There also seems to be some changing of the language, or I just misinterpreted some things. It's hard to get what is meant.
longinvest wrote:[*] I said that to make an asset allocation choice, there is no need for taking into consideration future return predictions. Note that I did not say that one cannot or should not take them into consideration; I said that one does not need to do so.
First of all, the thread title is "The Futility of Predicting Future Returns." That implies one should not take them into consideration, unless they like exercises in futility. (I'm pretty sure, that by responding here, I don't have enough of an aversion to such exercises.
I think that it is futile to use predictions, because one has no guarantee to select the best asset allocation that will deliver the highest return. One might as well loose all the anxiety and select a good enough
asset allocation using a Three-Fund Portfolio.
There is no contradiction, here. Just because I think that it is futile, doe not mean that one cannot
make or use predictions to select an asset allocation (AA); one can, but I think that it is futile. If one cannot sleep at night without using predictions to select an AA, then one should use predictions to set his AA; but this will remain futile, because one will not get an outperformance guarantee out of using these predictions. But, worse, if the predictions are used to put all one's money into one asset, then this could be harmful, not only futile.
I have yet to see anybody, in this thread, provide an actionable
alternative, like a better way to construct a portfolio using return predictions that is guaranteed
to outperform the proposed good enough
portfolio built without return predictions.
Fundamentally, going back to this:
longinvest wrote:Can you provide (1) tight-enough ranges and (2) guarantees, so that youingr predictions would be useful to me?
It depends on what kind of edge or information you think is actionable and useful.
Let's say you're a sports bettor and you're betting on the outcome of a game (versus the points spread). If you assume the line is placed at the median outcome (in practice this is not a great example because it's frequently not), there's a 50/50 chance of winning the bet. Let's say you do some snooping around and notice that the star player on one team suddenly came down with flu-like symptoms but nobody's reported on it yet. Is this information actionable?
You said, yourself, in your explanation of "expected value", that:
"Expressing a view on what we think (future) expected value will be does not require crunching future data, as stated above. It is a guess, a prediction.
"In real life, statistics is always subjective to some degree.
So, there is an embedded risk
a future return prediction, because the prediction is necessarily tainted
by subjective choices of the person making the prediction.
If you consider, on top of this prediction risk, the large error range of the prediction (which does not account for the subjectivity risk), then you end up into arbitrary
territory; you must acknowledge that you are making a bet. You've simply chosen a different approach than tossing a coin.
The framework I explained (that I have learned on this forum) to put no less than 25% in each of bonds and stocks, harvest market returns (guaranteed) in three markets, while considering that bonds are less volatile than stocks, but that stocks can deliver much higher (or lower) returns, is hard to improve upon.
Note that this framework does not
in any way depends on analyzing past return data. Not betting more than 3:1 on one asset is just rational. That bonds (total market, of course) have limited volatility is just due to mathematics of bond funds. That stocks have a chance at much higher growth (but can be subject to crashes, too), is due to the nature of stocks. You can analyze past data across all countries; this will always be true
, whether stocks or bonds outperform.
We still obviously can't guarantee who will win, but the odds have improved, perhaps enough in your favor that you might be expected to earn money by betting on the opposite team, even net of fees. Different people may disagree about what the expected value of a bet on the other team might be, what the information really means. It depends. Context is big.
This defies basic logic. This would mean that, lucky me longinvest, I have been privy to some secret information available publicly on the Bogleheads forum in posts of generous benefactors of market-beating advice.
Why should I believe that publicly available information hasn't been acted upon by institutional investors? Why would all the hedge funds, pension funds, and others ignore Fama-French research on factor investing? Why should only the select few Bogleheads members, that have been so lucky to be exposed to this theory daily in the forums, be the only ones acting on this information?
If, instead, institutional money has already acted on this information; why should I believe that market prices have not already adjusted? Why shouldn't I consider the possibility that I'm be the goat to be sacrificed
, here (and maybe you too)?
lack_ey wrote:Even in a market where you don't have unique information, if there is some feature about the conditions and setup—e.g. people seem to bet too frequently on speculative small growth stocks with zero profitability, resulting in low risk-adjusted returns historically—this may translate to an actionable edge if you suspect that certain features seen in the past have some chance of continuing to some degree in the future. No guarantees, but maybe you're doing better than flipping a coin now. These things are based on return expectations, that certain stocks will do worse than other ones, even. Never mind the much less controversial positions of "stocks have higher expected returns than bonds, probably."
Demand and supply does not rule out the possibility that a segment of the market is priced, often enough, so as to deliver higher returns, if it exposes investors to higher volatility and risk. But, I do not believe in free lunches.
In other words, one can always get a chance at even higher returns by taking the risk of even lower returns. There are many ways to do that, including tilting and leverage.
I am relatively conservative. I prefer to be the tortoise than the hare, even if it's not flashy.
I do believe in mathematics, though. So, I know
that when I invest in a low-cost total-market index fund, I am guaranteed to reap market returns, whatever they are. Not only that, but I'll also beat the active investors of that market in the aggregate, after fees. (Sharpe's theorem