Evidence of Active Investing trailing Passive for Individuals

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Enganerd
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Evidence of Active Investing trailing Passive for Individuals

Post by Enganerd »

TLDR: I have been repeating for years that: over investing lifetime passive investing is ~80% more likely to outperform active. I have recently been challenged on this position and now all references I see are for funds not individuals and admittedly funds have restraints that individuals do not. Do any bogleheads have good sources of the track records of individual investors that can be generalized?

If anyone is curious why I am currently questioning this position below is the context.

I, a mid-westnern boglehead, have recently been debating with friends in SV who work in tech. They see the reason bogleheads have touted passive in the past but believe the exponential curve of tech, having a better understanding of this market through experience and youth (grew up in a digital world versus boglehead or more traditional investors with a higher average age) they are confident most still do not appreciate the concept that software is eating the world. https://a16z.com/2011/08/20/why-softwar ... the-world/

Because most capital still belongs to older generations this tech market is undervalued. They have, and claim most associates, have out performed market returns by betting on multiple tech companies that they know have potential. Similar to tech angel investors, it is ok to miss a few because the wins will be massive, again due to the tech profit potential (low overhead and huge potential customer base). The philosophy of "I know nothing, so accept market returns minus least fees and taxes" does not fly with them, again they and their associates "all" beat the market because just acknowledging the tech potential has is a competitive advantage. When I mention evidence shows that over a lifetime something like 80% of active investors lag a passive investor they pushed back. The math is clear: active positions result in market return. So every year 50% lag average/market return factor in higher fees/taxes for active and you end up with <50% receiving real returns relative to the passive investor. Compound that over 20 or 30 years of investing and the odds that active investing is paying off for you drops. I am familiar with this concept and have repeated it for years. However, I always thought I had seen great evidence for it.

Now that I have been challenged I admit all the research I see of ~80% active trailing index is for funds not individual investors. Funds have restraints individuals do not. For one success leads to growth and growth can reduce the ability to taking large positions in smaller stocks.

This argument and the market reaction to the pandemic and fiscal response has me wondering if there is risk of group think staying the course could be bug not a feature. Thanks for your thoughts!
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steve roy
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by steve roy »

Pretty simple actually. Higher risk equals higher potential reward. Individual stocks might pay off bigly or erase your investment. There's nothing wrong with roping off some of your AA for single stocks, but understand the risks and your risk tolerances.
Enganerd wrote: Sun Aug 16, 2020 4:12 pm TLDR: I have been repeating for years that: over investing lifetime passive investing is ~80% more likely to outperform active. I have recently been challenged on this position and now all references I see are for funds not individuals and admittedly funds have restraints that individuals do not. Do any bogleheads have good sources of the track records of individual investors that can be generalized?

If anyone is curious why I am currently questioning this position below is the context.

I, a mid-westnern boglehead, have recently been debating with friends in SV who work in tech. They see the reason bogleheads have touted passive in the past but believe the exponential curve of tech, having a better understanding of this market through experience and youth (grew up in a digital world versus boglehead or more traditional investors with a higher average age) they are confident most still do not appreciate the concept that software is eating the world. https://a16z.com/2011/08/20/why-softwar ... the-world/

Because most capital still belongs to older generations this tech market is undervalued. They have, and claim most associates, have out performed market returns by betting on multiple tech companies that they know have potential. Similar to tech angel investors, it is ok to miss a few because the wins will be massive, again due to the tech profit potential (low overhead and huge potential customer base). The philosophy of "I know nothing, so accept market returns minus least fees and taxes" does not fly with them, again they and their associates "all" beat the market because just acknowledging the tech potential has is a competitive advantage. When I mention evidence shows that over a lifetime something like 80% of active investors lag a passive investor they pushed back. The math is clear: active positions result in market return. So every year 50% lag average/market return factor in higher fees/taxes for active and you end up with <50% receiving real returns relative to the passive investor. Compound that over 20 or 30 years of investing and the odds that active investing is paying off for you drops. I am familiar with this concept and have repeated it for years. However, I always thought I had seen great evidence for it.

Now that I have been challenged I admit all the research I see of ~80% active trailing index is for funds not individual investors. Funds have restraints individuals do not. For one success leads to growth and growth can reduce the ability to taking large positions in smaller stocks.

This argument and the market reaction to the pandemic and fiscal response has me wondering if there is risk of group think staying the course could be bug not a feature. Thanks for your thoughts!
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Broken Man 1999 »

Why not carve out maybe 5% and try your hand? Then, come back when you think you have your answer.

I have individual stocks, but I hold them a few years before I sell. Patience would be helpful in this endeavor.

Good luck!

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chassis
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by chassis »

A historical reason passive investing was believed to outperform active investing, for the retail investor, is trading fees.

Trading fees have dropped dramatically in the past couple of years. So it may be time to revisit the decades- (generations-?) long notion that trading fees and transaction costs are the reason active investing should be avoided.

Full disclosure, I am a relatively active investor for my own portfolio.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Rick Ferri »

The last time I read a thread like was at the peak of the tech bubble in 1999 when barbers were giving out free investment advice with each haircut.

I have a very sad story about a barber I visited in my home down who was doing just that. He had some financial show on television in the barbershop, and all the brokers in town would get their hair cut there. He ended up day-trading himself into bankruptcy trying to win back his retirement savings during the tech crash, his wife then divorced him for it, and the guy ended his life by running his car into a tree.

I think of that guy every time someone says this time is different.

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000
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

I think Vanguard and Fidelity have published some studies about the performance of individual investors in their plans over different time periods. Maybe some of that data is what you are looking for?

Ultimately, an individual can absolutely match or beat the index fund if (1) they have high discipline and (2) either value the time spent trading at zero or have an edge.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Rick Ferri »

000 wrote: Sun Aug 16, 2020 8:58 pm Ultimately, an individual can absolutely match or beat the index fund if (1) they have high discipline and (2) either value the time spent trading at zero or have an edge.
It is possible, but not probable.

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000
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

Rick Ferri wrote: Sun Aug 16, 2020 9:05 pm
000 wrote: Sun Aug 16, 2020 8:58 pm Ultimately, an individual can absolutely match or beat the index fund if (1) they have high discipline and (2) either value the time spent trading at zero or have an edge.
It is possible, but not probable.

Rick Ferri
What may be improbable for the average person may be probable for the "above average" person. To beat the index, one only needs to be slightly above average, i.e. do a little better than the costs of implementation. If one values one's trading time at zero (this is actually probably a reasonable assumption for many), uses a zero or low commission broker, and can control the spread resulting from PFOF, beating the index is not hard.

A disciplined individual has some advantages over an actively managed mutual fund or institutional investment, so comparisons with those may not be relevant (as OP noted):
  • Ability to operate effectively in microcap space.
  • Ability to tolerate long stretches of underperformance without having the rug pulled out by investors fleeing the fund or managers changing course.
  • No disclosure requirements, so other market participants have less knowledge of the strategy being pursued.
I will say that I would much rather pursue my own active strategy than pay 0.5%+ for an actively managed mutual fund to do it for me.
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David Jay
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by David Jay »

Enganerd wrote: Sun Aug 16, 2020 4:12 pmNow that I have been challenged I admit all the research I see of ~80% active trailing index is for funds not individual investors.
There is the Fidelity’s dormant account study. They looked at actively traded accounts versus dormant accounts. Dormant accounts outperformed active accounts by a wide margin.

Thread here, with link to the “Business Insider” article: viewtopic.php?t=146347
Last edited by David Jay on Sun Aug 16, 2020 10:21 pm, edited 1 time in total.
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David Jay
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by David Jay »

000 wrote: Sun Aug 16, 2020 9:22 pm
Rick Ferri wrote: Sun Aug 16, 2020 9:05 pm
000 wrote: Sun Aug 16, 2020 8:58 pm Ultimately, an individual can absolutely match or beat the index fund if (1) they have high discipline and (2) either value the time spent trading at zero or have an edge.
It is possible, but not probable.

Rick Ferri
What may be improbable for the average person may be probable for the "above average" person.
Yeah, don’t listen to Rick. He has no idea how talented you are. He has probably never been associated with someone with your market acumen.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
bryanm
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by bryanm »

This is just another “I’m smarter than the market” thread, with shaky premises. For one, it assumes a young investor, meaning it’s a de facto “this time it’s different” argument with no ability to verify. For another, it picks a massively dominant industry. Of course if you assume the argument is limited to the last X years when tech had dominated, and that people invest in that massively dominant industry, it’s going to look like you’re pretty smart.

But the idea that you’re smarter than the market seems silly to me. You think active funds are all old fogies? Their chock full of young quants. You think disclosure docs give up strategies? The funds move too fast for disclosures to tell you anything. You can’t even track their buys if you sell to them. They buy “order flow” from large brokers, take the other side of trades they want, and pass the rest on, meaning you can’t tell when they take a position.

These are companies that are literally competing for shorter fiber optic lines to the trading floor so that they can transact microseconds quicker.

If after all that you still think you have an edge, consider applying for a job at a hedge fund. Two and twenty pays real well. I have friends with the yachts to prove it.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

David Jay wrote: Sun Aug 16, 2020 10:01 pm
000 wrote: Sun Aug 16, 2020 9:22 pm
Rick Ferri wrote: Sun Aug 16, 2020 9:05 pm
000 wrote: Sun Aug 16, 2020 8:58 pm Ultimately, an individual can absolutely match or beat the index fund if (1) they have high discipline and (2) either value the time spent trading at zero or have an edge.
It is possible, but not probable.

Rick Ferri
What may be improbable for the average person may be probable for the "above average" person.
Yeah, don’t listen to Rick. He has no idea how talented you are. He has probably never been associated with someone with your market acumen.
:mrgreen: :mrgreen: :mrgreen:

I was not referring to myself, but to the OP's peers, who presumably view themselves as (and may be) "above average", so the arguments about the average may not be persuasive to them.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by shess »

Enganerd wrote: Sun Aug 16, 2020 4:12 pm Because most capital still belongs to older generations this tech market is undervalued. They have, and claim most associates, have out performed market returns by betting on multiple tech companies that they know have potential.
I am a software engineer who pretty much clambered onto the Internet in 1988 and rode it into early retirement. Over the years, I have come to the conclusion that the VAST majority of the gains to be made in tech are by being a strong employee working in tech companies, and making sure that you are working with strong co-workers. By doing that and not letting yourself ride a sinking company to the poorhouse, you should eventually hit a decent payout or two and do well (hmm, by this I mean "don't make huge swing-for-the-fences plays, but do avoid errors").

I think the core fallacy here is to assume that because "tech is going to take over everything", that means that "tech companies are going to make a lot of money". One does not follow from the other. For instance, Uber has clearly changed the future of how ordering up a ride works - but Uber itself hemorrhages money and may not survive. There are a ton of food-delivery things happening out there, but they are all bleeding money. Bike-share and scooter programs are all bleeding money.

Even success stories like Apple are a study in how long you can hold out for a payout. NeXT provided most of what Apple is today, but if you had bet big on NeXT in the early 90's, you'd have likely been wiped out well before the mid 00's when things started to rocket. But if you were an *employee* who came along to Apple, you are probably now a multi-millionaire.

At this point, I've seen enough failures in tech, both of companies and of industries, that the only way I'd be willing to earn more off of it would be to park my money safely and get back into creating something new. Ain't no way I'm going to bet on these companies in the market.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by MotoTrojan »

The big money has been made in tech already. Don’t become a bag holder.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by livesoft »

Index funds will hold all the tech winners anyways. Index funds won't hold the bankrupt tech losers. This is by definition.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by LFS1234 »

Enganerd wrote: Sun Aug 16, 2020 4:12 pm I have been repeating for years that: over investing lifetime passive investing is ~80% more likely to outperform active.
This sounds credible, at least as it pertains to stocks. It wouldn't be surprising if the percentage is even higher than that.

The "over an investing lifetime" part is extremely important. The biggest problem is that people tend to buy high (after stocks already have gone up) and to sell low (after they have gone down). By buying gradually over that whole investing lifetime and never selling, the results are much better.

Buying and never selling also means there aren't any capital gains taxes incurred while you "switch horses".

There is a famous study regarding the real return of average index fund investors being only 3.6% even though the real return of the fund itself was 6.2%, and it would seem reasonable to believe that the average investor in individual stocks will make the same market timing and tax mistakes as a the average investor in mutual funds.
Do any bogleheads have good sources of the track records of individual investors that can be generalized?
Not sure what you mean by "track records individual investors that can be generalized". Obviously, there are a lot of individuals who do much better than the market. The very most financially successful of these are published in the Forbes 400.
I, a mid-westnern boglehead, have recently been debating with friends in SV who work in tech. They see the reason bogleheads have touted passive in the past but believe the exponential curve of tech, having a better understanding of this market through experience and youth (grew up in a digital world versus boglehead or more traditional investors with a higher average age) they are confident most still do not appreciate the concept that software is eating the world.
There is a kernel of validity to this argument. However, there are also counter-arguments. Inexperienced investors (regardless of age) are less likely to be able to see the forest for the trees. If you were working for Osborne Computer Corporation (look it up) back in 1980, you were probably just as enthusiastic about your company as your peers at the Kaypro, and you may not have even been thinking about Apple down the road. But neither you (nor, most likely, anybody else) was able to foresee the twists and turns in the road.

I just very quickly googled Apple's stock prices from way back when, and apparently it was trading at (split-adjusted) around 50 cents in 1980, around $1 in 1987, around $2 in 1991 and around $4 in 2000. Then, back to $1 in 2003. So it doubled in 23 years, before going up 460-fold between 2003 and 2020. I would suggest the following:
- any enthusiastic Apple employees who maxed out their credit cards in 1980 in order to buy Apple stock, were bitterly disappointed.
- anyone who bought Apple in 1980 and then just sat on it until today, got rich. (Any such persons are in the older generations now, btw).

To do well in active investing you have to, among other things, figure out where the profits will end up. Many innovative companies never have any profits to speak of. A successful technology often does not translate into profits.

As someone mentioned upthread, this era is starting to seem quite a bit like 1999. Lots of money is being showered on lots of companies that are unlikely to attain the profitability required to sustain their valuations by historic metrics. Beating the market in 1998 or 1999 was not difficult at all, especially in technology stocks. 2000 and 2001 were very different stories.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by shess »

And something I can't find on the Internet, so will report as anecdotal: I'm pretty sure I read somewhere that the "robber baron" railroad tycoons mostly got that way by coming in and hovering up the small fry and consolidating and applying their resulting market power. Apparently there were a ton of "startup" railways, but they couldn't sustain their costs competitively until someone built a bigger system that could extract higher rents. I believe something similar happened with automobiles and airplanes, where there were tons of small startup companies that went under as the markets matured.

I mean, I think it's different this time - I'm not clear that Apple or Google or Facebook will be dethroned directly. But there are plenty of companies who had the basic idea those companies had, but who's names we hardly remember, because they were too early, or took the wrong direction, whatever.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Stef »

90% of all actively managed funds underperform the index after 15 years. This number gets closer to 100% the more time passes. Why should it be so different with individual investors? Shouldn't all these professional fund managers be better than the avg. guy anyway?
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by CurlyDave »

Stef wrote: Sun Aug 16, 2020 11:41 pm 90% of all actively managed funds underperform the index after 15 years. This number gets closer to 100% the more time passes. Why should it be so different with individual investors? Shouldn't all these professional fund managers be better than the avg. guy anyway?
But the real question is different. What percent of people on this board are above average? My personal guess would be at least 95%. We have self-selected for those with an aptitude and ability to invest.

We should be able to easily outperform the average by collaborating.

* * * * * * * * * * * * * * * *
And another issue is even if the average Boglehead is much better than the average investor, how does one prove this? Personally, I do not have a spreadsheet that could prove my returns. I might have records of everything, but finding them and putting them in order is the kind of tedious work I hate.

And I am not going to publish my net worth on the internet...
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

Stef wrote: Sun Aug 16, 2020 11:41 pm 90% of all actively managed funds underperform the index after 15 years. This number gets closer to 100% the more time passes. Why should it be so different with individual investors? Shouldn't all these professional fund managers be better than the avg. guy anyway?
I posted a few reasons upthread, namely that active managers operate under various constraints that an individual need not.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Uncorrelated »

Enganerd wrote: Sun Aug 16, 2020 4:12 pm TLDR: I have been repeating for years that: over investing lifetime passive investing is ~80% more likely to outperform active.
I think you meant to say "over a 6 month period passive investing is 80% likely to outperform active". Over an entire lifetime the probability is closer towards 99.9%.



There has been some research on the success of individual traders. For example Do Individual Day Traders Make Money? Evidence from Taiwan. Basically, they investigated the trading records of traders at a Taiwanese stock exchange.

They found that:
When partitioned by past day trading volume, all traders lose money.
When partitioned by past performance, In the top 0.5% quintile, 66% of traders continue to make money in the next 6-month period. In the 0.5%-2.5% quintile 44% of traders make money. Aggregated over all traders, the probability of making money is about 10% in a 6-month period.

tl;dr unless you are in the top 0.5% quintile of day traders, you lose money consistently. They don't say, but the people in the top 0.5% probably have written their own (HFT) trading software.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

Uncorrelated wrote: Mon Aug 17, 2020 12:22 am
Enganerd wrote: Sun Aug 16, 2020 4:12 pm TLDR: I have been repeating for years that: over investing lifetime passive investing is ~80% more likely to outperform active.
I think you meant to say "over a 6 month period passive investing is 80% likely to outperform active". Over an entire lifetime the probability is closer towards 99.9%.



There has been some research on the success of individual traders. For example Do Individual Day Traders Make Money? Evidence from Taiwan. Basically, they investigated the trading records of traders at a Taiwanese stock exchange.

They found that:
When partitioned by past day trading volume, all traders lose money.
When partitioned by past performance, In the top 0.5% quintile, 66% of traders continue to make money in the next 6-month period. In the 0.5%-2.5% quintile 44% of traders make money. Aggregated over all traders, the probability of making money is about 10% in a 6-month period.

tl;dr unless you are in the top 0.5% quintile of day traders, you lose money consistently. They don't say, but the people in the top 0.5% probably have written their own (HFT) trading software.
Do all active strategies involve day trading? Are the OP's peers pursuing day trading?
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Uncorrelated »

000 wrote: Mon Aug 17, 2020 12:28 am
Uncorrelated wrote: Mon Aug 17, 2020 12:22 am
Enganerd wrote: Sun Aug 16, 2020 4:12 pm TLDR: I have been repeating for years that: over investing lifetime passive investing is ~80% more likely to outperform active.
I think you meant to say "over a 6 month period passive investing is 80% likely to outperform active". Over an entire lifetime the probability is closer towards 99.9%.



There has been some research on the success of individual traders. For example Do Individual Day Traders Make Money? Evidence from Taiwan. Basically, they investigated the trading records of traders at a Taiwanese stock exchange.

They found that:
When partitioned by past day trading volume, all traders lose money.
When partitioned by past performance, In the top 0.5% quintile, 66% of traders continue to make money in the next 6-month period. In the 0.5%-2.5% quintile 44% of traders make money. Aggregated over all traders, the probability of making money is about 10% in a 6-month period.

tl;dr unless you are in the top 0.5% quintile of day traders, you lose money consistently. They don't say, but the people in the top 0.5% probably have written their own (HFT) trading software.
Do all active strategies involve day trading? Are the OP's peers pursuing day trading?
I don't seen any reason to believe that day traders make worse trades on average than other individual active investors. It'll just take longer for the negative performance to become obvious since the statistical significance for trading strategies are mostly based on the number of trades, not on the time period. (This is a big problem with backtesting active strategies. Usually people look at 20+ year time periods with only a few trades. It's pretty much impossible to infer any sort of conclusion from that).
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by annu »

The thing with tech is, it is redefining regularly what tech means.
You said Tech=Software, but what if that software was being written by another piece of software, look @ gtp-3(https://en.wikipedia.org/wiki/GPT-3)

This AI based tech can write software already, can simplify a lot of Software development work, and it is only gen 3.
So yes you can bet tech will grow like regular companies, bigger they get, more money they make, and they grow linearly....but tech can just become redundant quite fast as well.

Tech based service companies will grow, but service has been around for a while, and folks know how to evaluate and value them.
No one has been able to speculate on tech, if that was the case, folks would have been on google bandwaggon right away. Short of playing the IPO game, folks have been able to valuate tech service based companies well, and will continue to, only when every one is thinking they can understand tech, we end up in mess like 2000......
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

Uncorrelated wrote: Mon Aug 17, 2020 12:35 am I don't seen any reason to believe that day traders make worse trades on average than other individual active investors. It'll just take longer for the negative performance to become obvious since the statistical significance for trading strategies are mostly based on the number of trades, not on the time period. (This is a big problem with backtesting active strategies. Usually people look at 20+ year time periods with only a few trades. It's pretty much impossible to infer any sort of conclusion from that).
Why are so many active strategies pursued if it consistently underperforms? Shouldn't they be able to get an arbitrage bonus for keeping markets efficient?
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

OP, if your goal is to prove your peers wrong, the best thing would a forward-running test of their strategy vs. the index.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by oldzey »

"The broker said the stock was 'poised to move.' Silly me, I thought he meant up." ― Randy Thurman
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Uncorrelated »

000 wrote: Mon Aug 17, 2020 12:39 am
Uncorrelated wrote: Mon Aug 17, 2020 12:35 am I don't seen any reason to believe that day traders make worse trades on average than other individual active investors. It'll just take longer for the negative performance to become obvious since the statistical significance for trading strategies are mostly based on the number of trades, not on the time period. (This is a big problem with backtesting active strategies. Usually people look at 20+ year time periods with only a few trades. It's pretty much impossible to infer any sort of conclusion from that).
Why are so many active strategies pursued if it consistently underperforms? Shouldn't they be able to get an arbitrage bonus for keeping markets efficient?
The same reason people buy lottery tickets.

There is an arbitrage bonus for certain active trades. The problem is that in order to capture that arbitrage bonus, you have to be significantly better than your competitors. Unfortunately, your competitors include renaissance technologies.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by glorat »

I collected a bunch of useful references at viewtopic.php?t=316803

The most relevant one here is this
nisiprius wrote: Fri Jun 05, 2020 10:36 am S&P SPIVA report landing page

Image

And of course, for some reason that escapes me S&P is being kind, because according to their SPIVA U.S. Scorecard for year-end 2019, at ten years, 88.99% underperformed, and at 15 years 90.46% did.

Most of the indexing conversation amounts to

"Indexing is stupid. Nobody can possibly believe you can't do better by using a little intelligence and common sense."
"OK, then how come professionals using intelligence and common sense do worse nine times out of ten?"
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by noraz123 »

Enganerd wrote: Sun Aug 16, 2020 4:12 pm
but believe the exponential curve of tech, having a better understanding of this market through experience and youth (grew up in a digital world versus boglehead or more traditional investors with a higher average age) they are confident most still do not appreciate the concept that software is eating the world. https://a16z.com/2011/08/20/why-softwar ... the-world/
...
Because most capital still belongs to older generations this tech market is undervalued. They have, and claim most associates, have out performed market returns by betting on multiple tech companies that they know have potential
My argument to them wouldn't be they are wrong about tech. But that there are already hedge funds that believe this, too. And they may make up the majority of the volume (I am guessing about this, do not have data).

If they are so confident, then they should start their own hedge fund. Silicon Valley engineers / tech folks make great salaries, but nothing compared to what they could make if they are correct.

Also, the best technology doesn't always win. Novell, Informix, Sun are good examples.

One last thought, make a Warren Buffet wager. Bet them $100(00?) that your portfolio outperforms theirs over a 10 year period. You choose vtsax or the like.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

Uncorrelated wrote: Mon Aug 17, 2020 12:50 am The same reason people buy lottery tickets.

There is an arbitrage bonus for certain active trades. The problem is that in order to capture that arbitrage bonus, you have to be significantly better than your competitors. Unfortunately, your competitors include renaissance technologies.
I guess I have trouble reconciling the following two ideas:
1. 99.9% of active investments underperform passive investments over a lifetime.
2. Active arbitrageurs keep markets efficient.

Also, isn't it possible for two active traders to cancel each other out in a way that is mutually beneficial? Suppose together they hold the market portfolio, but one has a tax preference for low dividend stocks and the other is a tax-exempt investor. Or one has a preference for low volatility stocks and the other has the opposite preference?

These two investors will together perform exactly the same as the market in gross terms and somewhat under the market net of transaction costs. But, can differing investor preferences mean active strategies can improve results for those following them? i.e. there is a rational reason for some non-index strategies?
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Uncorrelated »

000 wrote: Mon Aug 17, 2020 1:07 am
Uncorrelated wrote: Mon Aug 17, 2020 12:50 am The same reason people buy lottery tickets.

There is an arbitrage bonus for certain active trades. The problem is that in order to capture that arbitrage bonus, you have to be significantly better than your competitors. Unfortunately, your competitors include renaissance technologies.

These two investors will together perform exactly the same as the market in gross terms and somewhat under the market net of transaction costs. But, can differing investor preferences mean active strategies can improve results for those following them? i.e. there is a rational reason for some non-index strategies?
There are reasons to follow a non-index strategies, but I don't think I have seen a boglehead that correctly executed such a strategy.

There are many reasons to follow various index strategies. Some investors have 60/40, others have 100/0. One is not better than the other, it all depends on your personal risk tolerances. But it turns out it's very difficult to specify your risk tolerance in more than one dimension. If your tax situation means that high-dividend stocks are more attractive than other stocks, then perhaps you have different preferences than the market in aggregate. But I don't consider that active investing.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Anon9001 »

What is the point of this question. To give you reference this is like going to reddit.com/r/vegan or reddit.com/r/vegeterian and submitting a post asking "Heh Guys Is Meat Really Unhealthy Yes? I have some evidence that is not" . There is a 0.0000001% possibility that you are going to get a answer saying yes individual can do better than index funds. This is a echo-chamber. That is not to insult the site. I have learned good things from it apart form active vs passive like keeping thing simple. The trick is not to take anything related to active vs passive seriously here. To answer the question a individual has certain advantages over institutions like mutual funds in that he can buy very small companies that institutions can't buy easily. If you want to you could get good alpha over index by investing in micro-cap companies but that carries a huge risk if you don't do research properly.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Enganerd »

Thanks for the responses and discussion. I should have clarified my intent a bit more although all discussion on the topic is interesting.

*I am not interested in active investing myself. I know I have no competitive advantage and would get higher ROI on my time focusing on my career and family.

*They are not talking short term trading but investing in tech companies early. Being in SV with a large network allows one to see the trends and developments. Basically being steeped in the culture and having a good feel for the industry they can pick companies with high potential and make a portfolio to hold long term. They offer evidence of many people who have been successful in tech regularly repeat their success. Whether starting other companies or through angel investing. Indicating that it is not luck like a passive promoter may presume.

*I am not interested in proving them wrong or convincing them otherwise. It is more for my intellectual curiosity. I have been walking and talking like I had seen great justification for confidence in the position that ~80% (even had a specific rough percentage) of active investors will lag market returns. But it looks like I was just conflating studies of active funds to passive funds with all investors.

I still am happy with the I know nothing philosophy myself when it comes to picking individual stocks or trading. But I do think there are plenty of examples of times in history where group think has caused people to not admit times are changing despite evidence all around them this time really is different. In the end, I trust the size and activity in the market is such that it would be a waste of energy to try to beat.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Enganerd »

Rick Ferri wrote: Sun Aug 16, 2020 8:45 pm The last time I read a thread like was at the peak of the tech bubble in 1999 when barbers were giving out free investment advice with each haircut.

I think of that guy every time someone says this time is different.

Rick Ferri
I agree. I kept mentioning it seems like they had not heard of the tech bubble and bust and it's naive to think this time is truly different. But they are confident. Also despite not accepting the fact they are taking more risk they do indicate they would be fine starting over if things go poorly. They are passionate about work so I take them at their word.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Enganerd »

LFS1234 wrote: Sun Aug 16, 2020 11:30 pm
Enganerd wrote: Sun Aug 16, 2020 4:12 pm Do any bogleheads have good sources of the track records of individual investors that can be generalized?
Not sure what you mean by "track records individual investors that can be generalized". Obviously, there are a lot of individuals who do much better than the market. The very most financially successful of these are published in the Forbes 400.
Yeah can be generalized was meant broad scale, ie not "look at Warren Buffet, he beat the market!". Similar to the papers written by a brokerage such as vanguard or fidelity showing that more trades/tinkering correlates with lower returns when they look at their data. Thanks for the input!
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Enganerd »

000 wrote: Sun Aug 16, 2020 10:04 pm :mrgreen: :mrgreen: :mrgreen:

I was not referring to myself, but to the OP's peers, who presumably view themselves as (and may be) "above average", so the arguments about the average may not be persuasive to them.
Thanks for keeping the discussion going. Similarly I do not think I can go out and pick the next tech stocks to out perform. Although I do think the world is rapidly changing and I suspect a lot of boglehead confidence suffers a bit of survivorship bias. If say we were still underwater from the 08 crash, CB interaction did not save ppl's confidence, how many would still be claiming just throw in 60/40 and don't pay attention, it won't do you any good!
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by LFS1234 »

shess wrote: Sun Aug 16, 2020 11:36 pm And something I can't find on the Internet, so will report as anecdotal: I'm pretty sure I read somewhere that the "robber baron" railroad tycoons mostly got that way by coming in and hovering up the small fry and consolidating and applying their resulting market power. Apparently there were a ton of "startup" railways, but they couldn't sustain their costs competitively until someone built a bigger system that could extract higher rents. I believe something similar happened with automobiles and airplanes, where there were tons of small startup companies that went under as the markets matured.
Here's three relevant short blurbs about automobiles and airplanes, all courtesy of a 1999 Fortune article authored by Buffett:

"All told, there appear to have been at least 2,000 car makes, in an industry that had an incredible impact on people's lives. If you had foreseen in the early days of cars how this industry would develop, you would have said, "Here is the road to riches." So what did we progress to by the 1990s? After corporate carnage that never let up, we came down to three U.S. car companies--themselves no lollapaloozas for investors. So here is an industry that had an enormous impact on America--and also an enormous impact, though not the anticipated one, on investors."

"The other truly transforming business invention of the first quarter of the century, besides the car, was the airplane--another industry whose plainly brilliant future would have caused investors to salivate. So I went back to check out aircraft manufacturers and found that in the 1919-39 period, there were about 300 companies, only a handful still breathing today. Among the planes made then--we must have been the Silicon Valley of that age--were both the Nebraska and the Omaha, two aircraft that even the most loyal Nebraskan no longer relies upon."

"Move on to failures of airlines. Here's a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact--though the picture would have improved since then--the money that had been made since the dawn of aviation by all of this country's airline companies was zero. Absolutely zero."
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by LFS1234 »

Enganerd wrote: Mon Aug 17, 2020 6:09 am
I still am happy with the I know nothing philosophy myself when it comes to picking individual stocks or trading. But I do think there are plenty of examples of times in history where group think has caused people to not admit times are changing despite evidence all around them this time really is different.
Although I've enjoyed the conversation, I'm not sure what the purpose of this thread is. Do you have an actionable question? If so, what is it?

It is indisputable that many people, possessing both deep industry knowledge and good financial sense, do very well investing in stocks that fall within their "circle of competence".

The most significant financial successes accrue to those who obtain their stock at very low prices. Sometimes this requires a seat at the table at an early stage; available to founders and key employees, but not to the general public. Other times, the opportunity is open to everyone when the stock can be purchased on the open market at depressed prices. These opportunities occur in all industries, not just technology.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Stef »

LFS1234 wrote: Mon Aug 17, 2020 7:18 am Although I've enjoyed the conversation, I'm not sure what the purpose of this thread is. Do you have an actionable question? If so, what is it?
Is there research about how many investors underperform the market after 15 years? Is there evidence that outperformance is mostly due to pure luck and not competence?
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by tibbitts »

Enganerd wrote: Mon Aug 17, 2020 6:22 am
000 wrote: Sun Aug 16, 2020 10:04 pm :mrgreen: :mrgreen: :mrgreen:

I was not referring to myself, but to the OP's peers, who presumably view themselves as (and may be) "above average", so the arguments about the average may not be persuasive to them.
Thanks for keeping the discussion going. Similarly I do not think I can go out and pick the next tech stocks to out perform. Although I do think the world is rapidly changing and I suspect a lot of boglehead confidence suffers a bit of survivorship bias. If say we were still underwater from the 08 crash, CB interaction did not save ppl's confidence, how many would still be claiming just throw in 60/40 and don't pay attention, it won't do you any good!
I don't agree with your other points but this one is definitely valid. We've seen generations that could have profited by just accepting market returns and not losing too much to costs. Boglehead philosophy is based on the average person winning over a reasonable period of time. If the average person loses, Boglehead enthusiasm will wane as time goes on. I'm pretty sure we won't be reading the same kinds of posts we always have after a twenty-year bear in both stocks and bonds, where the only people who have even broken even on their investments were traders or stock pickers - even though those winners will be in the minority. Bogleheads will gradually be joining your tech buddies and trying to figure out how to be in that above-average minority, although tech might not be turn out to be the preferred vehicle.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by goingup »

Bogleheads has plenty of professionals in every field who have been privy to innovations in tech, medicine, manufacturing, finance---you name it. I'm sure some have become wealthy through stock awards and holding individual stocks.

The conclusion that most Bogleheads have come to is that over the course of a lifetime it's a less risky and more profitable plan to hold broad index funds as one's core investment.

There is nothing new or unique about your colleagues who have some success selecting individual stocks. They are making a concentrated bet. Most here would rather hold an index of 500-5,000 stocks.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by Enganerd »

LFS1234 wrote: Mon Aug 17, 2020 7:18 am
Enganerd wrote: Mon Aug 17, 2020 6:09 am
I still am happy with the I know nothing philosophy myself when it comes to picking individual stocks or trading. But I do think there are plenty of examples of times in history where group think has caused people to not admit times are changing despite evidence all around them this time really is different.
Although I've enjoyed the conversation, I'm not sure what the purpose of this thread is. Do you have an actionable question? If so, what is it?

It is indisputable that many people, possessing both deep industry knowledge and good financial sense, do very well investing in stocks that fall within their "circle of competence".

The most significant financial successes accrue to those who obtain their stock at very low prices. Sometimes this requires a seat at the table at an early stage; available to founders and key employees, but not to the general public. Other times, the opportunity is open to everyone when the stock can be purchased on the open market at depressed prices. These opportunities occur in all industries, not just technology.
The main purpose for me was that I realized I couldn't verify a position I had been presenting. I thought I had seen good evidence for that position on this forum, and I knew if it existed people would share it.

How is it actionable? Although I am not sure it is broadly for others, for me the discussion helps me reinforce confidence that the passive strategy is right for me. Because, honestly the QE since 2008 and the global low rates are giving me concerns that the future may not resemble the past. I have an urge to do something, but because I would not know what to do to ease my concerns I am trying to reinforce the foundation of IPS.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by oldzey »

OP, here's another resource you might find useful:

A Case for Index Fund Portfolios
"The broker said the stock was 'poised to move.' Silly me, I thought he meant up." ― Randy Thurman
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by RomeoMustDie »

I have been beating SPY pretty handedly with 2 different portfolio strategies for the last year and it's changed my perspective on the passive vs active debate.

My active portfolios also have a lot less volatility and overall risk to the point that I'm considering levering them up at 25-50% ratios.

I think the three fund portfolio is good for people who want something very simple, but for someone who considers this as a hobby and enjoys the learning process I've found it much easier than expected to beat total market return.

You may say, but what about a different market environment, and my response is that I was also outperforming during the crash.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by alluringreality »

Enganerd wrote: Mon Aug 17, 2020 10:46 am I am trying to reinforce the foundation of IPS.
I think there's a lot of betting in investing. This forum is mostly retail investors, and retail investors like to try to outperform the market, so even on this forum there is a lot of discussion that really boils down to people trying to outperform the market. I realize that I'm also subject to these sorts of whims myself. One concept that I've borrowed from Bill Bernstein in The Investor's Manifesto is that when comparing two portfolios, the portfolio that's increasing in value significantly quicker probably has more risk, regardless of what a backtest of Sharpe ratios might suggest. Below is essentially a summary of what he says in the book regarding how Long Term Capital Management was making impressive returns before the downfall. Personally I would not be "fine starting over if things go poorly", so risk is something I consider when I question if I'm chasing performance.

No matter how elegant the theory, no matter how rigorous the analysis, from time to time things will go totally off the rails. Further, most of the time this will happen in a novel way.
http://www.efficientfrontier.com/ef/0adhoc/50.htm
Targets: 15% I Bonds, 15% EE Bonds, 45% US Stock (Mid & Small Tilt), 25% Ex-US Stock (Small Tilt)
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by shess »

Enganerd wrote: Mon Aug 17, 2020 6:09 am *They are not talking short term trading but investing in tech companies early. Being in SV with a large network allows one to see the trends and developments. Basically being steeped in the culture and having a good feel for the industry they can pick companies with high potential and make a portfolio to hold long term. They offer evidence of many people who have been successful in tech regularly repeat their success. Whether starting other companies or through angel investing. Indicating that it is not luck like a passive promoter may presume.
I've been in silicon valley for over 20 years, and worked the valley remotely for 10 before that, and I don't see a lot of evidence of this. YES, there are people I know who are super connected in the venture capital world, and they definitely have something going on (though I'm honestly not close enough to them to tell if they're making bigger returns now, or just working an expensive hobby enabled by their early-hire option grant's payoff - I see evidence on both sides for some of them!). But as far as I can tell, the regular schmoes seem to THINK they are super well connected, but they're living in the same shell game everyone else is living in. In fact, I remember reading on an internal forum and having an epiphany where I realized that just because these people were super-bright engineers didn't mean that they had any advantage outside their field.

Keep in mind that tech is inherently risky and also very episodic. I'd be inclined not to trust anyone who makes claims but hasn't gone through a few boom and bust cycles. It's easy to make money when investors are throwing money at inherent non-starters, but if you just get wiped out in the bust, it's not that helpful.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by langlands »

Enganerd wrote: Mon Aug 17, 2020 10:46 am
LFS1234 wrote: Mon Aug 17, 2020 7:18 am
Enganerd wrote: Mon Aug 17, 2020 6:09 am
I still am happy with the I know nothing philosophy myself when it comes to picking individual stocks or trading. But I do think there are plenty of examples of times in history where group think has caused people to not admit times are changing despite evidence all around them this time really is different.
Although I've enjoyed the conversation, I'm not sure what the purpose of this thread is. Do you have an actionable question? If so, what is it?

It is indisputable that many people, possessing both deep industry knowledge and good financial sense, do very well investing in stocks that fall within their "circle of competence".

The most significant financial successes accrue to those who obtain their stock at very low prices. Sometimes this requires a seat at the table at an early stage; available to founders and key employees, but not to the general public. Other times, the opportunity is open to everyone when the stock can be purchased on the open market at depressed prices. These opportunities occur in all industries, not just technology.
The main purpose for me was that I realized I couldn't verify a position I had been presenting. I thought I had seen good evidence for that position on this forum, and I knew if it existed people would share it.

How is it actionable? Although I am not sure it is broadly for others, for me the discussion helps me reinforce confidence that the passive strategy is right for me. Because, honestly the QE since 2008 and the global low rates are giving me concerns that the future may not resemble the past. I have an urge to do something, but because I would not know what to do to ease my concerns I am trying to reinforce the foundation of IPS.
edit: After reading the thread more closely, I see that 000 has already made many of the same points I'm making. Hopefully my more verbose in depth answer is of some value.

I agree much more with your friends than most of the posters in this thread. You are right that individual investors don't have the restraints that institutional active managers have, and this is exactly why they have a chance of beating the market.

Let's review why active investors as a whole trail passive. It's because the active management industry is completely saturated. If there were only one active manager in the market and everyone else were passive, he'd make out like a bandit from the bid ask spread. Instead, we have a situation where we have way too many active managers. As a result of this, bid ask spreads are small and all passive investors reap the benefits of an efficient market. As a whole, active managers underperform the market because arithmetic dictates that the sum total of active manager positions has to replicate the market (for every active manager that underweights AAPL, there must be another that overweights). Furthermore, the fees and market costs of transacting from the oversaturation of active traders far outweigh the value they are providing to the market (and hence the profits they reap thereby), namely the bid/ask spread (liquidity). So as a whole, active managers underperform the market by exactly these fees and market costs.

Individual investors that invest in individual stocks (1) don't pay fees (2) pay no commissions (new development) (3) have minimal market impact assuming their net worth isn't $20M+ and that they don't trade often. Thus, the primary reasons that they might underperform passive don't apply. Your friends are very smart. Buying and holding individual securities that are in your circle of competence is perhaps the only way to beat the market, and not only that, you have a good chance of doing it. What is important is that you stay fully invested. There are two main reasons an individual investor will underperform the market: (1) they try to time the market (2) they buy too few stocks. It doesn't matter how good you are at picking stocks, if you weren't fully invested in 2019, you most likely underperformed the market. If you buy too few stocks, the volatility of your portfolio will be high. Because of the way geometric returns work, this will lead the median outcome to drastically underperform the mean outcome. Think of a lottery ticket: the median outcome is that you come away with nothing. The mean outcome is of course positive (without including the cost of the ticket itself of course). But if you buy enough stocks (around 30) that aren't all highly correlated with each other, your median and mean outcomes will match fairly well.

Note that once you take fees/trading costs, etc. out of the equation (which is a good approximation for buy and hold individual investors), the average fully invested individual investor matches the market return. Restricting oneself further to the set of such buy and hold individual investors who are reasonably diversified, the median fully invested diversified individual investor matches the market return. Hence, it is not unreasonable to conclude that a substantial percentage of fully invested, diversified individual investors are beating the market. This is because fully invested, diversified individual investors are only competing with other fully invested, diversified individual investors. If you only trade once a year, you aren't competing with high frequency traders, quant firms such as Rentech or Two Sigma, or mutual funds that turn their portfolio over every quarter.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by 000 »

The irony is that Bogleheads are probably the group of retail investors in the best position to beat the index.
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Re: Evidence of Active Investing trailing Passive for Individuals

Post by langlands »

000 wrote: Mon Aug 17, 2020 4:10 pm The irony is that Bogleheads are probably the group of retail investors in the best position to beat the index.
True. It seems that economics is replete with such ironies. I forget who's quote it is, but some economist said that during the Great Depression, the people most willing to buy at the bottom and support the market were all bankrupt and those most able to buy at the bottom were too scared to invest.

Although on second thought, I'm not so sure. I think beating the market requires both patience/level-headedness and a certain competitiveness/arrogance. Very crudely, someone who attempts to beat the market needs to be equally at home on this forum and on r/wsb. To be clear, r/wsb is a toxic wasteland. But a market-beating investor should probably relate at least a little with the bravado that is expressed there 24/7.
Last edited by langlands on Mon Aug 17, 2020 4:34 pm, edited 1 time in total.
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