Thanks. I’m just trying to understand what people’s reasons are. My portfolio is also US-weighted more than market caps would dictate.
Rune
Karma: 379
This discussion is mostly irrelevant in practice, since the two funds track each other extremely well.
Even if it’s true that the S&P500 has beaten the overall market in the past, I doubt it’s statistically significant. Theoretically I can’t imagine a good reason why the optimal investment answer would be “pick roughly the top 500 companies, but not exactly those, but something like that picked by a committee of people you don’t know, in proportion to their market cap.” VTSAX just seems simpler as it tries to approximate “pick every company in proportion to their market cap.” This is also what the one mutual fund theorem in portfolio theory says one should do (if one limits oneself to US stocks only), so it has solid theoretical basis, unlike the S&P500.
I’m not a fan of this argument because even if you have some global coverage, why not get more and reap the benefits of diversification? It’s like saying hey I already own 2 car company stocks, there’s no point in owning all US car company stocks. Sure the stocks might move in tandem most of the time, but diversification allows you to reduce risk.
That’s an interesting argument I hadn’t heard before. It makes sense, although I think this argument can at best be used to rule out stocks of developing nations. That still leaves developed nations. So one might then diversify their stock holdings by adding some, say, Vanguard FTSE Developed Markets ETF (VEA) in addition to their VTSAX/VTI.
I can’t say much about other markets, but I do believe in the EMH is a reasonable approximation for the US stock market. The “obvious” rationalist investments into Tesla and AMD are an after-the-fact story to make it sound like that was the right thing to do back then. I’m sure one con construct an equally persuasive story for any other community of people. The pizza lover community will say you should have obviously invested in Dominos, and their stock has grown 25x in the past 10 years. Car enthusiasts will pick Tesla, etc.
Additionally, one prediction for a few years of returns is statistically insignificant. If you can today make, say 20, independent predictions about stocks that will beat SPY 1 year from now (in risk adjusted terms—after correcting for different risks), each of which has only a priori 50% chance of beating SPY, and then at the end of the year you’re correct on say 15+ of them, that would be statistically significant, for example.
Yes, you’re right. I’ll weaken the claim to 1.1x SPY will beat SPY in expected return historically and in almost all reasonable contexts. Certainly often enough to invalidate the incorrect EMH stated above.
My statement was motivated by the single time period investment model, as is considered in the standard mean-variance diagram of modern portfolio theory. On that diagram, as long as the risk free rate is below the market portfolio, you can draw a straight line between them and once you go beyond the market portfolio, you’ll always have higher expected return all the way to infinity. But a single time period is not the best way to model long-term investing.
By the EMH I mean this practical form: People cannot systematically outperform simple strategies like holding VTSAX. Certainly, you cannot expect to have a higher expected value than max(VTSAX, SPY). Opportunities to make money by active investing are either very rare, low volume, or require large amounts of work. Therefore people who are not investing professionally should just buy broad-based index funds.
This isn’t the right way to formulate an EMH. You can trivially get higher expected return than any investment by simply leveraging that investment. 1.1x leveraged SPY has higher expected return than SPY, and 1.2x SPY has even higher expected return and so on. As long as the borrowing rate is lower than the expected return on SPY, leveraging will always improve your return.
A better formulation would be that no strategy has a better risk-adjusted return than the market portfolio, which is the capital weighted portfolio of all securities held by everyone. If you restrict your investment universe to US equity only, the market portfolio is VTSAX (or SPY, they’re close enough). Then you could formulate the EMH as saying no portfolio of US equities will consistently outperform VTSAX in risk-adjusted terms, meaning, if we normalize the beta of the first portfolio to 1, then it won’t outperform VTSAX (which has a beta of 1 by virtue of being the market portfolio). Now my argument with leverage does not contradict this formulation, because a 1.1x leveraged VTSAX will have beta = 1.1. So if your normalize it to beta = 1, you get back VTSAX, which does not outperform VTSAX.
Is there a reason you only invest in the US stock market and not the whole world (VTWAX)? Or is VTSAX good enough and it’s not worth the effort to decide whether you should globally diversify and in what proportion?
That’s quite interesting! What was the stock/bond allocation in your examples that gave you a SWR of 4.3%?
I’m a big fan of NTSX and have done a bunch of back tests to see how it would have performed in various conditions. In all reasonably long time periods that I simulated, something like NTSX had lower volatility and higher return compared to SPY. About a year ago I went ahead and replaced most of my US equity exposure with NTSX.
3.5% might be safer, although I should have emphasized that I’m skeptical because the link you gave assumes you’re invested in only US stocks. This is hindsight bias because it so happened that the US market beat the world market in the last 50+ years. A more unbiased calculation would use a world market index (something like VTWAX instead of VTSAX).
And also maybe one should do the analysis without assuming that your home currency is US dollars, to avoid the bias that the US has been very prosperous in the past century? Not so sure about this. Maybe everyone should redo the analysis using their own home currency (e.g., Canadian dollars, Euros, etc.) and then decide what X% they can safely withdraw in retirement.
The fear is not that the stock market goes to zero, just that it rises slowly enough that withdrawing 4% leads you to deplete your portfolio before you’re dead. Ending up in the horrible situation that you have no money and are still alive. Even proponents of the 4% rule will say the simulations only show that you don’t run out of money (say) 90% of the time. There’s a decent 10% chance that you will run out of money. The original 4% calculation was done during a great time in US market history, so I’m not sure how optimistic I am about that being the case in the future.
Anyway, that 10% risk has to be compared to the chance of the insurance company not paying out. You can of course spread out your annuity into 4 different insurance companies, say. But even if you don’t, just like your money in your bank account is safe (up to a certain amount) even if your bank goes out of business due to FDIC insurance, and your stocks/bonds are safe (up to some amount) even if your broker goes out of business due to SIPC insurance, there’s an equivalent for insurance companies. All states in the US have state guarantee associations that back at least $250K of present value of annuity benefits. See here for more: https://www.annuity.org/annuities/regulations/state-guaranty-associations/
I’m not saying annuities are a great idea for everyone. But they might be a good idea for those who are risk averse enough that they don’t trust the 4% rule and want guaranteed (up to some major system collapsing event that causes even the state guarantee associations to fail) income.
This is a good guide. Thanks for writing it!
I wanted to comment on one important aspect that people sometimes feel uncomfortable about. That’s the assumption that you need to save roughly 25x your annual expenses to survive on the proceeds. Or in other words, you can approximately support a 4% spend every year from your savings. People are often uncomfortable with this rule of thumb since there’s so much uncertainty built into it about how the market will do. But it’s possible to completely do away with this uncertainty at a traditional retirement age by instead buying a Single Premium Immediate Annuity (SPIA). Here you just fork over your savings at (say) age 60 to an insurance company, and they’ll just pay you 5% of what you gave them for the rest of your life. It’s a guaranteed return independent of the market. The exact number (5%) will depend on your age and gender. But you’ll often get more than 4%, because you’ve given up your principal to the insurance company and there’s nothing to leave to your heirs. So you may not want to do this, but it’s good to know at least that in the worst case, when you turn 60 if you have saved X dollars, you have the option of getting (say) 5% every year until you die.
I get the impression that much of the official advice of the past was actively harmful; the official advice has flip-flopped on many things over the past decades; things which were touted as healthy were later shown to be unhealthy, and vice versa. So presumably some of the current official advice is also actively harmful, and some of it is merely useless. But I don’t know which.
This is not, in itself, a reason to stop trusting official advice on nutrition. On the science hierarchy of how certain we are of our understanding, nutrition science is very low and physics is very high. So we can treat all nutrition science recommendations as “we believe this slightly more than we believe the opposite”. So it will take a little bit of counter evidence for the field to update its point of view to the opposite. But once that has happened, it will take more counter evidence to flip back. The flip flops will get rarer as evidence accumulates, and at every point in time it could still be that official recommendations are the best that can be made given the data that we currently have. I’m not saying this is the case, but it is consistent with the data of flip flops.
Unfortunately, the official advice lags our current understanding (by decades, maybe). I think that’s a much bigger problem than the perceived flip flopping.
I don’t have any advice for nutrition, but examine.com is pretty decent for information about supplements and vitamins, and the NIH guide on supplements is even better: https://ods.od.nih.gov/factsheets/list-all/
Besides donating money to SENS, is there any way for people with money to help speed up this research? Specifically, are there companies that one can invest in to help this research? Say if you’re in charge of a lot of investment money (maybe you’re a fund manager or ethical investment advisor or something) and want to make investments that make the world a better place. Anti-aging sounds like it would be a great place to invest some of the financial capital available. How would one do that?
I don’t know the full answer to why stocks go up, but I have a partial answer based on risk. Imagine there are only 2 products available in the market:
(1) A US government bond that pays $100 in 1 year.
(2) Ownership in a company that will dissolve in 1 year, and at the end either return to the owner $95 or $105 with equal probability.
Note that both have the same expected return in 1 year, $100. But people will prefer to buy the first product compared to the second one, since the first one is risk free. Say the current 1-year interest rate for risk free returns is 1%, then people will pay $99 for the first product. But since the second product is less desirable, they might only pay $98 for it. So the second product has greater expected profit, since you paid $98 for $100 of expected returns. If you only invest in products like (2), then in the long run you’ll make more money in expectation compared to investing in risk-free assets like (1).
Your last example is actually weaker than it could be. Even though it’s completely equivalent, a better way to phrase this is the following:
The train is currently rushing to kill the child, and you’re not part of this situation. You, sitting in your car far away, see this happening. You now have the choice to drive up to the tracks and leave your car on the tracks. This will save the child but destroy your car.
Now it’s clear that you weren’t part of the situation to begin with; you’re just a distant observer who may choose to intervene.
“If you invest your money now, you might be able to make something like 10% annually with some risk.”
Speaking of this, does anyone know of any LW posts or other articles about how to make the most of idle capital with some risk? Ideally with the risk analyzed by a competent Bayesian.
I once met a philosophy professor who was at the time thinking about the problem “Are electrons real?” I asked her what her findings had shown thus far, and she said she thinks they’re not real. I then asked her to give me examples of things that are real. She said she doesn’t know any examples of such things.
Have you already written about the recent concerns with the Oxford vaccine causing Cerebral Sinovenous Thrombosis (CSVT)? I don’t mean just any old blood clots, but these specific blood clots that happen in the brain that are super rare and often lethal?
Much of the earlier blood clot discussion was unfortunately confused with regular blood clots, like deep vein thrombosis (DVT), which is not as big a deal, and neither is there good evidence that the Oxford Vaccine increases its occurrence. But CVST seems both serious and potentially a bigger side effect of one particular vaccine over the other options. So I would still take the Oxford vaccine over getting COVID, but now it’s unclear whether Oxford’s vaccine is just as good as the others, or somewhat inferior due to this side effect.