What If Long-Term Thinking Really Catches On?

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Ben Carlson
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What If Long-Term Thinking Really Catches On?

Post by Ben Carlson »

There have been some interesting discussions in the past few weeks on the changing dynamics in the financial advice industry from short-term brokers that were looking to make commissions by churning your account to a more passive fee-only approach. Some smart people have raised good points on the potential imbalances this could create if more investors switch to the Vanguard line of thinking.

These are my thoughts on this debate and what it could potentially mean for investors:

http://awealthofcommonsense.com/long-te ... y-catches/

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ERMD
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Re: What If Long-Term Thinking Really Catches On?

Post by ERMD »

should have called it: a wealth of common cents.
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mancuso
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Re: What If Long-Term Thinking Really Catches On?

Post by mancuso »

This is an interesting question, i.e. what happens if the *majority* of the market shifts away from actively-managed equities & funds towards a Vanguard-ian passive / indexed approach. Will there come a point when the weight of such investment fundamentally alters the buy-and-hold 3-fund approach so that it no longer works? Or is there theoretically room for say 75, 85, or 90%+ of the market to be invested in broad, passively-managed indexes?
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baw703916
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Re: What If Long-Term Thinking Really Catches On?

Post by baw703916 »

Facebook could never have had an IPO, because nobody would have been able to buy it, since it wasn't in any index. :)
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Re: What If Long-Term Thinking Really Catches On?

Post by MnD »

Passive investors earn the market return less expenses.
Active investors (in total aggregate) must also earn the market return less their expenses.

The expenses and poor timing/selection is what kills the typical active investor, not the fundamental pre-expense return potential, which is equal to the passive investor.
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baw703916
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Re: What If Long-Term Thinking Really Catches On?

Post by baw703916 »

But the timing/selection factor must sum to zero for all active investors in aggregate--they can't have bad market timing or below average stock picking performance. That's one thing that really bothers me about the statement "most investors buy and sell at exactly the wrong times." That can't be completely true, because there's always somebody on the other side of the trade. And if it is a sure thing that whatever the average individualactive investor is doing is wrong, that would be a very reliable contrarian indicator.

Everybody's returns will be hurt by expenses though.
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dmcmahon
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Re: What If Long-Term Thinking Really Catches On?

Post by dmcmahon »

baw703916 wrote:Facebook could never have had an IPO, because nobody would have been able to buy it, since it wasn't in any index. :)
Au contraire, it's rapid inclusion in many indexes forces passive indexers who wouldn't normally buy a stock at rich valuations to own it. What if the VC community could fob off almost anything on the investing public regardless of valuation, enriching themselves at our expense? Yes I am a cynic. Anyway active trading hopefully keeps this somewhat in check for the time being.
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Re: What If Long-Term Thinking Really Catches On?

Post by nisiprius »

The general retail grocery shopper goes to the supermarket and buys every item at its posted price, without engaging the produce manager in haggling. Nobody seems to think that is going to bring down the agricultural economy or destroy the commodity futures market.
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SamGamgee
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Re: What If Long-Term Thinking Really Catches On?

Post by SamGamgee »

It's self-correcting. The fewer people there are doing fundamental analysis (valuing a stock by valuing the business itself), the better fundamental analysis pays.
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ERMD
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Re: What If Long-Term Thinking Really Catches On?

Post by ERMD »

i also withdraw my indignation last week when i posted this exact same question and was rebuffed that it comes up all the time.
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Ben Carlson
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Re: What If Long-Term Thinking Really Catches On?

Post by Ben Carlson »

The point here is not just that investors all turn to index funds. It's that they somehow all turn passive. You can still be a passive long-term holder of an active managed fund. The index question has been debated for some time now. It's more what happens if demand for stocks from an asset allocation perspective continues to heat up. Many advisors still use active mutual funds. How does this affect valuations? Do we see more periods of booms and busts? What's the right balance between investors and speculators?
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Scott S
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Re: What If Long-Term Thinking Really Catches On?

Post by Scott S »

Long-term thinking and acceptance of being average is so against human nature that I don't expect demand for active investing to ever go away completely.
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zaboomafoozarg
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Re: What If Long-Term Thinking Really Catches On?

Post by zaboomafoozarg »

ERMD wrote:i also withdraw my indignation last week when i posted this exact same question and was rebuffed that it comes up all the time.
Just think, you're now qualified to perform said rebuffing :)
BradMajors
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Re: What If Long-Term Thinking Really Catches On?

Post by BradMajors »

If too great of a percentage of the money is invested in index funds it will lower the overall market return for everyone. We need active investors.
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Ged
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Re: What If Long-Term Thinking Really Catches On?

Post by Ged »

baw703916 wrote:Facebook could never have had an IPO, because nobody would have been able to buy it, since it wasn't in any index. :)
So we would have to come up with a new way to generate momentum stocks and bubbles. I don't think so. There will always be gamblers and cognitive biases with us.

What I'm interested in is how this might affect the economy itself. Not sure this would be off-topic for this forum or not. But such effects might be more important that the market impacts to investors.
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Ben Carlson
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Re: What If Long-Term Thinking Really Catches On?

Post by Ben Carlson »

Ged wrote:
baw703916 wrote:Facebook could never have had an IPO, because nobody would have been able to buy it, since it wasn't in any index. :)
So we would have to come up with a new way to generate momentum stocks and bubbles. I don't think so. There will always be gamblers and cognitive biases with us.

What I'm interested in is how this might affect the economy itself. Not sure this would be off-topic for this forum or not. But such effects might be more important that the market impacts to investors.
I do agree with you that there will always be speculators and active investors. Index funds are still only like 30% of the fund universe.

Good question on the economy as a whole. Soros's theory of reflexivity is all about feedback loops. So markets rising can increase confidence which can increase company investments which can increase hiring, etc. It would be hard to quantify this, but it's an interesting topic to consider.
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Re: What If Long-Term Thinking Really Catches On?

Post by avalpert »

BradMajors wrote:If too great of a percentage of the money is invested in index funds it will lower the overall market return for everyone. We need active investors.
By what mechanism will it lower the return for everyone - this isn't obvious such that you can assert it without evidence.
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Kevin21
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Re: What If Long-Term Thinking Really Catches On?

Post by Kevin21 »

I think companies would take more of a long term approach to business planning, and would benefit society in general.
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Phineas J. Whoopee
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Re: What If Long-Term Thinking Really Catches On?

Post by Phineas J. Whoopee »

Ben Carlson wrote:...Index funds are still only like 30% of the fund universe.
...
And funds are far less than 100% of the investable securities universe.
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Ged
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Re: What If Long-Term Thinking Really Catches On?

Post by Ged »

Kevin21 wrote:I think companies would take more of a long term approach to business planning, and would benefit society in general.
That is one possibility. Another is that these less dynamic allocation patterns won't allocate capital to growth as rapidly, thereby reducing the capital available to growth.
TareNeko
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Re: What If Long-Term Thinking Really Catches On?

Post by TareNeko »

I think we would have similar long term average gains in the markets with less volatility.
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Quidnam
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Re: What If Long-Term Thinking Really Catches On?

Post by Quidnam »

If long-term thinking truly caught on, we could raise capital for interstellar exploration missions and the terraforming of planetary bodies in the solar system...

As it stands, we'll have to settle for whatever Elon Musk can pull off before he dies. :happy
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