Past Performance

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hoops777
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Past Performance

Post by hoops777 » Sat May 11, 2013 12:08 pm

I know it is a big deal to ever own something based on past performance but isn't the entire Boglehead philosophy based on past performance?Own the total market because it has outperformed 80 whatever pct of managed funds with its low fees and no stock picking.My point is if 75 % of managed funds at Vanguard had outperformed the market their would be no bogleheads.I say this only because people here coming down on others owning Wellesley or the like simply because it has a great past performance which for some reason means nothing because it is not an index.
You are buying index funds because you believe you will have the best results because of diversification,low fees,etc.,but the bottom line is results...past results.
I believe the boglehead philosophy is great and right for 95% of investors,so do not misunderstand my point here.I also believe know matter how you want to spin it or rationalize it,the decision comes down to the past results which we all hope will repeat going forward.I just believe it is somewhat hypocritical to criticize another for buying a fund like Wellesley or any other successful fund with a long history because you are "chasing past results" because in essence bogleheads are doing the same thing but you choose index funds instead.
You believe index funds will provide the safest best returns going forward based on ......drum roll........past results.When the total market was decimated in 2007-8 you all held on and did not sell in a panic...why?Because your belief in past results told you eventually the market would recover.Thats it.
K.I.S.S........so easy to say so difficult to do.

dbr
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Re: Past Performance

Post by dbr » Sat May 11, 2013 12:13 pm

There are many nuances to what is meant by the term "past performance." Within and among all those nuances are the explanations for the points you are raising.

Whether or not any specific idea in investing is justified by past performance or foolish in relying on past performance depends on what the question is in detail.

Personally I think investing by aphorism is not a good idea.

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Re: Past Performance

Post by chaz » Sat May 11, 2013 12:19 pm

Past performance, momentum & timing are things I avoid.
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momar
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Re: Past Performance

Post by momar » Sat May 11, 2013 12:22 pm

It's true that if index funds had a poor track record, I would not invest in index funds.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

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InvestorNewb
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Re: Past Performance

Post by InvestorNewb » Sat May 11, 2013 12:23 pm

I agree 100% with the OP. We all look at past performance before investing. Otherwise, indexing would never have caught on in the first place.

IMO, looking at past performance over long periods is a good indication of future performance.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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rmelvey
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Re: Past Performance

Post by rmelvey » Sat May 11, 2013 12:45 pm

OP,

Give the paper titled "The Arithmetic of Active Management" a read. The argument for indexing is theoretical, and its outperformance is entirely predictable going forward. We also happen to have a good body of empirical evidence supporting it, but that is just icing on the cake.

The real past performance goose that I notice on the forum is more related to asset classes. The people who go heavy into equities are relying on past performance. Stocks have done well over the last 100 years. It's hard to know what they will do going forward.

mike127
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Re: Past Performance

Post by mike127 » Sat May 11, 2013 1:22 pm

I feel like this is a really important point. Many Bogleheads are so dogmatic about ideas like high fees bad/low fees good, active bad/passive good, full-service brokerage bad/Vanguard good, etc. Those conclusions are all right as far as I am concerned, but only because historically things like active management have not had a sufficiently positive impact on performance to outweigh fees relative to broad market indices. If reliable studies showed that a defined class of active funds consistently outperformed the relevant benchmarks by 60% year over year for the past 70 years, net of fees, the Boglehead philosophy would at least be a closer call.

The reason why this is important (to me, at least) is that I worry a dogmatic reaction to rookie questions does rookies a disservice. I'm pretty close to a rookie compared to most people on this board, but I've spent the past year doing enough reading to be able to sort the reality from the sales propaganda. In this environment, if you don't know better, hearing "fire your advisor, even though I don't know him, unless he is willing to guarantee outperformance" doesn't seem credible, specifically because NOBODY (including Vanguard) will guarantee that unless they are defrauding you. Similarly, "ignore the fund that has dramatically outperformed the S&P 500 over the past 1, 3, 5, and 10 year periods" isn't persuasive unless you understand that the S&P 500 is the wrong benchmark and that this fund has underperformed the correct benchmark in each of those periods. And the three-fund portfolio is a great starting place for pretty much everybody, but if you don't understand why that's not intuitive.

I want to be clear here: many of the people on this forum are among the best informed consumer finance experts in the world today and I am incredibly grateful for the time people have spent explaining to me and many other rookies the very basic points that informed investors take for granted. And the wiki is probably the best investing resource available for uninformed investors. But I worry that the "past performance is irrelevant" assumption is a shorthand that only people who already understand the theory will get.

hoops777
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Re: Past Performance

Post by hoops777 » Sat May 11, 2013 2:13 pm

Rmelvey....The only way that can be true if is if it is based on past results because the future is unknown.I can tell you I have 10 managed funds that will outperform the market by 15 % over the next 25 years.You ,I or Swedroe,Bogle,Buffet have no way of knowing if I am going to be right or wrong.You can make a calculation based on past results and that is all you can do.Every investment decision we make is based on what has happened in the past which gives us reason to believe in what we are investing in.You can twist it and turn it and do whatever you want with it but at some level it will be based on what has happened in the past.Again,I believe indexing is best for 95% of investors and I believe that because I can see the data of past performance.
K.I.S.S........so easy to say so difficult to do.

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rmelvey
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Re: Past Performance

Post by rmelvey » Sat May 11, 2013 2:20 pm

hoops777 wrote:Rmelvey....The only way that can be true if is if it is based on past results because the future is unknown.I can tell you I have 10 managed funds that will outperform the market by 15 % over the next 25 years.You ,I or Swedroe,Bogle,Buffet have no way of knowing if I am going to be right or wrong.You can make a calculation based on past results and that is all you can do.Every investment decision we make is based on what has happened in the past which gives us reason to believe in what we are investing in.You can twist it and turn it and do whatever you want with it but at some level it will be based on what has happened in the past.Again,I believe indexing is best for 95% of investors and I believe that because I can see the data of past performance.
Read the paper. It is literally impossible for the active community in aggregate to outperform the index net of fees. This has nothing to do with past performance or empirical evidence. It is basic arithmetic.

The argument for indexing was based first in theory, and has subsequently proven accurate empirically. You are familiar with the latter, but to truly understand the roots you have to read that paper.
Last edited by rmelvey on Sat May 11, 2013 2:28 pm, edited 1 time in total.

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momar
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Re: Past Performance

Post by momar » Sat May 11, 2013 2:23 pm

hoops777 wrote:Rmelvey....The only way that can be true if is if it is based on past results because the future is unknown.I can tell you I have 10 managed funds that will outperform the market by 15 % over the next 25 years.You ,I or Swedroe,Bogle,Buffet have no way of knowing if I am going to be right or wrong.You can make a calculation based on past results and that is all you can do.Every investment decision we make is based on what has happened in the past which gives us reason to believe in what we are investing in.You can twist it and turn it and do whatever you want with it but at some level it will be based on what has happened in the past.
Read the paper.

http://www.stanford.edu/~wfsharpe/art/active/active.htm
Over any specified time period, the market return will be a weighted average of the returns on the securities within the market, using beginning market values as weights3. Each passive manager will obtain precisely the market return, before costs4. From this, it follows (as the night from the day) that the return on the average actively managed dollar must equal the market return. Why? Because the market return must equal a weighted average of the returns on the passive and active segments of the market. If the first two returns are the same, the third must be also.

This proves assertion number 1. Note that only simple principles of arithmetic were used in the process. To be sure, we have seriously belabored the obvious, but the ubiquity of statements such as those quoted earlier suggests that such labor is not in vain.

To prove assertion number 2, we need only rely on the fact that the costs of actively managing a given number of dollars will exceed those of passive management. Active managers must pay for more research and must pay more for trading. Security analysis (e.g. the graduates of prestigious business schools) must eat, and so must brokers, traders, specialists and other market-makers.

Because active and passive returns are equal before cost, and because active managers bear greater costs, it follows that the after-cost return from active management must be lower than that from passive management.
A corollary is that low cost, actively managed funds (such as Wellesley) will on average perform as well as an index fund.

Another point is that this excludes non professional holders of individual securities.
Last edited by momar on Sat May 11, 2013 2:25 pm, edited 1 time in total.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep

hoops777
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Re: Past Performance

Post by hoops777 » Sat May 11, 2013 2:24 pm

Rmelvy....I do not know what you mean by the active community in aggregate but it cannot mean a group of managed funds because that is ridiculous.
K.I.S.S........so easy to say so difficult to do.

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Re: Past Performance

Post by rmelvey » Sat May 11, 2013 2:30 pm

hoops777 wrote:Rmelvy....I do not know what you mean by the active community in aggregate but it cannot mean a group of managed funds because that is ridiculous.
:D Just read the paper! It's a good read.

hoops777
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Re: Past Performance

Post by hoops777 » Sat May 11, 2013 2:40 pm

I read the paper and it said that a managed fund or group of managed funds can outperform the index towards the end of the paper.So what is the point?It basically says that indexes will usually outperform but it is not a certainty.
K.I.S.S........so easy to say so difficult to do.

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Robert C F
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Re: Past Performance

Post by Robert C F » Sat May 11, 2013 2:46 pm

I see it as a difference between short and long term performance. Overall I know the equity market will move up (with periods of scary drops and stagnation). What the overall equity market will do in the short term or which segments of this market will do in the short term, nobody knows. For example, I hold a fixed percentage allocation of international developed large cap equity indexes, equally split between European and Pacific. Noticed over the past year and half, European is a segment I have had to rebalance by selling off excess over my allocation several times. This in with the general backdrop of the "talking financial heads" of the general theme that the European economy was doomed.

John3754
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Re: Past Performance

Post by John3754 » Sat May 11, 2013 3:38 pm

The reason index funds beat actively managed funds is because of fees. This has nothing to do with past performance or using past performance to try and predict the future. Actively managed funds taken collectively own the entire market, they just charge people a lot more for it than index funds do. They claim to be selling you a better product but in reality they're selling you the same product with a different label and fancy marketing at a higher cost.

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Re: Past Performance

Post by assumer » Sat May 11, 2013 4:34 pm

John3754 wrote:The reason index funds beat actively managed funds is because of fees. This has nothing to do with past performance or using past performance to try and predict the future. Actively managed funds taken collectively own the entire market, they just charge people a lot more for it than index funds do. They claim to be selling you a better product but in reality they're selling you the same product with a different label and fancy marketing at a higher cost.
Okay but if you read the paper cited above, you'd realize that it is entirely possible for an active manager to beat the index, and even consistently! We are simply using past performance to tell us that there is little correlation and predictive power, in terms of which active managers will beat the index. I think that's part of the thrust of the OP.

So yes, collectively, actively stock picking will not on average beat the index if they charge fees, but that says nothing of any individual manager's performance. Again, past performance tells us that it's difficult, if nigh impossible, to pick which manager will beat the index in future years, but again that's the point that we are using past performance. As far as I know, that's simply empirical - not based on any theoretical foundation.

On another note, costs are one thing in our control. If we are close to the efficient frontier, then shaving off 0.50% of an expense, will increase our risk-adjusted returns by 0.50%. So that's a reason to use index funds, but also assumes we are on, or near, the efficient frontier.

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momar
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Re: Past Performance

Post by momar » Sat May 11, 2013 4:40 pm

assumer wrote:
John3754 wrote:The reason index funds beat actively managed funds is because of fees. This has nothing to do with past performance or using past performance to try and predict the future. Actively managed funds taken collectively own the entire market, they just charge people a lot more for it than index funds do. They claim to be selling you a better product but in reality they're selling you the same product with a different label and fancy marketing at a higher cost.
Okay but if you read the paper cited above, you'd realize that it is entirely possible for an active manager to beat the index, and even consistently! We are simply using past performance to tell us that there is little correlation and predictive power, in terms of which active managers will beat the index. I think that's part of the thrust of the OP.

So yes, collectively, actively stock picking will not on average beat the index if they charge fees, but that says nothing of any individual manager's performance. Again, past performance tells us that it's difficult, if nigh impossible, to pick which manager will beat the index in future years, but again that's the point that we are using past performance. As far as I know, that's simply empirical - not based on any theoretical foundation.

On another note, costs are one thing in our control. If we are close to the efficient frontier, then shaving off 0.50% of an expense, will increase our risk-adjusted returns by 0.50%. So that's a reason to use index funds, but also assumes we are on, or near, the efficient frontier.
No one is claiming anything different in this thread.

edit: except in the post immediately below this one
Last edited by momar on Sat May 11, 2013 4:41 pm, edited 1 time in total.
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Re: Past Performance

Post by daytona084 » Sat May 11, 2013 4:40 pm

Of course it is possible for an active manager to beat the market. In fact, every year a small percentage do just that. What is absolutely impossible is to predict which active managers will beat the market in the future. Every year the big investment magazines try to do that, and every year they fail.

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Re: Past Performance

Post by John3754 » Sat May 11, 2013 5:03 pm

assumer wrote:Okay but if you read the paper cited above, you'd realize that it is entirely possible for an active manager to beat the index, and even consistently! We are simply using past performance to tell us that there is little correlation and predictive power, in terms of which active managers will beat the index. I think that's part of the thrust of the OP.
[/quote]

The thrust of the OP, as far as I can tell, is this:

"You believe index funds will provide the safest best returns going forward based on ......drum roll........past results.When the total market was decimated in 2007-8 you all held on and did not sell in a panic...why?Because your belief in past results told you eventually the market would recover.Thats it."

And what I'm saying is no, that is not why I hold index funds instead of actively managed funds. The reason I hold index funds is because they remove a variable from the equation that has a huge drag on returns, high fees. Actively managed funds can beat the index, but to do so they must first overcome the fees they charge, which in many cases is no easy task. For me it has nothing to do with past performance and everything to do with simple arithmetic. Give me an actively managed fund that's run with a philosophy that I like and has fees as low or nearly as low as an index fund and I'd have no problem with that, but give me actively managed funds like the ones in my 401k with ERs of 1.5% and I'll take my money elsewhere.
Last edited by John3754 on Sat May 11, 2013 6:18 pm, edited 1 time in total.

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Re: Past Performance

Post by jay22 » Sat May 11, 2013 5:04 pm

I really find is surprising that so many people here continue to hold active funds and still preach about the Boglehead philosophy.

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Re: Past Performance

Post by daytona084 » Sat May 11, 2013 5:11 pm

momar wrote: No one is claiming anything different in this thread.

edit: except in the post immediately below this one
The post immediately below yours is also not claiming anything different.

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Re: Past Performance

Post by momar » Sat May 11, 2013 5:23 pm

wjwhitney wrote:
momar wrote: No one is claiming anything different in this thread.

edit: except in the post immediately below this one
The post immediately below yours is also not claiming anything different.
I just meant the bit about not being able to pick an active manager who will win in advance.

I agree with you and all the empirical evidence does too. But that hadn't come up and is not mandated by the mathematics.
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Re: Past Performance

Post by DiscoBunny1979 » Sat May 11, 2013 5:24 pm

To me, the Boglehead philosophy is about low fees, diversification and staying the course with one's plan. While investing in Index Funds is preferred, it's not a requirement. We all look at past performance, but that is just a guide to what has happened. I don't use the past as a predicting rule for the future. The future will write itself. What I write continually about is the expectation that an Index somehow is immune to the law of exponential growth. Everything has limits - whether it be gas production, human population, whatever. A stock market Index has a limit. For the DOW is that limit 15,000, 30,000, 60,000, 120,000? There are limits to an Index - that's potentially why each Index replaces bankrupt companies with new ones, why perhaps the DOW has only one original member left to it. If the DOW didn't replace poor performers, there wouldn't be a DOW Index. So, there are limits and human beings can go along thinking that "markets always recover" but that too shows many haven't accepted the fact that things associated with exponential growth have limits. We start out at age 1, go to age 2, soon 4, then 8, before we know it at age 16, 32 is right around the corner and then we retire around 64. But there isn't age 128 for most of us, at least not yet.

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Re: Past Performance

Post by Scooter57 » Sat May 11, 2013 5:53 pm

That said, some low expense Vanguard managed funds perform very well for a decade or more. They don't beat every year but the beat over a long enough period to be justifiable investments.

You would do best to pick those funds for their investment style and how it matches your long term goals going forward from the current situation, not on past performance.

hoops777
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Re: Past Performance

Post by hoops777 » Sat May 11, 2013 5:55 pm

To lump all managed funds together into one because the combination of all managed funds owns the total market and then say since the sum of all managed funds together will not beat the index with lower fees is totally nuts if that is what is being said.An individual fund or small group of managed funds is obviously not the same as owning all managed funds.
Anyway the point of the thread was that we all choose our investments based on past performance to a certain degree.We can rationalize or kid ourselves but we would not be buying index funds with low fees and great diversification if they historically produced a return of 3 % and managed funds produced a return of 8% now would we.Please tell me any devout Boglehead who is out there that would do so.Unless you can honestly answer yes to that question you are influenced by past performance.It really is that simple whether you want to admit to it or not.The main point being for the last time is that Bogleheads should not chastise people and accuse them for chasing past results when you all do the same thing with a belief in index funds.....which again I agree is best for probably 95% of investors.Some people on other threads were being very pompous and critical of some buying a wonderful fund like Wellesley for "chasing past results" .Great...I fully get the complete argument for index funds but all the great reasons would be pointless if the historical results were not what they are. I believe if you say you are not influenced in any way by the past results you are maybe not being 100% honest with yourself.I am done and thanks for the interesing comments :D
K.I.S.S........so easy to say so difficult to do.

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Re: Past Performance

Post by John3754 » Sat May 11, 2013 6:20 pm

jay22 wrote:I really find is surprising that so many people here continue to hold active funds and still preach about the Boglehead philosophy.
John Bogle himself holds Welligton. The Bogleheads philosophy is not a set of hard and fast rules, it's a set of guidelines and there is room for flexibility.

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Re: Past Performance

Post by John3754 » Sat May 11, 2013 6:44 pm

hoops777 wrote:We can rationalize or kid ourselves but we would not be buying index funds with low fees and great diversification if they historically produced a return of 3 % and managed funds produced a return of 8% now would we.
.

This logic is flawed. The past 10 year performance of vanguard total stock market index has been 8.64%, the 10 year performance of vanguard emerging market index has been 16.56%, does this mean I should be putting the bulk of my money into emerging market funds instead of total market index? Of course not because nobody in their right mind should be chasing past performance like that. I buy the funds I do because they are well diversified, low cost, they fit my risk tolerance, and they by definition cannot under perform the index, not because of past performance.

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Re: Past Performance

Post by jay22 » Sat May 11, 2013 7:05 pm

John3754 wrote:
jay22 wrote:I really find is surprising that so many people here continue to hold active funds and still preach about the Boglehead philosophy.
John Bogle himself holds Welligton. The Bogleheads philosophy is not a set of hard and fast rules, it's a set of guidelines and there is room for flexibility.
There's a difference between Bogle and investors like me, doesn't make any sense to hold Wellington because he does.

Bogleheads philosophy certainly has room for flexibility but I don't believe owning active funds is one of them.

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Re: Past Performance

Post by Random Musings » Sat May 11, 2013 7:18 pm

The problem with active funds and comparing them to benchmarks is that certain active funds have many asset class components. Or they are too sector specific. Or the beta higher or lower. Or........

Gets tough to compare apples when they are a little different, let alone if the fruit is different. Sometimes it's tough enough to sift though all the index and passive funds/ETF's these days.

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Re: Past Performance

Post by Johm221122 » Sat May 11, 2013 7:45 pm

jay22 wrote:I really find is surprising that so many people here continue to hold active funds and still preach about the Boglehead philosophy.
Ther are ten parts, if we follow nine this is still a passing grade :sharebeer
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Re: Past Performance

Post by meowcat » Sat May 11, 2013 7:52 pm

assumer wrote: Okay but if you read the paper cited above, you'd realize that it is entirely possible for an active manager to beat the index, and even consistently! We are simply using past performance to tell us that there is little correlation and predictive power, in terms of which active managers will beat the index. I think that's part of the thrust of the OP.
You will at some point notice that these very small nuber of managers that do happen to beat the market consistantly, over an exteded perioid of time, even the best ones, will offer up returns no greater than the market, net expenses.
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Re: Past Performance

Post by pkcrafter » Sat May 11, 2013 9:21 pm

hoops and others, I applaud you for asking these questions. Bogleheads must be able to explain their investing method.

hoops:
I know it is a big deal to ever own something based on past performance but isn't the entire Boglehead philosophy based on past performance?
No, past performance is not needed at all and that is one of the beautiful things about using index funds. Indexing eliminates all this guess work because you can be assured that you will see the same result 20 years from now. It is a mathematical certainty. Index funds will beat the great majority of active funds, but yes, some active funds will have great records, but as you know, you cannot determine which ones will be the winners. Indexing is all about playing the odds. You will get a B+. If you want to shoot for an A, you also run the risk of getting a D.
I say this only because people here coming down on others owning Wellesley or the like simply because it has a great past performance which for some reason means nothing because it is not an index.
Wellesley is an excellent active fund. Again, low cost is a major reason it stays afloat, and another reason is management consistency. Can you say it will never run into problems associated with manager decisions? No.

Mike wrote:
The reason why this is important (to me, at least) is that I worry a dogmatic reaction to rookie questions does rookies a disservice.
I dislike the use of the word dogmatic. Definition: "characterized by or given to the expression of opinions very strongly or positively as if they were facts"

We are not promoting opinions. It is a fact that index funds will outperform the majority of (NOT ALL) active funds over long time spans for two reasons. 1) Lower costs, 2) index funds are free of managerial and fund company problems that can and do arise over time. It may sound dogmatic because newer investors can understand and promote the philosophy even before they fully understand the subtleties.
The reason why this is important (to me, at least) is that I worry a dogmatic reaction to rookie questions does rookies a disservice
I think this is a fair concern, although the information provided is not dogmatic, but certainly may sound like it because it is repeated so often. On the other side of this coin is the fact that new investors must do their own due diligence and decide how they want to invest. To me, if a new investor as done his homework he will choose indexing: however, it doesn't work that way, some investors will choose active funds in spite of the odds.
Similarly, "ignore the fund that has dramatically outperformed the S&P 500 over the past 1, 3, 5, and 10 year periods" isn't persuasive unless you understand that the S&P 500 is the wrong benchmark and that this fund has underperformed the correct benchmark in each of those periods.
Even if the S&P500 is the right benchmark, I'd still suggest the index fund. Why, outperforming funds don't grow to the sky. Bill Miller is a legend because he beat the S&P500 for 15 years. After those 15 years, his fund was a disaster. One manager, 15 years, and he's called a legend because his accomplishment was so rare.
But I worry that the "past performance is irrelevant" assumption is a shorthand that only people who already understand the theory will get.
It is not an assumption. If you don't know why past performance is a non-starter, you have to do a little more research so you understand it. I touched on it earlier in this post.

Hoops wrote:
"Rmelvey....The only way that can be true if is if it is based on past results because the future is unknown."
Not True. It's based on costs. It's not a theory either, it's a mathematical certainty--It must be true.
I can tell you I have 10 managed funds that will outperform the market by 15 % over the next 25 years. You ,I or Swedroe,Bogle, Buffet have no way of knowing if I am going to be right or wrong.
That is true, but you should know if you hold 10 managed funds for 25 years, the odds are enormous that all of them will beat the average, much less the performance of a matching index fund.

Hoops wrote:
I read the paper and it said that a managed fund or group of managed funds can outperform the index towards the end of the paper.So what is the point?It basically says that indexes will usually outperform but it is not a certainty.
Can outperform and will outperform are two very different things. Some funds will outperform their benchmark, but how do you know which ones will?

Finally, if you want to use active funds, the last thing you should look at is past performance. You should select a fund because it's strategy matches what you need.

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Re: Past Performance

Post by ogd » Sat May 11, 2013 11:18 pm

Hoops: the "past performance" argument taken to the extreme (which you are attempting to do in this thread), means essentially "we know nothing". But in the absence of any information about the future, the only logical choice is still to lower costs to a minimum and stay diversified, which means either index funds or a *ton* of individual stocks; the former will generally have lower costs unless you have a really cozy relationship with a broker and lot of free time.

You seem to think of indexing as a strategy, the same as something like "buy stocks with a P/E close to a prime number" (silly example, I know). What it is really, is the lowest-cost method of diversified investing. Keep in mind that you have to take into account taxes too, in costs -- so e.g. minimizing turnover is important, which cap-weighted index funds do beautifully. If there was a fund with lower expenses than TSM and over 1k stocks, active or not, I'd certainly consider it. But I'm not holding my breath for that one.

It could very well have turned out that the "past performance" argument is false entirely and that certain funds (e.g. those that have "strategy" in the name) have repeatable results, they keep under- or out-performing. But we see absolutely no evidence of that. And before you start saying that evidence doesn't matter as per "past performance is no guarantee", beware that the argument is self-referential, it boils down to something like "if we know nothing, how come we know we know nothing?", which is a version of http://en.wikipedia.org/wiki/Liar%27s_paradox , and such statements tend to be meaningless. The way out of that morass is to either assume that "past performance is no guarantee" is true and stop arguing any further, or -- go ahead, assume it's false, look at the past and realize that the index funds do outperform for mysterious reasons. I just can't see how either choice would lead you to pay 1% of your money per year to play a game that doesn't seem to have been won for any length of time, ever.

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Re: Past Performance

Post by hoops777 » Sun May 12, 2013 12:24 pm

OK....The last poster,a very smart man says choosing to invest in index funds is NOT a strategy.Really?Then what is it?You and I have a different definition of that word.Yes I am carrying past performance to an extreme because I was simply trying to make the point that we all use past performance to some extent to decide how to invest our money.It is really quite simple if you all would be honest with yourselves.To say that you are not influenced by the historica data of managed funds vs index funds is just not possible when you read all of your arguments.There is not one boglehead on this site that can say they are not aware of the history of index vs managed funds.You have all seen it,know it and are influenced by it to a certain degree.A simple question I will ask again......If the research showed 90% of managed funds historically with fees,taxes and all have returned 7% more than index funds how many of you would be indexers?Before you say what I know you are going to say,I said 90% to make an extreme point.You are influenced and you know it.THAT DOES NOT MEAN YOU ARE EXPECTING THE SAME TOTAL RETURN THAT THE PAST GAVE YOU,but it does influence your decision to invest in the total market instead of managed funds.
Pkcrafter....Your point about mathematical certainty.The only certainty with an index is that you will have low cost,lower taxes and diversification of the market.The return is not a certainty and it can be 10% up or 10 % down over the next 20 years.
I read a paper written by a well known expert at Yale who stated that for a boglehead to be completely free of using past performance in choosing his or her investments is equivlant to being told not to think of a pink elephant and being able to not think of a pink elephant. :D
Honestly for the last time...I believe investing in the total mkt is the right thing to do for at least 95% of us,just be a little less dogmatic when someone likes a fund like Wellesley or Wellington and some of you accuse the poster of chasing past performance.They have not committed a crime :happy
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Re: Past Performance

Post by pkcrafter » Sun May 12, 2013 2:04 pm

Hoops wrote:
Pkcrafter....Your point about mathematical certainty.The only certainty with an index is that you will have low cost,lower taxes and diversification of the market.The return is not a certainty and it can be 10% up or 10 % down over the next 20 years.
It appears you did not read the suggested paper by William Sharpe. Investing in the market gives you the average of all active investors. Do you not believe that if the market is down by 10% over the next 20 years that all investors will be down an average of 10%? Do you believe active managers can do better in such an environment and that costs won't matter so much? Active investors cannot get what isn't there. The index return relative to the market and all active investors is a certainty. The absolute return is not a certainty, and of course that's why stocks are risky.
Honestly for the last time...I believe investing in the total mkt is the right thing to do for at least 95% of us,just be a little less dogmatic when someone likes a fund like Wellesley or Wellington and some of you accuse the poster of chasing past performance.They have not committed a crime
This is a completely different topic than the index one--don't confuse them. As I mentioned above, I don't have a problem with some active funds, especially those from Vanguard.

I participated in a recent Vanguard webcast on "Who should invest in active funds" and while it was interesting, I didn't really learn much. Here are the take aways. These are conclusions from the Vanguard panel, and not mine.

Fees are important
Fees, average
Vanguard active - 0.37%
Industry Index - 0.46%
Industry active - 1.05%

Probability of outperformance is no better in any market segment

You need to be more disciplined when using active funds

Expect lengthy periods of underperformance and continue to HOLD.

Actively managed funds should be used sparingly.

My take away is that Vanguard active funds are managed for the investors, not the profit of the company. They do not believe in go anywhere and that's a big plus. Low costs and sticking to the plan makes Vanguard funds more attractive options in the long term.



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Re: Past Performance

Post by ogd » Sun May 12, 2013 3:29 pm

hoops777 wrote:OK....The last poster,a very smart man says choosing to invest in index funds is NOT a strategy.Really?Then what is it?You and I have a different definition of that word.
Alright, the word "strategy" is maybe vague enough that I should have chosen my words better. What I meant was, we don't believe indexing is a specific investment strategy that produces outsized returns, but a method that outperforms because it's very low cost. If the answer to "what are you buying" is "everything, because I know nothing", that's a minimalistic strategy at best wouldn't you say? Ask an active fund manager and they'll say that an index fund is "flying blind" and "has no strategy", and that's why you should hand over your money to them instead. Oh, and thanks for the compliment :)
hoops777 wrote:Yes I am carrying past performance to an extreme because I was simply trying to make the point that we all use past performance to some extent to decide how to invest our money.It is really quite simple if you all would be honest with yourselves.To say that you are not influenced by the historica data of managed funds vs index funds is just not possible when you read all of your arguments.There is not one boglehead on this site that can say they are not aware of the history of index vs managed funds.You have all seen it,know it and are influenced by it to a certain degree.A simple question I will ask again......If the research showed 90% of managed funds historically with fees,taxes and all have returned 7% more than index funds how many of you would be indexers?Before you say what I know you are going to say,I said 90% to make an extreme point.You are influenced and you know it.THAT DOES NOT MEAN YOU ARE EXPECTING THE SAME TOTAL RETURN THAT THE PAST GAVE YOU,but it does influence your decision to invest in the total market instead of managed funds.
Yes, if past returns looked like that, I would think that maybe there is something to active management. To refuse to believe the evidence would be the worst kind of dogmatism. But as it happens, the evidence argues for indexing, matching the hypothesis that returns above or below the market are random and what matters is costs.

Think of it like this -- you can't have it both ways, either past performance means nothing and indexing is the logical choice because of costs, or past performance is an indication, and indexing wins because it's done so well. I should mention that the tilters (value/small/etc) on this board believe a version of the latter. I am not fully convinced that those premiums will survive the wide dissemination of the Fama-French ideas. We shall see.
hoops777 wrote:Honestly for the last time...I believe investing in the total mkt is the right thing to do for at least 95% of us,just be a little less dogmatic when someone likes a fund like Wellesley or Wellington and some of you accuse the poster of chasing past performance.They have not committed a crime :happy
If it's a crime, then I'm guilty :) I do hold Wellington, enough to qualify for Admiral shares, though less than I did and I'm not buying any more. It's a leftover from my initial round of investments, when I was buying based on Morningstar ratings without understanding what it's all about. Now that I know better, I'm still in no particular hurry to sell it, it's reasonably diversified, low-ish turnover and 0.17% is below my "cheap enough" threshold; but I am decidedly not holding it because of past performance, anymore. As for new investments, 0.17% is not 0.05%, and VWENX did distribute capital gains last December (which were most unwelcome), so TSM it is from now on.

Look, the greatest danger from believing in past performance is not buying & holding VWENX, it's performance chasing: you pick the latest hot fund, pay them enormous fees, then you get disappointed after a few years of bad returns and move on to the next one, perpetually buying high and selling low. Look at Morningstar's fund returns vs. investor returns, or their fund discussion boards for that matter, it's an eye opener. Performance chasing is a very strong human instinct and it's really really hard to convince people that "Europe has been underperforming lately, gotta sell it" is precisely the wrong thing to do. I think that's why Bogleheads' reactions to the whole past performance idea are so strong.

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Re: Past Performance

Post by umfundi » Sun May 12, 2013 4:24 pm

I am a latecomer to this thread.

I invest in Total Market funds because I believe they are on the efficient frontier, not because of past performance.

In a similar vein, I do not indulge in any kind of market timing, and pay no heed to momentum or reversion to the mean. By investing in Vanguard LifeStrategy Moderate I avoid any inclination to time my rebalancing events.

Keith
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Re: Past Performance

Post by enderland » Sun May 12, 2013 5:01 pm

I guess the way I look at it is there is a small percentage of total investments in index funds vs active investments (google suggests 10-15%). This means 85% or more of investments are being made by people who think they can beat the average, which is approximated by index fund(s). By definition, many if not most of these are wrong, and past experience shows this to be exactly what happens.

Worse still, fees mean an actively managed fund has to consistently beat lower cost index funds to actually result in a net benefit. Consider an index fund with 8% gain in a year vs an actively managed one with an ER of 1%. To tie the index, the active fund has to have roughly 13% more growth in that year (9% vs 8%). It's not just 1% more. The growth percentages are relative, so to avoid the ER causing the fund to do worse, the manager must have a considerably better improvement as compared to the index. This gets even worse in years with lower growth, if the overall market increases by 4%, then the active fund manager must have 25% more growth than the index to actually provide a better overall return.

This example might help. Imagine you had 100 people playing poker with $100 each and you need to decide which to financially back. Perhaps 10 of them decide they will play a separate game and just split the money afterwards so each leaves with $100. The other 90 play for keeps, but decide to charge you $2 as a fee to back them. They are all optimistic they can beat out the others. Your expected return on the first group is consistent - exactly average. The average for the other 90 will also be $100, but you will be paying $2 to get it, so your actual expected return is only $98. Possible to make more? Sure. But the expected value is less by definition. Which means, on average, you should invest in the first group to maximize your expected return.

Again, by definition, it is nearly impossible for all or even a large percentage of active funds to sustain double digit improvements in growth compared to the aggregate whole (which is pseudo approximated by index funds). The only real possibility here is active funds composed of sources outside the key indices they are compared against, which may have better relative growth... but this makes those comparisons fairly dubious at best.

None of this has anything to do with "past performance" at all.

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Re: Past Performance

Post by hoops777 » Sun May 12, 2013 6:51 pm

You guys are killing me.Why can't extremely smart people admit that their decision is influenced to some extent by past performance?I am not saying you are investing with the expectation to achieve the same past return,but that your decision HAS to be influenced at some level because you are aware of the history of managed and index funds.You did not wake up one beautiful morning with no historical knowledge of the market and say I am going to invest in index funds because they are low cost,blah blah blah.There are apparently a lot of bogleheads who have the superhuman ability to pass the pink elephant test.
In closing,most of you who responded are smarter than I am and I admit I carried the past performance thing to an extreme,but to say it has zero influence at any level at how you invest is simply not possible,unless you have zero knowledgeI of investing. Thanks for your comments. :sharebeer
K.I.S.S........so easy to say so difficult to do.

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Re: Past Performance

Post by avalpert » Sun May 12, 2013 7:51 pm

hoops777 wrote:You guys are killing me.Why can't extremely smart people admit that their decision is influenced to some extent by past performance?I am not saying you are investing with the expectation to achieve the same past return,but that your decision HAS to be influenced at some level because you are aware of the history of managed and index funds.You did not wake up one beautiful morning with no historical knowledge of the market and say I am going to invest in index funds because they are low cost,blah blah blah.There are apparently a lot of bogleheads who have the superhuman ability to pass the pink elephant test.
In closing,most of you who responded are smarter than I am and I admit I carried the past performance thing to an extreme,but to say it has zero influence at any level at how you invest is simply not possible,unless you have zero knowledgeI of investing. Thanks for your comments. :sharebeer
Geeze, you are killing me. Why can't you understand how theories work. You just don't seem to understand the difference between forming a hypothesis and testing in versus just looking at the data and thinking it is the story. No, the reason why I invest the way do is not at all due to past performance - using historical data is juat a way of validating the apriori hypothesis upon which it is based.

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Re: Past Performance

Post by pkcrafter » Sun May 12, 2013 8:12 pm

I guess we did not convince you, but the facts don't change. The beauty of indexing is you will do better than ~80% of investors over a 20 year period, and past returns simply validate the strategy--they don't provide the reason why the strategy works. If you fully understand the reason why they work, there is no point in reviewing past returns to embrace indexing.

I found the Diehards on M* in 1998 and no one said to look at past returns--they encouraged me to read and learn.

Having said all this, I am aware that some educated people cannot be happy indexing.

Paul
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Re: Past Performance

Post by ogd » Sun May 12, 2013 8:29 pm

pkcrafter: I don't think he came here to be convinced, but to play a game of gotcha. It might be best to let him be. Cheers!

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Re: Past Performance

Post by Bobbybell » Sun May 12, 2013 8:32 pm

pkcrafter wrote:I guess we did not convince you, but the facts don't change. The beauty of indexing is you will do better than ~80% of investors over a 20 year period, and past returns simply validate the strategy--they don't provide the reason why the strategy works. If you fully understand the reason why they work, there is no point in reviewing past returns to embrace indexing.

I found the Diehards on M* in 1998 and no one said to look at past returns--they encouraged me to read and learn.

Having said all this, I am aware that some educated people cannot be happy indexing.

Paul
It isn't indexing that wins. It is low expenses that wins. A low expense Vanguard active fund should be expected to beat a high expense index fund from somewhere else.

The index may beat 80% of all active funds, but it also beats close to 100% of all index funds.

I also think index versus active is one of the least important decisions that an investor can make. I think that being a passive investor is much more important than choosing passive investments.

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Re: Past Performance

Post by enderland » Sun May 12, 2013 9:39 pm

Bobbybell wrote:I also think index versus active is one of the least important decisions that an investor can make. I think that being a passive investor is much more important than choosing passive investments.
With all due respect, index vs active makes a huge difference.

If you have two funds:
Active: ER = 1%, annual return 7.5%
Passive: ER = 0.05%, annual return 8%

After 40 years of consistent contributions, a passive account will be 48% larger than the same from an active account. Even if the actively managed account only has an ER of 0.5% and it returns 7.75%, the passive account is still 21% larger after that time.

Now, granted, if you actively manage your retirement investments and play on your own you can make mistakes to cause damage much higher than 21%, but that is not a small difference.

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Re: Past Performance

Post by hoops777 » Mon May 13, 2013 11:51 am

Pkcrafter.....Maybe this will help you understand the way I look at this.In your own words you said at the beginning you were told to read and learn and not base your decisions on past results.In my mind when you read and learn you are of course looking at market history and how managed funds and index funds have performed.Did you not read about the historical data in your research?This info had to have some influence on your decision to be an index guy.There had to be a reason you chose to not invest in managed funds and that reason is because of the huge pct that underperform the index.So in that context the past performance of the market,the historical data influenced you to choose index funds.You may never think about it again but at some point you had to validate your investment choice.There has to be a reason you have a negative opinion of managed funds and that can only be based on their historical results.It is an extreme point but I believe it is just as extreme to say the historical data or past performance never at any level contributed to how you invest.Maybe I am just brain dead on this point but how can someone say they use historical data to validate their hypothesis and at the same time say that data has zero influence on their decision.Please give me ths one little point so I can sleep tonight and start eating again.Every decision we make in our life is influenced to some degree by our experience or knowledge of the past.No?I think I hear the guys coming to get me with the straight jackets :D
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Re: Past Performance

Post by Random Musings » Mon May 13, 2013 12:12 pm

hoops777 wrote:You guys are killing me.Why can't extremely smart people admit that their decision is influenced to some extent by past performance?
Because past performance doesn't mean squat. I'm looking at returns going forward. It's all about cost structure, diversification and tax efficiency. There are a variety of Index/passive funds that give you these tools to build your portfolio. Active funds have higher costs, less diversification and are typically less tax efficient. Three strikes and you're out !

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Re: Past Performance

Post by MindBogler » Mon May 13, 2013 12:18 pm

A theory can be backtested with known information which is not equivalent to using past performance for decision-making.

I'll also note that nothing is, has been, or can be proven. Someone earlier said something along the lines of, "the theory is proven." That isn't so. Theories are never proven (but they can be disproved).

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Re: Past Performance

Post by umfundi » Mon May 13, 2013 12:25 pm

Please see "Scientific Method". Wikipedia is as good a source as any.

Form a hypothesis or a theory. Get data to test the theory. If the data validates the theory, good. Example: Low cost passive index funds have better returns for investors than high cost active non-index funds.

If the theory is the data (like charting) where there is no prediction without the data, that is utilizing "past performance".

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Re: Past Performance

Post by YDNAL » Mon May 13, 2013 12:27 pm

hoops777 wrote:I know it is a big deal to ever own something based on past performance but isn't the entire Boglehead philosophy based on past performance? Own the total market because (my emphasis) it has outperformed 80 whatever pct of managed funds with its low fees and no stock picking.
You start with a faulty assumption, hoops777, and your entire hypothesis is faulty.

Last I checked, people who "own the total market" do so for (1) diversification, (2) cost, and (3) to avoid picking anything specific - especially picking because of past performance.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Past Performance

Post by allsop » Mon May 13, 2013 12:44 pm

The first chapter (No Guts, No Glory) of W. Bernstein's "The Four Pillars of Investing" is about historical financial risks and returns spanning thousands of years where one of the author's intentions was to give the reader an idea what is reasonably to expect in real return of an investment. Given that the book was published in 2002 one purpose was to lower the readers expectations of returns going forward.

So, I have indeed looked at past performance when investing, and so have many others.
Last edited by allsop on Mon May 13, 2013 1:14 pm, edited 1 time in total.

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