Bogleheads

[wklose99]

So I started my investment path as a daytrader a few months out of college. Not knowing what to do with a sudden inflow of cash supplied by my new job, i turned to the market in March of 2009. Some here may or may not be familiar with FAS and FAZ, which are leveraged ETFs trading at 3x the return of the financial market, FAS being long on financials and FAZ being short. How I did day-trading these stocks is irrelevant. What is relevant, however, focused on the discussion boards on google finance concerning these stocks. A poster on the google finance forum for both FAS/FAZ had, using extensive backtesting of data, devised a seemingly foolproof plan to perfectly time the opening 10 minutes of trading. His plan was devised such that if one bought either fas/faz based on pre-market percentage swings you could guaranteed yourself to make a huge profit. Using his backtested data, he set out rules to follow to ensure market crushing profits. Checking his data, his plan did seem to work, as long as the market kept behaving as it had the last 6 months. If it had behaved that way the last 6 months, why would it suddenly alter its behavior just becuase he had discovered this method?

Well, lo and behold, after garnering many followers on the board and convincing many people to test the method using as much margin as possible(its foolproof after all, right?), the market suddenly changed characteristics and I watched as people were wiped out. As it turns out, the plan relied heavily on the extremely volatile conditions of fall-winter-spring of 08/09 market. Once this method was discovered, the markets were already settling down and the method no longer worked.

After getting away from daytrading I google better investment strategies and learned about indexing.

Within indexing there are the two camps, S&D and TM(total market). I struggled for a while trying to decide which path to follow, but after taking a few steps back and looking at the big picture I deduced that the S&D method sounded an awful lot like the FAS/FAZ fiasco that unfolded earlier this year.

Now, I understand many people are going to scream and holler at me saying the French/Fama method tilting towards small cap/value stocks is based on 80 years of backtesting and isn't promising market crushing results. However, the truth of the matter is it IS based on backtesting, and it IS promising market-beating results, just to a much less severe degree than the FAS/FAZ method.

The fact that I read about such occurrences as "guaranteed 10000% return" methods in the Four Pillars and Boglehead's Guide after I had experienced such a debacle firsthand was nothing short of comical. The lesson was firmly cemented in my mind and that's why when I first learned of tilting towards small caps, it threw off many alarms.

It seems obvious that the tendency of small caps to outperform the market is simply a 'pattern' that has been discovered by extensive backtesting.

I'm not saying that people who S&D toward small caps are going to get wiped out, I just agree with Mr. Bogle who says that the probability they'll beat the market in the coming decades is slim, as the ugly RTM monster is out to get them. I also agree with Mr. Bogle in that the only thing you can count on is the market is going to go up, you just don't know what parts, so its best to own the whole market in its weighed proportions.

My point is, Boglehead's believe in NOT looking for sectors in the market that will outperform, and NOT relying on past data to predict the future. It seems all to clear to me that the S&D method blatantly violates BOTH of these principles and is kind of like a "diet" version of market speculation, i.e. a gamble. I am evening go so far as to say the S&D method attempts to highlight an inherent 'pattern' in the stock market. Yet I don't understand why so many Boglehead's follow it, maybe simply because it deals with indexing so they feel like its 'legal' in the Boglehead world?

[MrMatt2532]

No one is saying Small Value is a free lunch. There is more risk associated with it. Conversely, Large Growth has less risk.

[DaveS]

So if you don't want to slant a bit toward small and value and have a bit of international, and REIT then put all your money in Total Stock Market. As long as you don't trade in and out you will do fine. However over the 30 + years from now to your retirement, The S and D people are - based on all long term statistics, going to do 30 to 60% better than you. But thats only 1 to 2 % a year, not counting compounding. They will have a bit more volatility. But it's your money. Maybe you wont lose as much sleep during the volatile periods.

With any luck TrevorH will have the graphs ready for you to see. Dave

[stlutz]

I'm far from an authority here, but there are really 3 different approaches to slice and dice as I see it:

1) The market is 100% efficient. Any evidence that slice and dice has worked in the past (e.g. the last 100 years) in an anomaly and will not be repeated. If you don't replicate the weighting dictated by the market, you are doing it wrong and should be banished.

2) Slice and dice is a way to increase portfolio risk, and hopefully, portfolio return. The goal is to add assets like Emerging Markets, Microcap stocks, Canadian midcap value REITs etc. to try and juice things up in a more cost-effective way than 3x ETFs.

3) Slice and dice is a way to reduce portfolio risk. Different assets have differing correlations over time, and those correlations are likely to be repeated in the future. We can use a bunch of Excel functions to calculate the "efficient frontier" that will give you maximum return for minimum risk.

Okay, so I've been a little disingenuous with all of these, but the point is that all 3 approaches have evidence to support them and obvious problems.

[heyyou]

Fama and French's theory has held up for far longer than the daytrading scheme. It is based on as long a set of data as is available, from as many countries's markets as is available.

EXPECTED returns are related to risk. Small and SV are more risky, not a sure bet, so the higher reward may or may not arrive.

My opinion is that tilting toward higher risk equities is not much different than tilting towards more TSM than bonds. It is all about risk exposure. Swedroe's personal portfolio ratio has double the bonds to his high risk equity allocation, but that has the advantage of limiting his down side. Similar return as a 60/40 but with less total risk.

[baw703916]

There's a pretty fundamental distinction between day trading leveraged ETFs and buying SV funds. In the former you are not investing in anything--the ETFs don't even own any actual stocks, rather the tracking is created artificially with derivatives. But if you own SV funds, you are investing in small companies that the market isn't fond of (it has decided that they deserve a lower price per unit of book value than other companies). We can argue about the implications of why the market has assigned them a lower price: more risk, the perception of more risk, the market is throwing money at some bubble and find these stocks boring, etc. But you are buying indirect ownership of a large number of actual businesses.

Brad
_________________
I don't foresee any Black Swans appearing in the future

[SP-diceman]

Interesting perspective. One who day traded leveraged ETF's trying to spot "flaws" in thinking.

Do you think when McDonalds opened it was on every street corner?
Do you think when Microsoft opened everyone had windows?

The pattern you've spotted is called the "real world".
There are reasons why things happen.

Just because you cant connect the dots doesn't mean there's some hidden lie.



Thanks
SP-diceman

[spam]

From a psychological perspective, it is interesting to note that you are still trading in volitility. This time it is in emotional volitility. If you compare a strategy of trading faz / fas to rebalancing S/D with holding cap weight via tsm then you are again trading in opposing views.

Rebalancing a diversified portfolio to maintain a written allocation strategy each year is different than day trading 3x leveraged etfs. The flaw in your argument is that the analysis is based on the false claim of equivalence.

It would be more reasonable to compare day trading fas / faz to a strategy of day trading trading currency. Both are bad strategys imo. The typical slicer rebalances about once a year. How effective can you be as a day trader when you are limited to one trade per year?

[neverknow]

[wklose99]

Like I said, people were going to scream and holler at me because I'm comparing daytrading leveraged ETFs to 'longterm' indexing. I am asking you all to look past that and recognize the underlying methods here are the same: people are basing their investing on backtested data which 'proves' a pattern that outpaces the market. The essence of Bogle-osophy is that we believe in 100% market efficiency, and therefore there is no repeating pattern that outpaces the market.

Tilting indexing is just a less severe way of saying "Stock X outpaced the market by Y% the last 10 years, so its going to continue to outpace the market by Y% in the future". S&D'ers are saying the same thing, just with an entire market sector.

Yes, I understand it involves increasing risk to increase gain. But Bogle's whole mentality is avoid 'greeding' after increased gain at the cost of increased risk because the efficient market average is there for the taking. The odds are stacked against you to beat it, so don't attempt it.

As Bogle says "When you pick sectors, you might be right or you might be wrong. Emotions take over. People tend to get into a sector after the good returns have already happened. It's the rowboat syndrome—investors look backwards, buying after the sector has done well and selling after the sector has done poorly. "

[wklose99]

[ddb]

[Indexer88]

Welcome, wklose, and check out my TSM Philosophy thread for similar observations.

You've hit the nail on the head with the inherent condraction. I've always said SCV or Value is a sector play and that sector plays can become riskier. And that risk is not simple volatility.

The F/F model suggests that the size and value risk should be rewarded even in an efficient market. I argue that investors in equities will bid up SCV so that much of the premium will not be a permanent market feature. SCV is only 4.5% of the market. Slice and Dicer's don't want to hear they could underperform TSM for long periods. But see when you are on the path to 30-300% greater returns, things like risks, taxes, costs don't matter.

[dbr]

[ddb]

[Indexer88]

That it is a good question. However, I assume that there will be long periods were bonds will do better than stocks. Since 1980, people aren't used to that idea. I don't think the equity premium is a permanent market feature in the sense that one simple buys equities at any valuation and sits back to enjoy the premium over bonds.

And again, I believe that there may be a SV and Value premium. But with SCV there are also tax costs that aren't fully figured in. This is b/c SCV funds must sell stocks that have appreciated. Thus, even thought SCV and TSM are both equity assets, they have different cost and tax implications.

I actually think history has shown a SCV premium, but I also think the total markets adapt and react.

[hafis50]

[SP-diceman]

[Roy]

[richard]

[zhiwiller]

[richard]

[ddb]

[tetractys]

[richard]

[richard]

Here's an excerpt from an interview with Fama (emphasis added):

Q: The other dimension, of course, is size. Now the size effect is very easy for those of us in the investment community to accept. The notion that small companies are riskier than large companies seems obvious.

A: That's not the reason the community accepts it. What they think is that small companies pay higher returns because they're unknown, or something like that. It's not because they're more risky. The risk, in my terms, can't be explained by the market. It means that, because they move together, there is something about these small stocks that creates an undiversifiable risk. That undiversifiable risk is why you get paid for holding them.

Q: What causes that risk?

A: You know, that's an embarrassing question because I don't know.

Q: Fascinating. I would assume that the risk is that small companies have a lower survival rate than large companies.

A: No. That's not it at all. The good news and the bad news about that is that the reason small companies don't survive is because some of them fail, others get merged; that's bad news and good news. Here's a fact I always use. First I say I don't know, but then I say it's fair. Here's my example. The 1980s were, supposedly, the longest period of continuous growth the country's seen since the second world war. Yet, in that decade, small stocks were in a depression. Small stock earnings never recovered from the '80-'81 recession. They were low the whole decade. The market was fooled every year by that, because in every previous recession, the small companies came back. Why did that happen in the '80s? I don't know. But it happened. And it tells you there is something about small stocks that makes them more risky.

[Chuck]

[richard]

[spam]

richard wrote:

[unclemick]

Hmmm - 1966 fresh out of college, individual stocks and active mutual funds, full service broker - some penthouse living, new sportscar - and then 73/74 - Vanguard active funds(multi asset or slice and dice in other words) - 77 S&P 500 Index availible in 401k - varied between 60/40 and Ben Graham's 50/50 Defensive Investor - 95 drifted toward Lifestrategy mod with some income lifters including High Yield Corp, REIT Index, Sm Cap Value Index and Norwegian widow stocks - 2006 Target Retirement plus a few good stocks.

I ah er managed to make every investment mistake(except perhaps commoditiy futures) mentioned by scholars as common investor mistakes along the way. Fairly expensive education.

Meanwhile back at the ranch - 401k first Index 500 became the big dog on the porch that carried me to the bulk(?maybe 80-90%) of my retirement).

heh heh heh - Nowadays I try to fake wisdom and tell my young relatives to buy Target Retirement early and often, have faith, and don't waste time with Financial Advisors, reading books or watching the market - unless it happens to be your day job.

[richard]

deleted

[Fbone]

Deleted.

[Taylor Larimore]

Hi Fbone:

[tetractys]

[Roy]

[diasurfer]

[Fbone]

I failed to properly put my thoughts in writing ... again.

Thanks, Mr Larimore for your comments.

Deleted to avoid confusion.

[Doug1]

My $0.02 on this subject, which may be worth much less than $0.02.

People are now aware of the SCV premium. Also, it's relatively easy to take advantage of the SCV premium. That doesn't bode well for a future based on back tested assumptions of the SCV premium.

In taxable accounts, the increased taxation associated with SCV may negate the premium. That leaves tax advantaged accounts. My guess, with the emphasis on guess, is that the SCV premium will continue to exist, but it will decrease in size. IMO, there will be some unmet expectations among the slice and dice crowd in the future.

[Taylor Larimore]

Fbone:

[hafis50]

[spam]

Hafis50 wrote

[hafis50]

[wklose99]

[Indexer88]

Fama said in a interview: "Yet, in that decade [80;s], small stocks were in a depression. Small stock earnings never recovered from the '80-'81 recession. They were low the whole decade. The market was fooled every year by that, because in every previous recession, the small companies came back. Why did that happen in the '80s? I don't know. But it happened. And it tells you there is something about small stocks that makes them more risky."

Absolutely fascinating!

And yet after a decade of outperformance of SC, people are pouring their money in.... This is a time when reversion might very well matter.

This is fascinating that he/ they have no underlying reason to identify risk, but the market somehow does. "Earnings never recovered," but why not? Maybe competition in the world markets.

Radically overweighting your equities on a theory that does not have a explanation for risk does not sound like a great idea.

[richard]

[richard]

[richard]

[richard]

[wklose99]

I'm curious Richard and DDB, Could you do a quick breakdown of yall's portfolios and what you hold? It would be much appreciated!

[baw703916]

I believe there is a rebalancing bonus. I'm reposting something I wrote on another thread yesterday: