"Are Index-Fund Investors Smarter?"

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Topic Author
Taylor Larimore
Posts: 32842
Joined: Tue Feb 27, 2007 7:09 pm
Location: Miami FL

"Are Index-Fund Investors Smarter?"

Post by Taylor Larimore »

Bogleheads:

Today's Wall Street Journal has an article by Jonathan Clements titled "Are Index Fund Investors Smarter? The answer seems to be "yes." These are excerpts:
"Index funds don't just outperform most actively managed mutual funds. They also make more money for investors."

"It seems investors behave more sensibly when they bypass actively managed funds, which seek to beat the market, and instead purchase index funds."

"I asked Chicago Investment research firm Morningstar to analyze index funds and actively managed funds in 10 major stock-fund categories. -- For six of the 10 categories the 10-year dollar weighted returns for index funds were better than the average total return for those funds. What about active funds? There wasn't a single instance."

"Why have index-fund investors behaved more sensibly? -- I suspect it is less about greater intelligence and more about greater conviction. When you buy an index fund, your only worry is the market's performance. But when you buy an active fund, you have to worry about both the market's direction and your fund's performance relative to the market."
My link did not work more than once. Try Goggling the title to read the entire article.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
User avatar
Bustoff
Posts: 2033
Joined: Sat Mar 03, 2012 5:45 pm

Re: "Are Index-Fund Investors Smarter?"

Post by Bustoff »

Thanks for the article Taylor.
I've noticed an odd disconnect among some of my non-Boglehead friends. Even though they have used index funds within their defined contribution plans, many continue to rely on expensive brokers to manage their investments.
ShiftF5
Posts: 751
Joined: Wed Jan 11, 2012 7:59 pm

Re: "Are Index-Fund Investors Smarter?"

Post by ShiftF5 »

I'm the first to admit there are many people smarter than me, including many on this board, but I'm smart enough to follow an intelligent plan and be willing to always learn something new.

Thank you Bogleheads!
rayson
Posts: 210
Joined: Mon Dec 23, 2013 1:46 pm

Re: "Are Index-Fund Investors Smarter?"

Post by rayson »

Thanks for sharing this article, Taylor! Index-investing is boring, mundane, and automatic. But, it sure does work over long periods..
User avatar
noyopacific
Posts: 359
Joined: Wed Jan 28, 2009 5:06 pm
Location: Mendocino

Re: "Are Index-Fund Investors Smarter?"

Post by noyopacific »

Googling the words: "Are Index Fund Investors Smarter" did lead me to the excellent article.

I was pleased to note the authors comment: "I suspect it is less about greater intelligence and more about greater conviction."

I agree! It has long been my belief that being "smart" is seldom enough to succeed in most endeavors. Having superior intellectual ability (which I'd define as memory and analytical skills) is useful but often characteristics like temperament, judgement, organizational habits, dedication and hard work will take someone further than one who may have exceptional "smarts," but is lacking in other qualities.
The information contained herein, while not guaranteed by us, has been obtained from from sources which have not in the past proved particularly reliable.
User avatar
Watty
Posts: 28859
Joined: Wed Oct 10, 2007 3:55 pm

Re: "Are Index-Fund Investors Smarter?"

Post by Watty »

It a lot of ways personal investing is one of the things where "Knowing what you don't know." and acknowledging it is as important as the things you can actually know.
User avatar
mickeyd
Posts: 4898
Joined: Fri Feb 23, 2007 2:19 pm
Location: Deep in the Heart of South Texas

Re: "Are Index-Fund Investors Smarter?"

Post by mickeyd »

When you buy an index fund, your only worry is the market's performance.
Oh no! I don't worry about anything. Should I be worrying about market performance?
Part-Owner of Texas | | “The CMH-the Cost Matters Hypothesis -is all that is needed to explain why indexing must and will work… Yes, it is that simple.” John C. Bogle
Swampy
Posts: 804
Joined: Fri Aug 31, 2012 7:16 am
Location: Paradise

Re: "Are Index-Fund Investors Smarter?"

Post by Swampy »

I think Index Fund investors are more frugal than the average investor.

For a long time, I considered myself an above average investor, complete with a high wrap fee to show for it (ego had a lot to do with it).

I finally figured out that by thinking I was above average I was getting below average returns by letting others have too big a piece of my pie.

For me, that was the end for high priced soothsayers and actively managed funds.

I'm quite content being 'average.'

Truth be told, I seek out less than average returns based on my conservative asset allocation.

I'm able to comfortably get 3 months worth of living expenses each and every year just by cutting out the high priced phonies. (That was the high price I paid annually for so-called above average advice.)
If I have seen further, it was by standing on the shoulders of giants.
pkcrafter
Posts: 15461
Joined: Sun Mar 04, 2007 11:19 am
Location: CA
Contact:

Re: "Are Index-Fund Investors Smarter?"

Post by pkcrafter »

Smarter? Perhaps wiser. :idea:

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
ShiftF5
Posts: 751
Joined: Wed Jan 11, 2012 7:59 pm

Re: "Are Index-Fund Investors Smarter?"

Post by ShiftF5 »

Watty wrote:It a lot of ways personal investing is one of the things where "Knowing what you don't know." and acknowledging it is as important as the things you can actually know.
+1.
Fallible
Posts: 8798
Joined: Fri Nov 27, 2009 3:44 pm

Re: "Are Index-Fund Investors Smarter?"

Post by Fallible »

pkcrafter wrote:Smarter? Perhaps wiser. :idea:
Paul
Wiser, in the sense of good judgement, is a better word than smarter and maybe even than conviction (which I didn't really understand). Then again, maybe it's all three. If indexers know their only worry is market performance and that they can save money and have a better chance of staying the course, that's smart and wise and they have the conviction of their beliefs (which I guess is what Clements meant). It's certainly smarter and wiser than worrying about market direction, fund performance relative to the market, and higher costs, all adding up to greater chance of bailing in a bad market.

Then again, just saying index-fund investors "behave more sensibly" is affirmation of Jack Bogle's "common sense" investing, so 'sensible' would be good enough for me.

Thanks for another good article Taylor.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
Confuscious
Posts: 99
Joined: Tue Jan 21, 2014 10:35 pm

Re: "Are Index-Fund Investors Smarter?"

Post by Confuscious »

Just some thoughts. None of the following are facts:

We may have selective bias. Indexing seems relatively new.

I imagine that very few people used index funds in the 70s and 80s. They were uncommon. I imagine investing in the stock market was less common then as it is today and people took what they could get. High fees were the norm. Sure, if someone had the foresight to choose an index in the 70s that person would be considered "smart".
sawhorse
Posts: 3745
Joined: Sun Mar 01, 2015 6:05 pm

Re: "Are Index-Fund Investors Smarter?"

Post by sawhorse »

It bugs me that they use the word "smarter". There are many types of intelligence, intelligence is not equal to wisdom, and neither are equal to informed.

Index fund investors may be more informed about historical fund performance. That doesn't mean they are smarter overall.
691175002
Posts: 352
Joined: Tue Mar 17, 2015 7:22 pm

Re: "Are Index-Fund Investors Smarter?"

Post by 691175002 »

These studies come up occasionally, and are structured to be intentionally deceptive.

When you are dealing with an investment class that has constantly growing assets (such as index funds), the dollar weighted return will always be higher after a bull market and lower after a bear market. You are just weighing the most recent time periods more heavily.

For more information on the math used in these articles see the following posts which discuss the same issue:
http://awealthofcommonsense.com/the-mos ... -industry/
http://www.wikinvest.com/wiki/Time-weighted_return
User avatar
PaFromFL
Posts: 47
Joined: Sat Dec 13, 2014 9:20 am

Re: "Are Index-Fund Investors Smarter?"

Post by PaFromFL »

Balanced index funds become attractive after you have been burned by a broker or take some time to figure out how he makes so much money. After you decide not to let a broker control your life savings, balanced index funds work well for those of us who don't want to spend a lot of time following the markets, or who have learned that they are competing with other traders who have access to inside information or have the ability to manipulate markets. A degree from the school of hard knocks doesn't mean you're smarter, but it does indicate you are able to learn from mistakes and recognize the game for what it is.
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: "Are Index-Fund Investors Smarter?"

Post by Leeraar »

691175002 wrote:These studies come up occasionally, and are structured to be intentionally deceptive.

When you are dealing with an investment class that has constantly growing assets (such as index funds), the dollar weighted return will always be higher after a bull market and lower after a bear market. You are just weighing the most recent time periods more heavily.

For more information on the math used in these articles see the following posts which discuss the same issue:
http://awealthofcommonsense.com/the-mos ... -industry/
http://www.wikinvest.com/wiki/Time-weighted_return
Oh, my.

Dollar-weighted returns (whateve that is) are intentionally deceptive.

Struggling to turn my sarcasm-o-matic off.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
User avatar
Cernel
Posts: 306
Joined: Sun May 04, 2008 11:06 am

Re: "Are Index-Fund Investors Smarter?"

Post by Cernel »

ShiftF5 wrote:I'm the first to admit there are many people smarter than me, including many on this board, but I'm smart enough to follow an intelligent plan and be willing to always learn something new.

Thank you Bogleheads!
+1
Couldn't have said it better myself. The only thing I would add is that in addition to "many people smarter than me," there are many more experienced than I. Also, to add to "follow an intelligent plan" having the conviction to "stay the course" has proven to be a valuable lesson for me.
chessmannextmove
Posts: 278
Joined: Mon Feb 23, 2015 12:57 pm

Re: "Are Index-Fund Investors Smarter?"

Post by chessmannextmove »

Probably not smarter. But good luck coming up with a rigorous definition of smarts.
fortyofforty
Posts: 2083
Joined: Wed Mar 31, 2010 12:33 pm

Re: "Are Index-Fund Investors Smarter?"

Post by fortyofforty »

Confuscious wrote:Just some thoughts. None of the following are facts:

We may have selective bias. Indexing seems relatively new.

I imagine that very few people used index funds in the 70s and 80s. They were uncommon. I imagine investing in the stock market was less common then as it is today and people took what they could get. High fees were the norm. Sure, if someone had the foresight to choose an index in the 70s that person would be considered "smart".
You're correct. Believe it or not, even front end loads were "normal" back then, as were high 12b-1 fees and back-end loads. No-load funds seemed to be new on the scene, and often denigrated by the established fund companies. Then we had 1987 to live through, and those who had avoided stocks during the 1980s thought they'd had the last laugh.

Now, it we delve a bit into the definition of intelligence, we can get into trouble. Some people think others are smarter than they are, and are willing to pay them high fees to manage an active fund for them, or to manage their entire portfolio of active funds for them. In fact, I think that is part of the marketing ploy used by these actively-managed fund companies, and it's what you see every day on CNBC. "Trust us. Let us invest your money. We know what to do. We are smarter than you." It's financially dangerous to believe that, of course. Realizing the limitations of your financial knowledge can reasonably lead you to one of two paths, and indexing is the "smarter" path.
Gropes & Ray
Posts: 1094
Joined: Wed Jul 16, 2014 7:28 am

Re: "Are Index-Fund Investors Smarter?"

Post by Gropes & Ray »

In my personal experience, smarter people tend to be worse investors because they are over confident. I don't think I'm particularly smart, but I know how to research and identify what works. Humility is probably the more important trait.
User avatar
backpacker
Posts: 1620
Joined: Mon Sep 22, 2014 2:17 pm

Re: "Are Index-Fund Investors Smarter?"

Post by backpacker »

Gropes & Ray wrote:In my personal experience, smarter people tend to be worse investors because they are over confident. I don't think I'm particularly smart, but I know how to research and identify what works. Humility is probably the more important trait.

I really like this interview with Warren Buffett and Charlie Munger. They make a similar point.

Munger: "We’ve learned how to outsmart people who are clearly smarter than we are."

Buffett: "Temperament is more important than IQ. You need reasonable intelligence, but you absolutely have to have the right temperament. Otherwise, something will snap you."
User avatar
bnwest
Posts: 168
Joined: Thu Mar 01, 2007 6:25 pm
Location: durham, north carolina

Re: "Are Index-Fund Investors Smarter?"

Post by bnwest »

Smarter and on average better looking ;)

I agree with
sawhorse wrote:There are many types of intelligence, intelligence is not equal to wisdom, and neither are equal to informed.
I considered myself mostly better informed.

The Financial Services industry prides itself with the great deluge of misinformation they produce. One may need a touch of intelligence to filter the small signal from the large noise.
User avatar
Maynard F. Speer
Posts: 2139
Joined: Wed Mar 18, 2015 10:31 am

Re: "Are Index-Fund Investors Smarter?"

Post by Maynard F. Speer »

Themperament sounds about right to me ..

When Research Affiliates ran this study showing straight index investors returned more (dollar-weighted), they compared it to value investors ..

Now it could be a personality trait, or a buy-and-hold mantra, but also risk factors (such as value and smaller cap) do take a sturdier temperament to hold on to ... Even now, holding a lot of value funds myself, I have to convince myself value still works sometimes .. I have to convince myself a lull in smaller companies isn't investors trying to reign in risk as a prelude to a bear market .. There's a lot of choice with active funds - which can make switching more tempting
"Economics is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." - John Maynard Keynes
User avatar
nedsaid
Posts: 19275
Joined: Fri Nov 23, 2012 11:33 am

Re: "Are Index-Fund Investors Smarter?"

Post by nedsaid »

I don't think that Index Fund investors are necessarily smarter, they just keep their egos in check.

Would you rather remotely open an account with Vanguard or would you rather be wooed by well-dressed financial advisors in a fancy office? Many people with means would choose the latter as it is really good for the ego to get all that personal attention. Vanguard would tell you to just invest in a few index funds where a financial advisor will give you a personalized plan with lots of impressive graphs and charts and a mix of investments picked specially for you.

Shoot, most of us are taken for granted at home. We don't feel really appreciated at home or at work. Maybe we aren't always treated with the respect we think we deserve. Go to a financial advisor with a huge wad of cash from a 401k rollover and you will get treated almost as well as the Queen of the U.K. That special attention is really hard to resist.

And yes, there is ego involved in the belief that each of us can beat the market. Somehow I am a little smarter than the average guy, have a little better emotional control, and am little better at planning. We are all from Lake Woebegone.
A fool and his money are good for business.
sschullo
Posts: 2840
Joined: Sun Apr 01, 2007 8:25 am
Location: Long Beach, CA
Contact:

Re: "Are Index-Fund Investors Smarter?"

Post by sschullo »

Agree with the wise comments. Reminds me of Psychologist and Philosopher, William James, who said: The art of being wise is knowing what to overlook
Never in the history of market day-traders’ has the obsession with so much massive, sophisticated, & powerful statistical machinery used by the brightest people on earth with such useless results.
691175002
Posts: 352
Joined: Tue Mar 17, 2015 7:22 pm

Re: "Are Index-Fund Investors Smarter?"

Post by 691175002 »

Leeraar wrote:Dollar-weighted returns (whateve that is) are intentionally deceptive.

Struggling to turn my sarcasm-o-matic off.

L.
They are intentionally deceptive when you pretend that the gap between dollar and time weighted returns can be attributed to "investors being smarter". As I said, it is an unavoidable consequence of AUM growth into a bull market following 08.

Assuming that the trend towards passive management continues, if the market rolls over then dollar returns will be lower than time weighted returns as the most recent periods will be negative. There is no reason why a bear market should make passive investors "dumber".
Image

Dollar weighted returns have nothing to do with investor intelligence (or market timing skill) unless you correct for the long term trend, and even then the relationship is questionable.
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: "Are Index-Fund Investors Smarter?"

Post by Leeraar »

691175002 wrote:
Leeraar wrote:Dollar-weighted returns (whateve that is) are intentionally deceptive.

Struggling to turn my sarcasm-o-matic off.

L.
They are intentionally deceptive when you pretend that the gap between dollar and time weighted returns can be attributed to "investors being smarter". As I said, it is an unavoidable consequence of AUM growth into a bull market following 08.
Why someone like Clements would get caught up in this is beyond me.

I have looked at how Morningstar calculates "Investor Return", and the more I ponder it the foggier it becomes. I don't know what it means.

I'm guilty of bad behavior myself - I can remember choosing funds based only on their Morningstar ratings. I believe that investors behave badly in terms of performance chasing and market timing. I just don't believe the metrics that are trotted out to support the assertion. Especially when they are used to "prove" a point.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
Fallible
Posts: 8798
Joined: Fri Nov 27, 2009 3:44 pm

Re: "Are Index-Fund Investors Smarter?"

Post by Fallible »

sawhorse wrote:It bugs me that they use the word "smarter". There are many types of intelligence, intelligence is not equal to wisdom, and neither are equal to informed.

Index fund investors may be more informed about historical fund performance. That doesn't mean they are smarter overall.
A good point about different kinds of intelligence. Two basic types are IQ and EQ, the latter being emotional intelligence. EQ is no doubt as important, and probably in many ways more important, than IQ, especially when it comes to investing since it includes self-control.

Another point about "smarter" is that it can mean many things. Also, the article mentions "conviction" as a key factor in addition to smarter and it refers to index-fund investors as behaving "more sensibly." The latter reminded me of Jack Bogle's "common sense" investing and common sense would be more a matter of emotional intelligence.

In the end, I think all the words apply although I kind of like common sense. If indexers know their only worry is market performance and that they can save money and have a better chance of staying the course, isn't it just common sense to index? After all, the active alternative is worrying about market direction, fund performance relative to the market, and higher costs, all leading to greater chance of bailing out in a market crash. Common sense tells me the choice is an easy one, but then I'm a Boglehead.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
User avatar
goingup
Posts: 4910
Joined: Tue Jan 26, 2010 12:02 pm

Re: "Are Index-Fund Investors Smarter?"

Post by goingup »

An article in the WSJ yesterday profiled Fidelity's Abigail Johnson's take on the inflow into index funds:

"Despite the numbers, Ms. Johnson believes investors’ push into passive funds is a temporary trend and will reverse when performance improves, according to executives who are familiar with her thinking. “She believes it’s cyclical,” said Brian Hogan, president of Fidelity’s equity division." The article is "Fidelity's New Chief Confronts Market Shift" WSJ 4-07-15. (Mods, if I erred about copyright attribution please instruct)

I wonder too, if new index converts will be surprised when the all-equity indexes fall further than actively managed funds that hold cash and bonds.
User avatar
Maynard F. Speer
Posts: 2139
Joined: Wed Mar 18, 2015 10:31 am

Re: "Are Index-Fund Investors Smarter?"

Post by Maynard F. Speer »

691175002 wrote:They are intentionally deceptive when you pretend that the gap between dollar and time weighted returns can be attributed to "investors being smarter". As I said, it is an unavoidable consequence of AUM growth into a bull market following 08.

Assuming that the trend towards passive management continues, if the market rolls over then dollar returns will be lower than time weighted returns as the most recent periods will be negative. There is no reason why a bear market should make passive investors "dumber".
Image

Dollar weighted returns have nothing to do with investor intelligence (or market timing skill) unless you correct for the long term trend, and even then the relationship is questionable.
I appreciate the effect you're talking about, but I don't think it's as big as you think ..

Vanguard's study into lump-sum investing vs drip-feeding showed a small difference in favour of lump-summing (which is - I believe - essentially the same effect: that money flowing in during a bull lags .. it does, but by a surprisingly small amount when you average it out .. and we've had fairly cyclic markets since the 90s)

Here's a look at institutional investor behaviour .. As you can see, the market timing abilities of large insurance firms couldn't be much worse - and I seriously doubt retail investors are any better

Image
"Economics is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." - John Maynard Keynes
Post Reply