Um, evidence? It does not look to me like that, so where’s the data?
Who do you think consistently does well, and what data do you use to support that view? That’ll help me determine if I have evidence you’ll find convincing.
They don’t get “average” return on capital in any meaningful sense of the word “average”
Similarly, what does “average” mean to you?
Given this I am not sure why do you think they consistently do well—this seems to contradict your acceptance of EMH earlier.
The EMH has holes; Buffet has famously outperformed the market and index funds by dint of superior rationality, but most people are not qualified to judge which money managers are rational enough to be better than index funds.
I don’t have a good explanation for why value investing works. The most charitable and plausible one I know is “most investors look for short-term mispricings instead of long-term mispricings, and so there are more opportunities where less people are looking.”
Who do you think consistently does well, and what data do you use to support that view?
I don’t know. I am not even sure what is the classification you have in mind when you ask this question—are you talking about what kind of people do well? What kind of investment strategies? Are you talking about US or the whole world? Do you have in mind the last 20 years or the last 200 years?
what does “average” mean to you?
An arithmetic mean. Is this a trick question?
Buffet has famously outperformed the market and index funds by dint of superior rationality
Really? And how do you establish that particular causality?
Buffet has a specific investment approach. It clearly worked for him, it also clearly did not work for many other people who tried it. And if you posit the existence of Buffet’s wealth as evidence that “value investing works”, I can posit the existence of Soros’ wealth as evidence that currency speculation works.
I don’t know. I am not even sure what is the classification you have in mind when you ask this question
My interpretation of this comment is that you’re not asking an object-level question of me (why I think value investing is better for the modern American individual investor than technical analysis, for example) but the meta question of why I think that some investment strategies are better than other investment strategies. I’m afraid I don’t find that question interesting enough to give it a good answer, and I don’t think you would find a quick answer satisfying.
An arithmetic mean. Is this a trick question?
Are you making the comment that “market capitalization-weighted average returns on stocks” would have been more accurate than “average return on capital”, or what am I missing here?
And how do you establish that particular causality?
I used my judgment and publicly available information. You might be interested in this speech by Munger, this short summary of highlights from him, this book. I’ve mostly linked to Munger, since I’ve found his writings on rationality to be more useful, but any biography of Buffett will clarify the link between the two, and Buffett’s letters will make obvious that he thinks in similar ways.
Buffet has a specific investment approach.
I should comment that I think a critical part of Buffett’s approach is the “only invest in sure deals” component, which I don’t think is a widely followed rule in value investment as a whole.
Re arithmetic mean: an “average” return presupposes some set that you’re averaging. It could be the set of all investors (or the set of US investors, or the set of retail investors, etc.). It could be the set of all investments (or the set of US equties, or mutual funds, etc.). I don’t understand how investing in an index fund provides “average” returns.
If, by any chance, you mean that an investment in a portfolio of securities provides a weighted average of the returns of the assets included in the portfolio, why, this is a property of any basket of investments. In that sense a portfolio composed of, say, currency derivatives and interest-rate swaps will provide an “average” return as well, just like any portfolio at all.
Re Buffet: I am well aware of the claims made about him. I don’t take them at face value and don’t recommend that you do (and yes, I know who Munger is). People who have been successful through luck have just as compelling narratives how some feature of their {method/mind/character/upbringing/etc.} made their success inevitable. Hindsight, after all, provides perfect vision :-/
an “average” return presupposes some set that you’re averaging.
Okay. The set I’m imagining is the set of investments that meet some criteria, like “US stocks listed on the NYSE” or “US large cap stocks” or even “home robotics stocks.” It seems meaningful to me to state that indexing across that set will provide “average” returns in the sense that it will provide low-variance returns centered around the set mean, relative to a picking a portfolio based on personal taste from stocks in that set. For investors as a whole, the effects of their personal taste must average out to the mean (once weighted by participation in that set), and so unless you have special knowledge you should expect your returns to be centered around the set mean, but with higher variance. For risk-averse investors, higher variance is a bad thing. Justifying the expectation that your returns will be higher than the set mean requires a statement like “I can pick home robotics stocks better than the market as a whole,” or the less questionable “I can pick industries better than the market as a whole”, but the safest is probably “I can’t pick better than the market as a whole,” which suggests indexing across all industries (and, barring legal barriers, across all countries).
People who have been successful through luck have just as compelling narratives how some feature of their {method/mind/character/upbringing/etc.} made their success inevitable.
I understand the outside view that most successful people are likely to be highly lucky, and are unlikely to have public correct causal models of their success. (It’s very unlikely that a boy band star or male actor would admit to having sex with a gay talent agent in order to land a position, for example, even if that’s the primary differentiator between them and their competition that did not go on to become famous.)
That said, as someone who formally studies good decision-making, I think I have a strong inside view of what works about Buffett’s decision-making, and it seems likely to me that it actually is a causal factor in his success. I have no doubt that luck played a role in Buffett making his way to the top, rather than just doing well for himself. (There are other residents of Graham-Doddsville, many of whom have also gotten rich, but none of whom have gotten as rich as Buffett.)
Well, let’s try to sort this out a little better. There’s a general superset of all investment opportunities. That’s too much to chew on, so let’s limit ourselves to a semi-arbitrary subset. As an example let’s take the standard large-cap US equity and define it as members of the S&P500 index. There is a variety of tradeable instruments (mutual funds, ETFs, futures, etc.) which will allow you to buy the S&P500.
indexing across that set will provide “average” returns in the sense that it will provide low-variance returns centered around the set mean
That is not correct. Owning an index security will provide returns similar to the set mean (defined appropriately, here the mean is cap-weighted), but these returns will not be low-variance. Provided the security that you chose is run competently, your tracking error with respect to the the index will be small and so low-variance, but the returns themselves can be as high-variance as they like.
If you pick a portfolio from the same set based on personal taste, the tracking error will be much greater, but the variance of the portfolio returns themselves might be greater or might be smaller. For example, if your taste runs to low-beta stocks, the variance of your personal-taste portfolio is likely to be less than the variance of the S&P500 index.
so unless you have special knowledge you should expect your returns to be centered around the set mean, but with higher variance
Again, this is not true. Indices are not homogenous, my personal taste will affect the variance of my portfolio. It might end up higher than the index or it might end up lower. Similarly, my personal taste will affect the expected returns as well.
higher variance is a bad thing
Given everything else equal, which it never is. If investors were only interested in expected variance, why even invest? Holding cash has zero variance in nominal terms. And, of course, different investors have different risk tolerances.
Let me also point out again that investing is a much broader field than just picking stocks and choosing a subset to invest in often has more significant consequences than deciding which securities from that subset to pick. The advice to “index” tells me nothing whether I should have municipal bonds in my portfolio, for example. Or any bonds. Or any equities. Or, actually, anything in particular.
Re Buffet, I fully agree that he possesses superior decision-making abilities. He’s probably better than 99.9% of the population. However his wealth is far beyond the average wealth of the top 0.1% best decision makers. More importantly, I am not sure how the superiority of Buffet’s personal abilities translates to believing that value investment can “beat the market”.
Provided the security that you chose is run competently, your tracking error with respect to the the index will be small and so low-variance, but the returns themselves can be as high-variance as they like.
This is what what I meant by “low variance centered on the set mean,” as I assumed the set mean was a stochastic object (with the variance that implies). Similarly, you can read “high variance” about the personal taste portfolio as “high tracking error variance,” which as you point out may be the result of low absolute variance in returns. Holding cash has a high-variance tracking error relative to the S&P 500, even though cash is zero nominal variance.
Given everything else equal, which it never is.
What does it add to the conversation to point this out?
I don’t get the impression that this conversation is productive. I think if someone doesn’t want to become proficient at finance, their best way to invest money is to set aside part of their salary* and buy into VTSMX every month. I don’t think they need to know what “dollar cost averaging” is, or why index funds are better than actively managed funds, and I think that crude heuristic arguments (“on average, money managers subtract value, you should expect to be average”) are the right way to convince them to invest this way.
As of yet, I don’t think I’ve seen you make a positive recommendation, which strikes me as worse than useless for a PSA thread. If finance is hard, then what?
*I feel the need to point out that I understand not everyone has a salary.
I’ve said it before—my point is that there are no good general-purpose universally-applicable recommendations for personal investing. They do not exist.
Certainly there are not-horrible recommendations. Investing in VTSMX is one of them. Putting your money into T-bills is another one. Putting it into TIPS is yet another one. Putting it into a 50-50 mix of high-grade corporate bonds and Russel 3000 is yet another one. Etc., etc.
All of these are not horrible. But none of them is particularly good or a good fit for everyone.
It’s like asking “what kind of food should I eat?” There are many not-horrible answers to it, starting with “follow the US government’s food pyramid”. But it’s not a particularly good answer and there is no single universal answer. People are too different for that. Same with investing—no generic answer is good enough.
However I agree that this particular chain of exchanges got too long. Your arguments seem incoherent to me and, no doubt, mine seem obtuse to you. If I get to writing a post on introduction to thinking about investing this conversation might continue...
Who do you think consistently does well, and what data do you use to support that view? That’ll help me determine if I have evidence you’ll find convincing.
Similarly, what does “average” mean to you?
I said earlier:
I don’t have a good explanation for why value investing works. The most charitable and plausible one I know is “most investors look for short-term mispricings instead of long-term mispricings, and so there are more opportunities where less people are looking.”
I don’t know. I am not even sure what is the classification you have in mind when you ask this question—are you talking about what kind of people do well? What kind of investment strategies? Are you talking about US or the whole world? Do you have in mind the last 20 years or the last 200 years?
An arithmetic mean. Is this a trick question?
Really? And how do you establish that particular causality?
Buffet has a specific investment approach. It clearly worked for him, it also clearly did not work for many other people who tried it. And if you posit the existence of Buffet’s wealth as evidence that “value investing works”, I can posit the existence of Soros’ wealth as evidence that currency speculation works.
My interpretation of this comment is that you’re not asking an object-level question of me (why I think value investing is better for the modern American individual investor than technical analysis, for example) but the meta question of why I think that some investment strategies are better than other investment strategies. I’m afraid I don’t find that question interesting enough to give it a good answer, and I don’t think you would find a quick answer satisfying.
Are you making the comment that “market capitalization-weighted average returns on stocks” would have been more accurate than “average return on capital”, or what am I missing here?
I used my judgment and publicly available information. You might be interested in this speech by Munger, this short summary of highlights from him, this book. I’ve mostly linked to Munger, since I’ve found his writings on rationality to be more useful, but any biography of Buffett will clarify the link between the two, and Buffett’s letters will make obvious that he thinks in similar ways.
I should comment that I think a critical part of Buffett’s approach is the “only invest in sure deals” component, which I don’t think is a widely followed rule in value investment as a whole.
Re arithmetic mean: an “average” return presupposes some set that you’re averaging. It could be the set of all investors (or the set of US investors, or the set of retail investors, etc.). It could be the set of all investments (or the set of US equties, or mutual funds, etc.). I don’t understand how investing in an index fund provides “average” returns.
If, by any chance, you mean that an investment in a portfolio of securities provides a weighted average of the returns of the assets included in the portfolio, why, this is a property of any basket of investments. In that sense a portfolio composed of, say, currency derivatives and interest-rate swaps will provide an “average” return as well, just like any portfolio at all.
Re Buffet: I am well aware of the claims made about him. I don’t take them at face value and don’t recommend that you do (and yes, I know who Munger is). People who have been successful through luck have just as compelling narratives how some feature of their {method/mind/character/upbringing/etc.} made their success inevitable. Hindsight, after all, provides perfect vision :-/
Okay. The set I’m imagining is the set of investments that meet some criteria, like “US stocks listed on the NYSE” or “US large cap stocks” or even “home robotics stocks.” It seems meaningful to me to state that indexing across that set will provide “average” returns in the sense that it will provide low-variance returns centered around the set mean, relative to a picking a portfolio based on personal taste from stocks in that set. For investors as a whole, the effects of their personal taste must average out to the mean (once weighted by participation in that set), and so unless you have special knowledge you should expect your returns to be centered around the set mean, but with higher variance. For risk-averse investors, higher variance is a bad thing. Justifying the expectation that your returns will be higher than the set mean requires a statement like “I can pick home robotics stocks better than the market as a whole,” or the less questionable “I can pick industries better than the market as a whole”, but the safest is probably “I can’t pick better than the market as a whole,” which suggests indexing across all industries (and, barring legal barriers, across all countries).
I understand the outside view that most successful people are likely to be highly lucky, and are unlikely to have public correct causal models of their success. (It’s very unlikely that a boy band star or male actor would admit to having sex with a gay talent agent in order to land a position, for example, even if that’s the primary differentiator between them and their competition that did not go on to become famous.)
That said, as someone who formally studies good decision-making, I think I have a strong inside view of what works about Buffett’s decision-making, and it seems likely to me that it actually is a causal factor in his success. I have no doubt that luck played a role in Buffett making his way to the top, rather than just doing well for himself. (There are other residents of Graham-Doddsville, many of whom have also gotten rich, but none of whom have gotten as rich as Buffett.)
Well, let’s try to sort this out a little better. There’s a general superset of all investment opportunities. That’s too much to chew on, so let’s limit ourselves to a semi-arbitrary subset. As an example let’s take the standard large-cap US equity and define it as members of the S&P500 index. There is a variety of tradeable instruments (mutual funds, ETFs, futures, etc.) which will allow you to buy the S&P500.
That is not correct. Owning an index security will provide returns similar to the set mean (defined appropriately, here the mean is cap-weighted), but these returns will not be low-variance. Provided the security that you chose is run competently, your tracking error with respect to the the index will be small and so low-variance, but the returns themselves can be as high-variance as they like.
If you pick a portfolio from the same set based on personal taste, the tracking error will be much greater, but the variance of the portfolio returns themselves might be greater or might be smaller. For example, if your taste runs to low-beta stocks, the variance of your personal-taste portfolio is likely to be less than the variance of the S&P500 index.
Again, this is not true. Indices are not homogenous, my personal taste will affect the variance of my portfolio. It might end up higher than the index or it might end up lower. Similarly, my personal taste will affect the expected returns as well.
Given everything else equal, which it never is. If investors were only interested in expected variance, why even invest? Holding cash has zero variance in nominal terms. And, of course, different investors have different risk tolerances.
Let me also point out again that investing is a much broader field than just picking stocks and choosing a subset to invest in often has more significant consequences than deciding which securities from that subset to pick. The advice to “index” tells me nothing whether I should have municipal bonds in my portfolio, for example. Or any bonds. Or any equities. Or, actually, anything in particular.
Re Buffet, I fully agree that he possesses superior decision-making abilities. He’s probably better than 99.9% of the population. However his wealth is far beyond the average wealth of the top 0.1% best decision makers. More importantly, I am not sure how the superiority of Buffet’s personal abilities translates to believing that value investment can “beat the market”.
This is what what I meant by “low variance centered on the set mean,” as I assumed the set mean was a stochastic object (with the variance that implies). Similarly, you can read “high variance” about the personal taste portfolio as “high tracking error variance,” which as you point out may be the result of low absolute variance in returns. Holding cash has a high-variance tracking error relative to the S&P 500, even though cash is zero nominal variance.
What does it add to the conversation to point this out?
I don’t get the impression that this conversation is productive. I think if someone doesn’t want to become proficient at finance, their best way to invest money is to set aside part of their salary* and buy into VTSMX every month. I don’t think they need to know what “dollar cost averaging” is, or why index funds are better than actively managed funds, and I think that crude heuristic arguments (“on average, money managers subtract value, you should expect to be average”) are the right way to convince them to invest this way.
As of yet, I don’t think I’ve seen you make a positive recommendation, which strikes me as worse than useless for a PSA thread. If finance is hard, then what?
*I feel the need to point out that I understand not everyone has a salary.
I’ve said it before—my point is that there are no good general-purpose universally-applicable recommendations for personal investing. They do not exist.
Certainly there are not-horrible recommendations. Investing in VTSMX is one of them. Putting your money into T-bills is another one. Putting it into TIPS is yet another one. Putting it into a 50-50 mix of high-grade corporate bonds and Russel 3000 is yet another one. Etc., etc.
All of these are not horrible. But none of them is particularly good or a good fit for everyone.
It’s like asking “what kind of food should I eat?” There are many not-horrible answers to it, starting with “follow the US government’s food pyramid”. But it’s not a particularly good answer and there is no single universal answer. People are too different for that. Same with investing—no generic answer is good enough.
However I agree that this particular chain of exchanges got too long. Your arguments seem incoherent to me and, no doubt, mine seem obtuse to you. If I get to writing a post on introduction to thinking about investing this conversation might continue...