Recency Bias vs Market Cap

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
the_wiki
Posts: 2882
Joined: Thu Jul 28, 2022 11:14 am

Recency Bias vs Market Cap

Post by the_wiki »

The term "Recency Bias" is thrown around a lot on this forum. And I get why. Future returns are not based on past performance.

But it got me thinking. Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot. We now buy a couple percent of TSLA with each VTI share because TSLA had a huge run up in price in 2020, but we bought almost none 5 years ago. We buy 1% less META than we did last year because it has dropped in price significantly this year.

If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?
asif408
Posts: 2616
Joined: Sun Mar 02, 2014 7:34 am
Location: Florida

Re: Recency Bias vs Market Cap

Post by asif408 »

It is, but the reason it generally wins in the long run is that it is the lowest cost and lowest turnover strategy vs pretty much every other approach. So every other strategy has to outperform before even consider what they lose in fees and turnover. Over short periods it can be beat, but over a long period most other strategies will lose to it simply because of lower cost and churn.

That's why I'm generally not open to strategies other than market cap that don't keep costs and turnover minimal.
User avatar
UliKunkel1953
Posts: 232
Joined: Tue Dec 01, 2009 1:43 pm

Re: Recency Bias vs Market Cap

Post by UliKunkel1953 »

In an abstract sense, market cap weighting doesn't require *buying* more AAPL when AAPL goes up. Just holding. As the value of the shares go up, they adjust themselves to their new market cap.

Obviously there are logistics involved, and new companies come and go, but the basic idea is that the market cap weighting is somewhat self adjusting.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Recency Bias vs Market Cap

Post by vineviz »

the_wiki wrote: Thu Oct 06, 2022 12:19 pm If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?
No.

For one thing, "recency bias" is a well-defined cognitive bias that has little to do with the relative market capitalization of individual stocks. Recency bias is something all investors must confront, and might be responsible for investors FAVORING funds or asset classes that have done well recently. Look at all the "diversification is dead" threads for examples.

But "recency bias", strictly defined, has only marginal impact on the relative market capitalization of stocks: market cap is mostly a function of earnings, not valuation.

BTW, market cap funds do NOT "always buy more of the stocks that have done better last year". It's not uncommon to see language like this in the popular press, but it's not literally true.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
JohnFromPNW
Posts: 194
Joined: Tue Apr 26, 2022 11:58 pm

Re: Recency Bias vs Market Cap

Post by JohnFromPNW »

I took the "buy more" comment to mean when someone is contributing new dollars into their investment portfolio and buying more VTI, they are in turn now buying more of whatever has done better recently.
alluringreality
Posts: 1511
Joined: Tue Nov 12, 2019 9:59 am

Re: Recency Bias vs Market Cap

Post by alluringreality »

JohnFromPNW wrote: Thu Oct 06, 2022 1:18 pm I took the "buy more" comment to mean when someone is contributing new dollars into their investment portfolio and buying more VTI, they are in turn now buying more of whatever has done better recently.
That is also how I interpret the second paragraph in the original post. It's difficult to argue against the idea that investors buying across time and purchasing a total market fund receive a varying allocation depending on recent performance. For example the market portfolio and large cap performed relatively poorly after the late 1990s run up, as shown in the first link comparison to mid and small cap. Essentially the top of the market, especially large cap growth, had a big price increase and fall around 2000. Presuming the market is capable of creating colloquial bubbles, where an individual purchase happens potentially determines the received allocation, and relatively how badly a purchase might get hit by a decline. While something like RSP (equal-weight S&P 500) or YPS (reverse-weight S&P 500) has higher costs and turnover than a more market-based portfolio like VOO (S&P 500), it's difficult to say if market weighting will necessarily prove advantageous for a particular purchase in advance. William Berstein has basically suggested that what goes up in value faster might also end up going down in value faster.
https://www.portfoliovisualizer.com/bac ... ion3_3=100
https://www.portfoliovisualizer.com/bac ... tion3_2=50
45% US Indexes, 25% Ex-US Indexes, 30% Fixed Income - Buy & Hold
Topic Author
the_wiki
Posts: 2882
Joined: Thu Jul 28, 2022 11:14 am

Re: Recency Bias vs Market Cap

Post by the_wiki »

JohnFromPNW wrote: Thu Oct 06, 2022 1:18 pm I took the "buy more" comment to mean when someone is contributing new dollars into their investment portfolio and buying more VTI, they are in turn now buying more of whatever has done better recently.
Yes, that was what I was trying to convey.
acegolfer
Posts: 3029
Joined: Tue Aug 25, 2009 9:40 am

Re: Recency Bias vs Market Cap

Post by acegolfer »

If you look at that way, then yes. A new investor will buy more of companies that did well recently vs. investors who bought 1 month ago.

But I don't consider this as a bias. My investment decision is based on market weight not by past performance.
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Recency Bias vs Market Cap

Post by nisiprius »

the_wiki wrote: Thu Oct 06, 2022 12:19 pm... Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot...
No, we don't.

We buy VTI at a time when Apple is, perhaps, 3% of the total US market, and years later we find that Apple is 5% of our holding, but it didn't happen because we bought more AAPL. It happened without any purchases at all. The AAPL that was already in our holding simply became a larger percentage of the whole because AAPL did well. It did not involve buying more AAPL, the same number of shares of AAPL just gradually grew faster than the rest of the market and became a larger percentage.

It is a common misconception that indexing forces investors to buy more of stocks that are growing faster--that it is a momentum strategy. It is not. I don't know why it this misconception is so common. Maybe it is innocent confusion, or maybe it is just a plausible-sounding talking point for attacking indexing.

In any case, that isn't recency bias.

I don't happen to use a momentum tilt, which does mean systematically giving more weight to stocks that are growing rapidly, but that isn't recency bias, either.

Recency bias is mentally giving undue weight to recent performance... for example, buying the ARKK ETF in February of 2021 because it "destroyed" VTI in 2020.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
JohnFromPNW
Posts: 194
Joined: Tue Apr 26, 2022 11:58 pm

Re: Recency Bias vs Market Cap

Post by JohnFromPNW »

nisiprius wrote: Thu Oct 06, 2022 5:45 pm
the_wiki wrote: Thu Oct 06, 2022 12:19 pm... Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot...
No, we don't.

We buy VTI at a time when Apple is, perhaps, 3% of the total US market, and years later we find that Apple is 5% of our holding, but it didn't happen because we bought more AAPL. It happened without any purchases at all. The AAPL that was already in our holding simply became a larger percentage of the whole because AAPL did well. It did not involve buying more AAPL, the same number of shares of AAPL just gradually grew faster than the rest of the market and became a larger percentage.

It is a common misconception that indexing forces investors to buy more of stocks that are growing faster--that it is a momentum strategy. It is not. I don't know why it this misconception is so common. Maybe it is innocent confusion, or maybe it is just a plausible-sounding talking point for attacking indexing.

In any case, that isn't recency bias.

I don't happen to use a momentum tilt, which does mean systematically giving more weight to stocks that are growing rapidly, but that isn't recency bias, either.

Recency bias is mentally giving undue weight to recent performance... for example, buying the ARKK ETF in February of 2021 because it "destroyed" VTI in 2020.
Yes, but what if we now buy VTI again with Apple at 5% with new monies transferred to our investment portfolio? I think that’s the question.
alluringreality
Posts: 1511
Joined: Tue Nov 12, 2019 9:59 am

Re: Recency Bias vs Market Cap

Post by alluringreality »

nisiprius wrote: Thu Oct 06, 2022 5:45 pm We buy VTI at a time when Apple is, perhaps, 3% of the total US market, and years later we find that Apple is 5% of our holding, but it didn't happen because we bought more AAPL. It happened without any purchases at all. The AAPL that was already in our holding simply became a larger percentage of the whole because AAPL did well. It did not involve buying more AAPL, the same number of shares of AAPL just gradually grew faster than the rest of the market and became a larger percentage.
According to VTI fund details, on 8/31/2022 Apple was 6.07% of a new purchase, and Microsoft was 4.91%. Either of these may end up essentially being overpaying relative to other parts of the purchase. It's not entirely unreasonable to suggest that purchasing Apple or Microsoft today at market weight might be based more around past performance, instead of reasonable future expectations, at least such a fate isn't entirely unusual historically. Of course long-term investors basically hope one of the lesser-weight purchases eventually grows to displace the current pack leaders, which often happens historically.
https://awealthofcommonsense.com/2017/0 ... st-stocks/
45% US Indexes, 25% Ex-US Indexes, 30% Fixed Income - Buy & Hold
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Recency Bias vs Market Cap

Post by JoMoney »

Note everyone is buying a market cap weighted portfolio, some people are withdrawing/selling. Along the lines of what OP suggested, perhaps those people drawing down their index fund portfolio are selling more of the stocks recently high priced. :D
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
Logan Roy
Posts: 1838
Joined: Sun May 29, 2022 10:15 am

Re: Recency Bias vs Market Cap

Post by Logan Roy »

the_wiki wrote: Thu Oct 06, 2022 12:19 pm The term "Recency Bias" is thrown around a lot on this forum. And I get why. Future returns are not based on past performance.

But it got me thinking. Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot. We now buy a couple percent of TSLA with each VTI share because TSLA had a huge run up in price in 2020, but we bought almost none 5 years ago. We buy 1% less META than we did last year because it has dropped in price significantly this year.

If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?
The way I prefer to think about it is that market cap weighting is the only possible portfolio everyone in the market can hold at once, and because it doesn't need rebalancing, it incurs fewer costs than other ways of putting indexes together.

In essence, I don't think you're wrong – in that cap-weighting is always a snapshot of recent market history. But I think it's more a question of: how would you weight an index to produce a *better* result? Equal-weighting is probably no less valid – and has a history of returning a bit more – but it's more expensive to do, so knowing nothing about what weightings will work better in the future, cap-weighting makes more sense because it factors in the only variable we can be certain about: costs.
User avatar
arcticpineapplecorp.
Posts: 15080
Joined: Tue Mar 06, 2012 8:22 pm

Re: Recency Bias vs Market Cap

Post by arcticpineapplecorp. »

if you bought apple when it was 3% of the market (so $3 of every $100 invested) and now it's 5% of the market:
1. your $3 invesment out of ever $100 just made you $2 on every $100 you previously invested. Congratulations.
2. your new $100 investments will now buy $5 of apple out of every $100. That might or might not be good depending on if apple in the future is >5% or <$5% of the market.

but here's the thing.

the market has determined that apple should make up 3% of the market and now it should make up 5% of the market.

Do you know more than the market?

If yes, then what do you plan to do about that?

Also ask yourself if you think you know more than the market ask yourself if you could have been thinking apple makes up too much of the market back when it was 3% of the market (many did) only to see it rise to make up more of the market (at 5%). And you could have sold apple when it was 3% of the market thinking it was too much of the market...only to have been wrong, because it then went up and became 5% of the market, right?

If no, (you can't outsmart the market) then you have to surrender to the market and accept the return of the market, right?

if you can't beat em, join em.

has that been a bad thing?

Jack Bogle used to say the market has given a fair and decent return to investors throughout time. It's allowed people to have a comfortable retirement. What's wrong with that?

I don't think trying to outsmart the market is a wise strategy but if you do, perhaps we should be discussing overconfidence bias instead of recency bias?

thoughts?
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
User avatar
Donnie Baseball Fan
Posts: 76
Joined: Fri Aug 28, 2009 1:32 am

Re: Recency Bias vs Market Cap

Post by Donnie Baseball Fan »

I have thought about this before, more specifically about the global market cap between U.S. and ex-U.S. For a while I thought that it might be interesting to hold 100%-US global market cap share in US stocks, and 100%-ex-US market cap share in ex-U.S. stocks. In other words, if right now market cap is 58% US and 42% ex-US, to hold 58% ex-US and 42% US. I would have to manually adjust these percentages if I were to implement this, though.
What made me think about this is that usually future returns are inversely related to current valuations, and these current valuations make up the global market caps the way they are. It would reason to think that you would want more of the lower valuations and less of the higher ones.
NoRegret
Posts: 505
Joined: Sat Dec 16, 2017 1:00 am
Location: California

Re: Recency Bias vs Market Cap

Post by NoRegret »

the_wiki wrote: Thu Oct 06, 2022 12:19 pm The term "Recency Bias" is thrown around a lot on this forum. And I get why. Future returns are not based on past performance.

But it got me thinking. Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot. We now buy a couple percent of TSLA with each VTI share because TSLA had a huge run up in price in 2020, but we bought almost none 5 years ago. We buy 1% less META than we did last year because it has dropped in price significantly this year.

If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?
Yes cf Rob Arnott/fundamental indexing.
Market timer targeting long term cycles -- aiming for several key decisions per asset class per decade
billaster
Posts: 2930
Joined: Wed Apr 27, 2022 2:21 pm

Re: Recency Bias vs Market Cap

Post by billaster »

Some people get hung on the concept of market cap weighting. But for Total Stock Market it is really simpler than that. If you buy a Total Stock Market Fund there is no "weighting". You own everything, every share. You get exactly the same rate of return as if you bought every single share of every single public company -- all $40 trillion of it.

So you have one alternative, Total Stock Market, in which you own every share of every company. Any other alternative you have to decide which shares of which companies you shouldn't own.
User avatar
firebirdparts
Posts: 4411
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: Recency Bias vs Market Cap

Post by firebirdparts »

the_wiki wrote: Thu Oct 06, 2022 12:19 pm Isn't the entire basis for market cap weighting based on recency bias?
Sort of. Sometimes people will twist the idea of past performance not being a guarantee of past performance and they'll change it, in writing, to where they'll say past performance is not an indication of past performance, as if there was some chance that next summer we'll be living at the bottom of the ocean and eating rocks. It's ridiculous.

The correct word has always been guarantee. And that's what that means.

There's every reason to believe that tomorrow will be very similar to today. Once in a while, something strange happens locally, like a hurricane, or the war comes through town. Even in those cases, most things continue to occur normally. People have to eat.
This time is the same
Call_Me_Op
Posts: 9881
Joined: Mon Sep 07, 2009 2:57 pm
Location: Milky Way

Re: Recency Bias vs Market Cap

Post by Call_Me_Op »

asif408 wrote: Thu Oct 06, 2022 12:44 pm It is, but the reason it generally wins in the long run is that it is the lowest cost and lowest turnover strategy vs pretty much every other approach.
Does it generally win over the long term? Where is the evidence for that, and what is the metric?
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Recency Bias vs Market Cap

Post by nisiprius »

Call_Me_Op wrote: Fri Oct 07, 2022 7:31 am
asif408 wrote: Thu Oct 06, 2022 12:44 pm It is, but the reason it generally wins in the long run is that it is the lowest cost and lowest turnover strategy vs pretty much every other approach.
Does it generally win over the long term? Where is the evidence for that, and what is the metric?
One piece of evidence for that is the S&P SPIVA reports, for which the metric is "return."

For "risk-adjusted return," there is mathematical theory with the usual pack of assumptions--assumptions which are neither realistic nor totally crazy--which says that the market portfolio, the entire set of stocks in a market, which is intrinsically cap-weighted, has the highest Sharpe ratio of any weighting.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Recency Bias vs Market Cap

Post by nisiprius »

NoRegret wrote: Thu Oct 06, 2022 10:27 pm
the_wiki wrote: Thu Oct 06, 2022 12:19 pm ...If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?...
Yes cf Rob Arnott/fundamental indexing.
The proof of Rob Arnott's pudding is in the eating. The performance of e.g. the Schwab Fundamental US Large Company Index, which at $6 billion in assets I think is the largest real-world trial of RAFI fundamental indexing, has been a major yawn. The best you can say about it is "no complaints," but based on, yes, past performance, it's hard to see any obvious reason to prefer it over the cap-weighted S&P 500.

What is particularly notable to me is that despite avoiding participation in stocks with weaker fundamentals, it experienced a slightly deeper drawdown in 2008-2009 than the S&P 500 index fund, -55% versus -51%. And again in 2020, -26% versus -24%.

Plausible-sounding fantasy reasons why some other weighting ought to be better than cap-weighting are a dime a dozen.

source

Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
markus75
Posts: 78
Joined: Mon Aug 15, 2022 7:45 am

Re: Recency Bias vs Market Cap

Post by markus75 »

JohnFromPNW wrote: Thu Oct 06, 2022 6:35 pm Yes, but what if we now buy VTI again with Apple at 5% with new monies transferred to our investment portfolio? I think that’s the question.
It's true that more dollars are going to the biggest companies. But the important point is, that each dollar which goes into VTI buys the equal share from each company. So it will affect the stock price of each company by the same. It does not inflate the stock prices of big companies more than the stock prices of small companies.
MBB_Boy
Posts: 899
Joined: Sat May 12, 2018 4:09 pm

Re: Recency Bias vs Market Cap

Post by MBB_Boy »

For the record, there are also equal weight indexes for people who are concerned about this kind of thing.
User avatar
arcticpineapplecorp.
Posts: 15080
Joined: Tue Mar 06, 2012 8:22 pm

Re: Recency Bias vs Market Cap

Post by arcticpineapplecorp. »

MBB_Boy wrote: Fri Oct 07, 2022 8:50 am For the record, there are also equal weight indexes for people who are concerned about this kind of thing.
but why is that the magic solution to this "problem"? (I'm putting this in quotes because posts like this about the so called "problems of market cap weighting" is a solution in search of a problem)

If apple makes up 5% of the market but there are 3000 companies then in an equal weight, wouldn't apple only be 1/3000% of the market along with the other 2999 companies that would also each be 1/3000% of the market?

should one own apple in the same percentage as the smallest of the 3000 companies in the market?

if so why?

If the OP is concerned with the percentage of ownership in the market of a company, like apple, for instance, there's a lot of space between owning it at market cap (say 5% of total stock holdings) and 1/3000%, right?

what's the right percentage then, and why?
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
JohnFromPNW
Posts: 194
Joined: Tue Apr 26, 2022 11:58 pm

Re: Recency Bias vs Market Cap

Post by JohnFromPNW »

billaster wrote: Thu Oct 06, 2022 11:36 pm Some people get hung on the concept of market cap weighting. But for Total Stock Market it is really simpler than that. If you buy a Total Stock Market Fund there is no "weighting". You own everything, every share. You get exactly the same rate of return as if you bought every single share of every single public company -- all $40 trillion of it.

So you have one alternative, Total Stock Market, in which you own every share of every company. Any other alternative you have to decide which shares of which companies you shouldn't own.
I’m not sure I follow the logic here; VTI is weighted on market cap. Yes, you own everything, but in proportion to their market caps. So you own far more Apple than, say, lululemon. Not that there’s anything wrong with that, but it is “weighted”.

As an example of an alternative, buying VOO will give you different weights of each underlying security in S&P in proportion to their market cap. However, buying RSP (Invesco equal weight S&P) will give you equal weights of all the same companies as in VOO. The same would apply for an equal weight VTI equivalent (although I’m not aware of one).
alluringreality
Posts: 1511
Joined: Tue Nov 12, 2019 9:59 am

Re: Recency Bias vs Market Cap

Post by alluringreality »

JohnFromPNW wrote: Fri Oct 07, 2022 9:14 am I’m not sure I follow the logic here; VTI is weighted on market cap. Yes, you own everything, but in proportion to their market caps. So you own far more Apple than, say, lululemon. Not that there’s anything wrong with that, but it is “weighted”.
I agree that total stock market funds have relative weights assigned by the market. My best guess is the statement might include a viewpoint that is in a bit more agreement with efficient-market hypothesis (EMH) than my own take. Agreeing with ideas like "asset prices reflect all available information" and "market prices should only react to new information", I suppose I'm able to reinterpret the suggestion as indicating market prices represent fair value, which includes relative valuation. Personally I'm not sure emperical evidence entirely supports such a position, especially the strong-form category. I'm willing to entertain various ideas, including EMH. As a long-term investor I tend to wonder how the market ends up assigning two tech companies nearly 11% of the entire US market, so there are other concepts, such as the beauty contest.
https://en.m.wikipedia.org/wiki/Keynesi ... ty_contest
Last edited by alluringreality on Fri Oct 07, 2022 11:28 am, edited 1 time in total.
45% US Indexes, 25% Ex-US Indexes, 30% Fixed Income - Buy & Hold
NoRegret
Posts: 505
Joined: Sat Dec 16, 2017 1:00 am
Location: California

Re: Recency Bias vs Market Cap

Post by NoRegret »

nisiprius wrote: Fri Oct 07, 2022 7:58 am
NoRegret wrote: Thu Oct 06, 2022 10:27 pm
the_wiki wrote: Thu Oct 06, 2022 12:19 pm ...If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?...
Yes cf Rob Arnott/fundamental indexing.
The proof of Rob Arnott's pudding is in the eating. The performance of e.g. the Schwab Fundamental US Large Company Index, which at $6 billion in assets I think is the largest real-world trial of RAFI fundamental indexing, has been a major yawn. The best you can say about it is "no complaints," but based on, yes, past performance, it's hard to see any obvious reason to prefer it over the cap-weighted S&P 500.

What is particularly notable to me is that despite avoiding participation in stocks with weaker fundamentals, it experienced a slightly deeper drawdown in 2008-2009 than the S&P 500 index fund, -55% versus -51%. And again in 2020, -26% versus -24%.

Plausible-sounding fantasy reasons why some other weighting ought to be better than cap-weighting are a dime a dozen.

source

Image
Proof of pudding is in the eating indeed. Let’s see how it does in this bear market and beyond. I suspect it will do better. It is essentially a large value fund overweighting energy and financials, which explains the drawdowns observed.

Backrests are useful but mostly in the sense of telling how something behaved under various economic conditions.

I’m not in this personally, there are better hiding places in equity land.
Market timer targeting long term cycles -- aiming for several key decisions per asset class per decade
JohnFromPNW
Posts: 194
Joined: Tue Apr 26, 2022 11:58 pm

Re: Recency Bias vs Market Cap

Post by JohnFromPNW »

nisiprius wrote: Fri Oct 07, 2022 7:58 am
NoRegret wrote: Thu Oct 06, 2022 10:27 pm
the_wiki wrote: Thu Oct 06, 2022 12:19 pm ...If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?...
Yes cf Rob Arnott/fundamental indexing.
The proof of Rob Arnott's pudding is in the eating. The performance of e.g. the Schwab Fundamental US Large Company Index, which at $6 billion in assets I think is the largest real-world trial of RAFI fundamental indexing, has been a major yawn. The best you can say about it is "no complaints," but based on, yes, past performance, it's hard to see any obvious reason to prefer it over the cap-weighted S&P 500.

What is particularly notable to me is that despite avoiding participation in stocks with weaker fundamentals, it experienced a slightly deeper drawdown in 2008-2009 than the S&P 500 index fund, -55% versus -51%. And again in 2020, -26% versus -24%.

Plausible-sounding fantasy reasons why some other weighting ought to be better than cap-weighting are a dime a dozen.

source

Image
A comparison between VFINX (Vanguard 500) and RSP (Invesco equal weight 500) paints a somewhat favorable comparison for non-market weighting, with RSP slightly outperforming after the higher fee since its inception. But, again, only slightly.
invest2bfree
Posts: 1279
Joined: Sun Jan 12, 2020 8:44 am

Re: Recency Bias vs Market Cap

Post by invest2bfree »

the_wiki wrote: Thu Oct 06, 2022 12:19 pm The term "Recency Bias" is thrown around a lot on this forum. And I get why. Future returns are not based on past performance.

But it got me thinking. Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot. We now buy a couple percent of TSLA with each VTI share because TSLA had a huge run up in price in 2020, but we bought almost none 5 years ago. We buy 1% less META than we did last year because it has dropped in price significantly this year.

If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?
The way I look at this is "Recency Bias" is defined as over weighting an asset class above and beyond its market cap weighting.

If Every dollar invested is equally smart then Market cap weight is your default position.


Investing anything over 60% in VTI would be considered a recency bias.

At 60/40 VTI/VXUS would not.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
acegolfer
Posts: 3029
Joined: Tue Aug 25, 2009 9:40 am

Re: Recency Bias vs Market Cap

Post by acegolfer »

invest2bfree wrote: Fri Oct 07, 2022 11:20 am Investing anything over 60% in VTI would be considered a recency bias.
It's called home bias.
Topic Author
the_wiki
Posts: 2882
Joined: Thu Jul 28, 2022 11:14 am

Re: Recency Bias vs Market Cap

Post by the_wiki »

invest2bfree wrote: Fri Oct 07, 2022 11:20 am
the_wiki wrote: Thu Oct 06, 2022 12:19 pm The term "Recency Bias" is thrown around a lot on this forum. And I get why. Future returns are not based on past performance.

But it got me thinking. Isn't the entire basis for market cap weighting based on recency bias? We buy more APPL in VTI because APPL has done really well the past 10 years and so its stock is worth a lot. We now buy a couple percent of TSLA with each VTI share because TSLA had a huge run up in price in 2020, but we bought almost none 5 years ago. We buy 1% less META than we did last year because it has dropped in price significantly this year.

If market cap funds always buy more of the stocks that have done better last year, and less of the ones that did worse, isn't that just grand scale recency bias?
The way I look at this is "Recency Bias" is defined as over weighting an asset class above and beyond its market cap weighting.

If Every dollar invested is equally smart then Market cap weight is your default position.


Investing anything over 60% in VTI would be considered a recency bias.

At 60/40 VTI/VXUS would not.
What about investing in stocks vs bonds? Total value of all bonds issued globally is about the same as the total market cap of all stocks. Is it recency bias to have anything other than 50-50 Stock vs Bonds?

Do we extend this to real estate and precious metals market cap? What about cash market cap?

How far do we take this?
rkhusky
Posts: 17763
Joined: Thu Aug 18, 2011 8:09 pm

Re: Recency Bias vs Market Cap

Post by rkhusky »

Market cap weighting is the weighting most tolerant of mergers and spin-offs.

Imagine that two companies merge and the resultant single company maintains the same combined market share, expenses, products, as prior to the merger. The only thing that changes is the top level ownership (and perhaps name and stock symbol).

No changes would be needed for a cap weighted index. Weighting methods closer to equal weighting would need to sell shares of the new company because two companies became one and they weigh ownership (and name and stock symbol) more than market share.

The reverse happens with spin-offs. Imagine that Berkshire-Hathaway spun off all its holdings as individual companies. Weighting closer to equal weighting would need to buy more of those spun-off companies, whereas a market cap fund would not need to change its allocation.

It’s odd when so much emphasis is given to the the stock symbol, compared to the market share, products, cash, technology, and assets under the stock symbol.
invest2bfree
Posts: 1279
Joined: Sun Jan 12, 2020 8:44 am

Re: Recency Bias vs Market Cap

Post by invest2bfree »

acegolfer wrote: Fri Oct 07, 2022 11:36 am
invest2bfree wrote: Fri Oct 07, 2022 11:20 am Investing anything over 60% in VTI would be considered a recency bias.
It's called home bias.
It is both.

Recency bias causes home country bias.

A fun experiment go to year 2008 in this forum and see how many people were asking about international stocks.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
alluringreality
Posts: 1511
Joined: Tue Nov 12, 2019 9:59 am

Re: Recency Bias vs Market Cap

Post by alluringreality »

rkhusky wrote: Fri Oct 07, 2022 12:53 pm Market cap weighting is the weighting most tolerant of mergers and spin-offs.

Imagine that two companies merge and the resultant single company maintains the same combined market share, expenses, products, as prior to the merger. The only thing that changes is the top level ownership (and perhaps name and stock symbol).

No changes would be needed for a cap weighted index. Weighting methods closer to equal weighting would need to sell shares of the new company because two companies became one and they weigh ownership (and name and stock symbol) more than market share.
One example of this is the research from Bessembinder and Labriola that suggests "Just over 4% of stocks are responsible for boosting the market’s overall returns higher than those on Treasury bills." The percentage partly results from their methodology of using equal weighting, and because their timeline covers 90 years. Within their equal weight framework "stocks are delisted, for both positive (e.g., due to acquisition) or negative (e.g., share price below specified minimums) reasons", so the calculation draws no difference between merged or other defunct companies. New companies are added every year, and defunct companies remain in the data forever, so that also tends to skew the percentage. When authors typically using a market weight framework, and writing to investors with shorter timelines, draw attention to this factoid there's probably a reasonable potential for misinterpretation.
viewtopic.php?p=6769329#p6769329
45% US Indexes, 25% Ex-US Indexes, 30% Fixed Income - Buy & Hold
User avatar
steve r
Posts: 1300
Joined: Mon Feb 13, 2012 7:34 pm
Location: Connecticut

Re: Recency Bias vs Market Cap

Post by steve r »

acegolfer wrote: Fri Oct 07, 2022 11:36 am
invest2bfree wrote: Fri Oct 07, 2022 11:20 am Investing anything over 60% in VTI would be considered a recency bias.
It's called home bias.
I suspect though, for some, it can be both. U.S. outpeformed recently, so ...

Interestlingly though, "one" of the reasons I own international at close to cap weighting is the same concern some have about too much of XYZ stock, be it Apple, Microsoft or Tesla today, ExxonMobile, Cisco, or AOL, in the past (or even 2nd Bank of the U.S. for stock market historians).

If you want less of XYZ, more of something else you already own (like RSP does or fundemental funds do) and I am tempted by this but have not pulled the trigger.

Alternatively, just buy something else completely -- in my case international at close to cap weight.
"Owning the stock market over the long term is a winner's game. Attempting to beat the market is a loser's game. ..Don't look for the needle in the haystack. Just buy the haystack." Jack Bogle
MBB_Boy
Posts: 899
Joined: Sat May 12, 2018 4:09 pm

Re: Recency Bias vs Market Cap

Post by MBB_Boy »

arcticpineapplecorp. wrote: Fri Oct 07, 2022 8:59 am
MBB_Boy wrote: Fri Oct 07, 2022 8:50 am For the record, there are also equal weight indexes for people who are concerned about this kind of thing.
but why is that the magic solution to this "problem"? (I'm putting this in quotes because posts like this about the so called "problems of market cap weighting" is a solution in search of a problem)

If apple makes up 5% of the market but there are 3000 companies then in an equal weight, wouldn't apple only be 1/3000% of the market along with the other 2999 companies that would also each be 1/3000% of the market?

should one own apple in the same percentage as the smallest of the 3000 companies in the market?

if so why?

If the OP is concerned with the percentage of ownership in the market of a company, like apple, for instance, there's a lot of space between owning it at market cap (say 5% of total stock holdings) and 1/3000%, right?

what's the right percentage then, and why?
I never said it was. I don't use them
Gaston
Posts: 1220
Joined: Wed Aug 21, 2013 7:12 pm

Re: Recency Bias vs Market Cap

Post by Gaston »

MBB_Boy wrote: Fri Oct 07, 2022 8:50 am For the record, there are also equal weight indexes for people who are concerned about this kind of thing.
I don’t own one, but I understand the advantage of an equal weight index is that more of your dollars go into smaller cap stocks (where “smaller” is a relative term vis-a-vis the average for the relevant index). And if you believe that smaller cap stocks will outperform larger cap stocks, then you too will outperform.
“My opinions are just that - opinions.”
Gaston
Posts: 1220
Joined: Wed Aug 21, 2013 7:12 pm

Re: Recency Bias vs Market Cap

Post by Gaston »

billaster wrote: Thu Oct 06, 2022 11:36 pm If you buy a Total Stock Market Fund there is no "weighting". You own everything, every share. You get exactly the same rate of return as if you bought every single share of every single public company -- all $40 trillion of it.
Perhaps I am misunderstanding your point, but if you buy a total mkt index fund, your dollars still will be invested in specific companies based on their cap weighting.
“My opinions are just that - opinions.”
User avatar
firebirdparts
Posts: 4411
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: Recency Bias vs Market Cap

Post by firebirdparts »

Gaston wrote: Sat Oct 08, 2022 9:57 pm
billaster wrote: Thu Oct 06, 2022 11:36 pm If you buy a Total Stock Market Fund there is no "weighting". You own everything, every share. You get exactly the same rate of return as if you bought every single share of every single public company -- all $40 trillion of it.
Perhaps I am misunderstanding your point, but if you buy a total mkt index fund, your dollars still will be invested in specific companies based on their cap weighting.
yeah, I think everybody else probably doesn't need to be informed about this. Just one person.
This time is the same
User avatar
arcticpineapplecorp.
Posts: 15080
Joined: Tue Mar 06, 2012 8:22 pm

Re: Recency Bias vs Market Cap

Post by arcticpineapplecorp. »

MBB_Boy wrote: Sat Oct 08, 2022 9:17 am
arcticpineapplecorp. wrote: Fri Oct 07, 2022 8:59 am
MBB_Boy wrote: Fri Oct 07, 2022 8:50 am For the record, there are also equal weight indexes for people who are concerned about this kind of thing.
but why is that the magic solution to this "problem"? (I'm putting this in quotes because posts like this about the so called "problems of market cap weighting" is a solution in search of a problem)

If apple makes up 5% of the market but there are 3000 companies then in an equal weight, wouldn't apple only be 1/3000% of the market along with the other 2999 companies that would also each be 1/3000% of the market?

should one own apple in the same percentage as the smallest of the 3000 companies in the market?

if so why?

If the OP is concerned with the percentage of ownership in the market of a company, like apple, for instance, there's a lot of space between owning it at market cap (say 5% of total stock holdings) and 1/3000%, right?

what's the right percentage then, and why?
I never said it was. I don't use them
right, thanks. that's good to know. I was just writing this for those who might be considering equal weight as a solution to the "problem" of market cap weighting.

and I think these are questions (above in red) that someone who does want to equal weight should probably ask themselves before doing so.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
Post Reply