not sure I’d know the reasons for buying index funds if not for spending a fair amount of time reading econ blogs.
Agreed: I have no idea why I should be investing in index funds (if, indeed, I were investing in anything). My skepticism about that example, though, actually comes from a slightly different place:
If I decided to do some investing, went to five financial experts, asked them what I should invest in, and they all said “Yep, index funds, definitely the way to go”, then I would invest in index funds. Right? Where would I even get the idea to do anything else?
And thus, why does “invest in index funds” qualify as a counterintuitive idea? Why is it a thing that some people might not take seriously? Wouldn’t it just be the default?
Because this
probably wouldn’t happen. If you asked uninvolved experts, it would, but the most accessible experts aren’t uninvolved. What is much more likely is that you (the average American with some money to invest) go to invest your money with an investment firm. And that investment firm pushes you toward actively-managed funds, since that’s where their incentives are. In order for the idea of investing solely in index funds to be available, you have to put in meaningful thought, if only enough to look for non-corporate advice on how to invest well.
Huh. That makes sense, I suppose. Do people generally not seek advice from uninvolved experts? Is that true only in investing, or in other domains?
I’m not an expert, but my impression is that most people don’t think about this kind of thing without prompting. Which means that they don’t think about it unless they, for example, see an ad for Charles Schwab and call them to look into investing. Getting to the point of considering whether the expert has an incentive to lie to you seems to mark you as of substantially above-average reasoning skills.
Isn’t it a little bit self-contradictory, to propose that smart people have beaten the market by investing in Bitcoin, and at the same time, that smart people invest in index funds rather than trying to beat the market? Or in other words, are those who got rich off Bitcoin really different from those who picked some lucky stocks in 1997 and cashed out in time?
That’s a good point but I’m going to argue against it anyway.
Unlike a lucky stock, Bitcoin wasn’t accounted for by mainstream markets at the time. An index fund amortizes the chances of lucky success and catastrophic failure across all the stocks into a single number, giving roughly the same expected value but with much lower variance. Bitcoin wasn’t something that could be indexed at that point, so there was no way you could have hedged your bet in the same way that an index fund would let you hedge.
Actually, I’ve been working on a mini-essay on exactly this topic: because of my PredictionBook use, I have a long paper trail of explicit predictions on Bitcoin which implied major +EV at every time period, but I failed to meaningfully exploit my beliefs and so my gains have been far smaller than they could have been.
UPDATE:
I think index funds are a good example of something that fits my criteria #s 1, 2, and 3. (Thank you to the commenters who’ve explained to me both why they are a good idea and why many/most people may not understand or believe this.)
Do index funds fit #s 4 and 5? It might be interesting to ask, in the next survey: do you invest? If so, in index funds, or otherwise? If the former, how much money have you made as a result? In the absence of survey data, is there other evidence that rationalists (or “rationalists”) invest in index funds more than the general population, and that they win thusly (i.e. make more money)?
I think modafinil is clearly a good example of my #s 2 and 3; I am not so sure about #1. I am still researching the matter. Gwern’s article, though very useful, has not convinced me. (Of course, whether it fits #s 4 and 5 also remains to be demonstrated.)
I remain unsure about whether the Bitcoin investment is a good example of anything. Again, if anyone cares to elucidate the matter, I would be grateful.
Thank you for the response.
I’d like to hear this from a financial expert. Do we have any who’d like to speak on this?
Oh? What will modafinil do for me? (Will google and return to this thread, but if someone wants to recommend some links with concentrated useful info, it would be appreciated.)
I also have some objections to this sort of “obvious win” that do not depend on what modafinil’s specific effects are: namely, that “deciding to start taking a drug without the advice and supervision of a licensed medical professional is bad” seems to be a decent heuristic to live by. It’s not unalterable, but it seems good to a first approximation. Do you disagree?
Forgive me for my ignorance: so this guy has lots of Bitcoin now? What can you buy with Bitcoin? Can you just convert the Bitcoin into dollars? If so, how much money did this person make from this?
My suspicion is that these examples are actually more like “it’s not clear whether these things are, in fact, even wins for the people who did them, never mind whether they will be wins for other people who are considering doing them”. I was really looking for something more unambiguous than that.
I will comment more when I’ve investigated / received clarifications on the examples you’ve provided. In the meantime I would love to see more examples.
I’m one (PhD in economics) and yes and ordinary investors should use low fee index funds.
Thank you. A couple of follow-up questions, if you don’t mind:
Do most ordinary investors not do this?
If not, do you know why? Do most people not know about the advantage of index funds? Or do they know, but don’t use them anyway?
If the latter, why don’t they? That seems strange. What makes index funds the “non-default” idea, so to speak? If index funds are known by financial experts to be superior to mutual funds (or other investing strategies), where would an ordinary person get the idea that they should be using anything other than index funds?
An index fund is intended to go up or down y the exact same amount as the entire exchange as a whole. For example, you might hear that the S&P 500 rose a total of 7% last year. If that happened, then your index fund would go up by 7%.
The main reason people don’t invest in index funds is because they want to “beat the market.” They see some stocks double or triple within a year and think “oh man, if only I’d bought that stock a bit earlier, I’d be rich!” So some people try to pick individual stocks, but the majority of laypeople want to let “experts” do it for them.
Mutual funds generally have a fund manager and tons of analysts working there trying to figure out how to beat the market (get a return greater than the market itself). They all claim to be able to do this and some have a record to point to to prove that they have done it in the past. For example, fund A may have beat the market in the previous 3 years, so investors think that by investing in Fund A over an Index fund, they will come out ahead.
But unfortunately, markets are anti-inductive so past success of individual stocks, mutual funds, and even index funds is no guarantee of future performance.
If you look at the performance of all funds over the past 20+ years and correct for survivorship bias (take into account all the funds that went out of business as well as the ones that are still around today), it becomes very clear that almost no mutual funds actually beat the market in terms of your ACTUAL RETURN when averaged over each year.
The final big problems with actively managed funds are fees and taxes. Actively managed funds charge higher percentage rates each year to cover their work. That’s how they make money. They also tend to sell a percentage of your stocks each year and buy new ones in their attempt to beat the market. This gives a certain “portfolio turnover” percentage and the higher that is, the more you have to pay in taxes (capital gains), which lessens your return even more.
The bottom line is that mutual funds claim to be able to beat the market and many do in any given year. People chase the money and pay more in capital gains and fees to try to make a higher return. Over time though, the index fund beats all others in terms of total return over time.
But mutual funds are. I don’t remember the citation, but I recall that mutual funds that do very poorly one year are more likely to do so in the future when you take into account fees and taxes.
Clearly, there are actively managed funds that do consistently worse than index funds, otherwise index funds wouldn’t be able to make money, since financial markets are negative-sum.
Financial markets are positive-sum. If you just buy a bunch of stocks and hold onto them, on average you’ll outperform cash.
If you buy a stock A at price X, somebody must be selling you stock A at price X.
If buying turns out to be a good deal (that is, the discounted dividends Y you collect from holding stock A are greater than X), then selling must turn out to be a bad deal: if the other party held stock A they would have collected the profit Y-X that they forfeited to you. Your gain is their lost profit, therefore the market is zero-sum between investors. Add transaction costs and it becomes negative-sum.
This analysis is simplified by the fact that I didn’t take into account risk aversion and the fact that different parties can discount future utility in different ways (different discount rates or even hyperbolic discounting). But I suppose that when it comes to collective investors such as mutual funds or banks, these parameters can be considered to be roughly the same.
The stock market is not (necessarily) zero-sum or negative-sum as a whole, since money is transferred from companies to investors each time dividends are paid, but the way the investors slice the cake between them is negative-sum.
Not necessarily. First, it depends on the market. Some are zero-sum, and about others one can say that they are NOT zero-sum, but that’s it. They might be negative-sum or positive-sum, depending on the circumstances.
That also depends. Average over what? Which countries and what time periods?
Survivorship bias means that most existing funds can have beating index funds in the past.
Yes, but taking into account survivorship bias, there are some actively managed funds that do do consistently worse than the market, and eventually fail (and are replaced by other funds that do so)
1) No but I’m doing my best as a columnist for Better Investing Magazine to tell them. Still, lots of money is in index funds.
2 and 3) Actively managed mutual funds put a lot of money into marketing, and the explanation for index funds is probably beyond most people. A huge number of financial experts would be out of jobs if all non-professional investors switched to index funds.
I don’t know, the simple explanation for index funds is “on average, you will get the market average. So why not avoid the fees?”, though it requires people being self-aware enough to recognize situations where they are, in fact, average.
But the actively managed mutual fund you are considering investing in has consistently outperformed the market even when taking into account taxes and fees.
Am I above average at picking actively-managed mutual funds?
What if you are the kind of person who is above average in most things. It’s far from obvious why you shouldn’t think you would be above average at picking stocks or mutual funds.
Why, thanks for noticing. ;) This is where the self-awareness comes in, and I agree if you can’t rely on that then you do need to build up the argument that the financial advisors and active managers are not worth their cost.
For ordinary investors won’t there still be an issue of buying these funds at the right time, so as not to buy when the market is unusually high?
You can migitate the problem by making the investment gradually.
Yes
Two questions:
Doesn’t this ignore the very important question of “which indices?”
Is this advice different from the “hold a sufficiently diversified portfolio” one?
Not an economist or otherwise particularly qualified, but these are easy questions.
I’ll answer the second one first: This advice is exactly the same as advice to hold a diversified portfolio. The concept of an index fund is a tiny little piece of each and every thing that’s on the market. The reasoning behind buying index funds is exactly the reasoning behind holding a diversified portfolio.
For the second question, remember the idea is to buy a little bit of everything, to diversify. So go meta, and buy little bits of many different index funds. But actually, as this is considered a good idea, people have made such meta-index funds, that are indices of indices, that you can buy in order to get a little bit of each index fund.
But as an index is defined as “a little bit of everything”, the question of which one fades a lot in importance. There are indices of different markets, so one might ask which market to invest in, but even there you want to go meta and diversify. (Say, with one of those meta-indices.) And yes, you want to find one with low fees, which invests as widely as possible, etc. All the standard stuff. But while fiddling with the minueta may matter, it does pale when compared to the difference between buying indices and stupidly trying to pick stocks yourself.
This is not true. An index fund holds a particular index which generally does not represent “every thing that’s on the market”.
For a simple example, consider the most common index—the S&P 500. This index holds 500 largest-capitalization stocks in the US. If you invest in the S&P500 index you can be fairly described as investing into US large-cap stocks. The point is that you are NOT investing into small-cap stocks and neither you are investing in a large variety of other financial assets (e.g. bonds).
Yes. What I wrote was a summery, and not as perfectly detailed as one may wish. One can quibble about details: “the market”/”a market”, and those quibbles may be perfectly legitimate. Yes, one who buys S&P 500 indices is only buying shares in the large-cap market, not in all the many other things in the US (or world) economy. It would be silly to try to define a index fund as something that invests in every single thing on the face of the planet, and some indices are more diversified than others.
That said, the archetypal ideal of an index fund is that imaginary one piece of everything in the world. A fund is more “indexy” the more diversified it is. In other words, when one buys index funds, what one is buying is diversity. To a greater or lesser extent, of course, and one should buy not only the broadest index funds available, but of course also many different (non-overlapping?) index funds, if one wants to reap the full benifit of diversification.
Maybe in your mind. Not in mine. I think of indices (and index funds) as portfolios assembled under a particular set of rules. None of them tries to reach everything in the world, in fact a lot of them are designed to be quite narrow.
I still disagree. An index fund’s most striking feature is that it invests passively, that is its managers generally don’t have to make any decisions, they just have to follow publicly announced rules. I don’t think a fund is more “indexy” if it owns more or more diverse assets.
Sigh. Still no. You’re buying a portfolio composed under certain rules. Some of these portfolios (= index funds) are reasonably diversifed, some aren’t, and that depends on how do you think of diversification, too.
The “classic” index fund, one that invests into S&P500, is not diversified particularly well. It invests in only a single asset class in a single country.
Yup. Take an actively managed fund that seems to be indexy by ygert’s standards today. It might not be so indexy tomorrow.
The hypothetical investor probably has the same amount of Bitcoins he always had, but Bitcoins are worth many more dollars now than previously, a difference of three orders of magnitude.
Noted. And as for the other things I asked?
You can easily sell Bitcoins for US dollars on mtgox.com, but after mid-2013 you need a verified account (which IIRC requires sending them proof of residence) to transfer them to your bank account, which is a heck of a trivial inconvenience. (For all I know there might be an easier way, though.)
I heard other exchanges, e.g., BitStamp don’t have this problem.
So—holding up Said, and for that matter my own memories, as evidence—most people simply haven’t considered these options.
Which … checks … does fit with the original criteria:
I don’t think it does, actually. The following are three distinct scenarios (as pertain to my point #2):
1. Being entirely unaware of what options/possibilities exist in some domain.
Example: I don’t do any investing, and so, prior to this thread, had no opinion on index funds whatsoever, nor on mutual funds, nor on anything related.
2. Being unaware of some particular (potentially counterintuitive) idea or option.
Example: I’d never had anyone recommend modafinil to me, or suggest that I should take it, or explain what benefits it might have.
3. Being aware of some idea or option, but not taking it seriously.
Example: I have no idea. Gaming poorly-designed lotteries? I suspect this example fails for other reasons, but it does fit the criterion #2.
The claim, as I understand it, was:
There are numerous cases like scenario 3 above, where the main thing that keeps people from taking advantage of an opportunity, and winning thusly, is not taking some idea seriously — despite being aware of that idea. Rationalists, on the other hand, do take the idea seriously, and win thusly.
Index funds are not a good example for people who have no knowledge of investing, because what kept me, for instance, from taking advantage of the profit opportunities offered by the idea “invest in index funds” was not having any knowledge of investing whatsoever, not some failure to take things seriously.
Modafinil is not a good example for people not aware of modafinil or its (alleged) positive effects, because what kept me, for instance, from taking advantage of the cognitive boosts offered by the idea “take modafinil” was not being aware of modafinil, not some failure to take things seriously.
I haven’t gotten a good response about Bitcoin, so I won’t comment on that.
Now, don’t get me wrong: I think index funds are a good example in general, based on the very helpful and clear comments I’ve gotten on that topic (thank you, commenters!). (Modafinil is not as clearly a good example. I’m still researching.) But my case, and similar others, are not good evidence for those examples.
Oh, indeed! Sorry, I didn’t mean to state that they proved his point or anything like that. I was just observing that they do seem to fit the criteria listed in the original comment Yvain was replying to.
Well… my point is that they do not, in fact, fit the criteria — specifically, criterion #2 — in the case of people who haven’t considered these ideas as options.
Really?
Unless they’re not considering them as options because they wouldn’t work for them (e.g. not having the necessary resources/connections, being risk-averse, having a different utility function, etc.), but rather because they’re unusual in some fashion...
I guess perhaps you weren’t clear on why, exactly, you wanted them to have been ignored?
I’m not claiming that a majority of the people who don’t do these options don’t do them because they’re aware of them but don’t take them seriously. I’m claiming a majority (or at least many) of the people who possess enough knowledge about them to be able to figure out that they should do them, don’t.
My source is mainly anecdotes from people I’ve talked to who know all the arguments for these but don’t do them.
So, concretizing your claim, we get:
A majority of the people who know enough about investing to know that they should invest in index funds rather than something else, do not do so, instead continuing to invest in other, less-optimal financial instruments.
I find this hard to believe. Do you really have anecdotes supporting this? (And a lack of a comparable or greater quantity of anecdotes to the contrary?)
A majority of the people who possess enough knowledge about nootropic drugs to be able to figure out that they should take modafinil, do not take modafinil.
I am entirely unconvinced that taking modafinil is a good idea, so you would have to first demonstrate that.
Something about Bitcoin. I don’t know what your claim even means in this case, honestly. Please explain.
I think your post would greatly benefit from the inclusion of some of those anecdotes you allude to. In other words, why do you believe this thing you believe? What has caused you to come to this conclusion? I would love to know!
There’s lots of modafinil info at gwern’s page. Wikipedia is also a pretty good source. The short (and only slightly inaccurate) version is that it gives you the good effects of caffeine, but stronger, and with no withdrawal or other drawbacks. It’s had positive effects on my mood and focus.
Reasonable! Which is why I’m taking modafinil with the advice and supervision of a licensed medical professional. If you’re wary of self-medication, you might want to look into that route.
Thank you for the link, I will look into that.
If you are so inclined, I would be interested in hearing how you approached the “advice of a medical professional” aspect; did you go to your GP and say “So I’m considering taking modafinil”? (If you’d prefer not to answer, I entirely understand, no need to even respond to say no; thank you in any case for your comment.)
I’d been seeing a psychiatrist to get treated for anhedonia. We tried a few different SSRIs, which didn’t help. Then I read about modafinil, and it seemed like it could plausibly help treat some of my symptoms (although not their causes), so I brought it up. He agreed it was a reasonable thing to try and prescribed it. I’ve been taking modafinil regularly for a year, now. It’s not a giant boost for me, but it is a boost, and the drawbacks are negligible.
That’s pretty remarkable, I would expect that most psychiatrists would be highly resistant to such a proposal. Also, having to try SSRIs first in order to maybe get them to agree is not an insignificant cost.
Yeah, it doesn’t sound like Ben_LandauTaylor’s strategy of modafinil acquisition is viable for me.
No kidding!
How much data is there behind this conclusion. Is it comparable to the centuries of experience we have with caffeine?
Why are you asking, instead of looking?