Indexers Are Average?

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Indexers Are Average?

Postby meowcat » Tue Jul 02, 2013 7:38 am

I come across this concept of averages in almost every investing book I read. The basics of indexing is accepting the averages because you'll usually end up better than most. The index investor is an average investor with average returns. I've never agreed with the word "average" when indexing. Non-indexers use this as their argument all the time, "well if you want to be just average, go ahead with indexing", they say. In my own opinion, I believe the word should be stricken from the index philosophy because the opposite is actually the case. For example, say I invest my entire life in low cost index funds. 40 years of indexing will put me ahead of 90% - 95% of all investors out there including professional money managers and hedge fund managers. Why would any investor in the top 5 or top 10 percentile be called average? This has never made sense to me.
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Re: Indexers Are Average?

Postby Tom_T » Tue Jul 02, 2013 7:49 am

The way the term 'average' is being used is really misleading. It makes it sound as if the market return is actually the median, and that 50% of investors will have returns above that level (and you can be one of them, too, if you only abandon indexing!) The truth is that only a small percentage of investors can beat the 'average', and they don't do so consistently.
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Re: Indexers Are Average?

Postby Investing is boring » Tue Jul 02, 2013 7:51 am

Average: Constituting the result obtained by adding together several quantities and then dividing this total by the number of quantities.

By this definition they are correct. An indexer get the average market return. However, their portfolio returns are anything BUT average. Why is this? We spend a whole lot less in expenses, taxes, and trading costs - all of which come off of your portfolio return and do not appear in the market return. The rest is a zero-sum game. So non-indexer's need not only win the zero sum game of trading and market timing to achieve average market returns, they have to win consistently by a margin greater then the added cost of expenses, taxes, and trading costs. Very few have been able to do this. A great many believe they can do this.

So why is indexing and accepting the market return so powerful, and for me the correct strategy? Simply because standing still is the hardest thing to do - and that is why it is, on average (forgive the pun), the most successful strategy.
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Re: Indexers Are Average?

Postby IlliniDave » Tue Jul 02, 2013 7:54 am

meowcat wrote:I come across this concept of averages in almost every investing book I read. The basics of indexing is accepting the averages because you'll usually end up better than most. The index investor is an average investor with average returns. I've never agreed with the word "average" when indexing. Non-indexers use this as their argument all the time, "well if you want to be just average, go ahead with indexing", they say. In my own opinion, I believe the word should be stricken from the index philosophy because the opposite is actually the case. For example, say I invest my entire life in low cost index funds. 40 years of indexing will put me ahead of 90% - 95% of all investors out there including professional money managers and hedge fund managers. Why would any investor in the top 5 or top 10 percentile be called average? This has never made sense to me.


That sort of reasoning is based on either honest ignorance or is a self-serving and disingenuous tactic to pilfer money from potential clients by people who indeed know better.
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Re: Indexers Are Average?

Postby neurosphere » Tue Jul 02, 2013 8:00 am

If all the stocks in the SP500 line up to run a race, we can take the all the finish times and average them. This is the average time.

Then we have an "index runner" who assembles a team of runners which is identical to the 500. However, the penalty is that each of these 500 "mimics" has to run with a rock in their pocket.

Then we have the "active" teams, who gets to pick and choose from among the SP500 runners a subset to represent his team. But to "pay" for this benefit, each of these selected runners has to run holding a bowling ball.

Which team will beat the average? Answer: Probably no one. The SP500 team can only BE average. It can't beat it's own averaged time. The index fund can't win either, it's guaranteed to lag the average given the rocks in the pocket.

As for the active teams, well, those bowling balls sure weigh a lot. That's all I need to know.
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Re: Indexers Are Average?

Postby cheese_breath » Tue Jul 02, 2013 8:02 am

meowcat wrote:Non-indexers use this as their argument all the time, "well if you want to be just average, go ahead with indexing", they say.

Advisors (aka salesmen) use this argument all the time when trying to persuade us he can beat the averages if we sign with them. The problem is we have a better chance of becoming below average if we do sign with them.
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Re: Indexers Are Average?

Postby Cautious Optimist » Tue Jul 02, 2013 8:30 am

Doesn't this "average is bad" argument really misinterpret what L/T investors are competing against..?? For example doesn't one get ahead by realizing "average" L/T growth that outpaces inflation..??
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Re: Indexers Are Average?

Postby rustymutt » Tue Jul 02, 2013 8:38 am

It's not in the best interest of Wall Street for them to give up the huge profits they collect on management fees, and trading expenses each year.
Banks also play into this game. The system is rigged for a zero sum game that consumers loose if they play along. Indexing should be the core of every investors written plan. It's the only way to come out on top consistently year in, and year out.
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Re: Indexers Are Average?

Postby meowcat » Tue Jul 02, 2013 8:44 am

Interesting replies, thanks for all of your opinions. My point, however, was not the argument of passive vs. active investing, we already know that. My point is, why do even passive investors (Bogleheads) continue to refer to their strategy as average when in reality, they're beating the pants off of most active investors?
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Re: Indexers Are Average?

Postby Joe S. » Tue Jul 02, 2013 9:01 am

Your stocks have an average return. However index funds have below average expenses and below average tax costs. So after expenses and taxes, you are doing better than the average investor. Also index funds have greater diversity, that lowers your risk. If you bought active funds, their higher risk should theoretically make you want to slightly increase your bond allocation, further cutting your return.

When discussing index funds, I would stick to referring to them as having above average returns. You can't ignore expenses and taxes.
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Re: Indexers Are Average?

Postby staythecourse » Tue Jul 02, 2013 9:05 am

Investing is boring wrote:By this definition they are correct. An indexer get the average market return. However, their portfolio returns are anything BUT average.


Well said.

Good luck.
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Re: Indexers Are Average?

Postby Rick Ferri » Tue Jul 02, 2013 9:06 am

Index investors are smarter than average investors because they consistently outperform them.

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Re: Indexers Are Average?

Postby tadamsmar » Tue Jul 02, 2013 9:13 am

meowcat wrote:I come across this concept of averages in almost every investing book I read. The basics of indexing is accepting the averages because you'll usually end up better than most. The index investor is an average investor with average returns. I've never agreed with the word "average" when indexing. Non-indexers use this as their argument all the time, "well if you want to be just average, go ahead with indexing", they say. In my own opinion, I believe the word should be stricken from the index philosophy because the opposite is actually the case. For example, say I invest my entire life in low cost index funds. 40 years of indexing will put me ahead of 90% - 95% of all investors out there including professional money managers and hedge fund managers. Why would any investor in the top 5 or top 10 percentile be called average? This has never made sense to me.


Can you give an example? I am of the opinion that every book that advocates indexing makes it clear that indexers get above average returns after fees. The books use the concept of average market returns to prove this, as in Bogle's famous simple arithmetic proof:

https://personal.vanguard.com/bogle_site/sp20060101.htm
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Re: Indexers Are Average?

Postby IlliniDave » Tue Jul 02, 2013 9:45 am

meowcat wrote:Interesting replies, thanks for all of your opinions. My point, however, was not the argument of passive vs. active investing, we already know that. My point is, why do even passive investors (Bogleheads) continue to refer to their strategy as average when in reality, they're beating the pants off of most active investors?


It depends on what average you mean. If you buy TSM you'll pretty much get the market-weighted average return of all the publicly traded US stocks (less a very small fee). If you do that over 40 years you'll actually fall a little further behind the average market returns (even small fees compound) but compared to other investors you'll likely wind up ahead of the average returns they get. So when looking at returns indexers shoot for some sort of weighted average return (allocation-based). I don't spend a lot of time comparing myself to other investors, but I know that that the term "average" means something different in each context. One average is across people, the other is across markets.

Folks can call me whatever they want as long as they don't charge me 1% to do it. :D
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Re: Indexers Are Average?

Postby Ged » Tue Jul 02, 2013 10:03 am

Market average is better than the returns obtained by the average investor. The statement is a disingenuous comparison of two different measurements intended to confuse and mislead people with money into using professional services that are designed to enrich the people supplying the service.

I used to work with a quite good chemist who had some experience working as a stockbroker. I asked him why he changed careers and he said something like "well, the money was good, but I hated spending my time working on ways to separate people from their savings".

That was about 25 years ago, and was pretty vivid clarification of why you don't want to be the customer of one of these people.
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Re: Indexers Are Average?

Postby HomerJ » Tue Jul 02, 2013 11:50 am

neurosphere wrote:If all the stocks in the SP500 line up to run a race, we can take the all the finish times and average them. This is the average time.

Then we have an "index runner" who assembles a team of runners which is identical to the 500. However, the penalty is that each of these 500 "mimics" has to run with a rock in their pocket.

Then we have the "active" teams, who gets to pick and choose from among the SP500 runners a subset to represent his team. But to "pay" for this benefit, each of these selected runners has to run holding a bowling ball.

Which team will beat the average? Answer: Probably no one. The SP500 team can only BE average. It can't beat it's own averaged time. The index fund can't win either, it's guaranteed to lag the average given the rocks in the pocket.

As for the active teams, well, those bowling balls sure weigh a lot. That's all I need to know.


Heh, I really like this analogy
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Re: Indexers Are Average?

Postby LL30 » Tue Jul 02, 2013 1:14 pm

I remember a qoute I heard once that stated when you index (or are a passive investor) you're not getting "average" returns you are getting "market" returns.
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Re: Indexers Are Average?

Postby neurosphere » Tue Jul 02, 2013 5:20 pm

LL30 wrote:I remember a qoute I heard once that stated when you index (or are a passive investor) you're not getting "average" returns you are getting "market" returns.


Yep, you are getting market returns, and market returns are well above the returns of the "average" actively managed fund.

It's a semantic thing, and anti-indexers are just playing around and taking advantage of the fact that words have different meanings in different contexts, in order to confuse the issue.
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Re: Indexers Are Average?

Postby allenneal99 » Tue Jul 02, 2013 5:53 pm

Index Investing is the "North Star" of investing.

It's what all active managers compare themselves to and what some of them attempt to beat.

From reading prospectus's and semi-annual reports of active funds, I've always wondered why actively managed funds only compare their performance to either the respective "benchmark index" or the "category average", but never to other related actively managed competing funds. :confused

I wondered even more when active funds would sometimes change their "benchmark index" after a few years to a different "benchmark index".


Whether the actively managed fund outperforms the index one year and then under-performs another year, it will always be "off course".
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Re: Indexers Are Average?

Postby Savvy » Tue Jul 02, 2013 6:53 pm

Average before expenses
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Re: Indexers Are Average?

Postby Jack » Tue Jul 02, 2013 7:28 pm

Investing is boring wrote:An indexer get the average market return.

No, the indexer gets the market return -- full stop. There is no averaging involved. It's just the market return (minus expenses).

There is simply never any reason to use the word average when describing the market return. There is no mathematical averaging operation involved in the calculation of the market return.
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Re: Indexers Are Average?

Postby pingo » Tue Jul 02, 2013 8:05 pm

This is more or less how I like to phrase it:

It is a mathematic certainty that on average the average actively-managed fund will produce average returns at higher costs, resulting in underperformance over the long-term (relative to the market). Therefore, costs become the only consistent predictor of a fund’s relative performance and index funds tend to be the most cost-effective as they passively move in-sync with the market. To illustrate:

SSgA S&P 500 Index Fund (SVSPX) (after costs)
All U.S. Large Blend Funds Combined (after costs)
Image
Source: Link to Morningstar.com chart

Active investors often speak as if the market is not them; as if accepting market returns is settling for less. Not so. Market indices ride effortlessly on the backs of all active investors as the latter trade the same stocks back and forth with each other in order to try to outperform...well...each other.

The most sure way to be in the top 25% of mutual funds is to be in the bottom 25% of costs.
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Re: Indexers Are Average?

Postby pkcrafter » Tue Jul 02, 2013 9:44 pm

Average returns, not exactly. We are getting market returns minus the cost of investing in indexes. All other investors are getting market returns minus the higher costs they incur. In the short term it's a thin green line, in the long term it's a football field. :wink:

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