Good reads from around the Web.
Many economists claim that all investors are rational and that all known facts are incorporated into prices.
I think differently.
That doesn’t mean it’s easy to beat the market – quite the opposite, it’s demonstrably incredibly difficult and most people shouldn’t try – but that’s another matter.
A suitably advanced alien onlooker or an all-seeing God could tell you how many people are standing on one leg on the planet Earth right now.
It’s a knowable fact, but you or I would just be guessing.
Faulty logic
People who write about investing (myself included, no doubt) detract even more credibility from the rational market school of thinking.
Frequently you’ll read statements that are just plain silly.
For instance, I regularly hear US ‘experts’ proclaim that the rise in popularity of index funds and ETFs in the past few years is due to the steady rise in the value of the stock market.
But that’s just a US perspective, with its main markets hitting all-time highs on a regular basis in 2014.
The growth of indexing has been just as visible in the UK.
Yet our leading market – the FTSE 100, down again in 2014 – is still below its peak achieved in 1999.
The active edge that isn’t
On the same note, we often hear some of those US pundits proclaim that people will abandon index funds for active funds when a bear market strikes.
Articles like this recent anti-indexing one in Market Watch claim that “stock pickers have an edge in a downturn”.
Are we really going to have to spend another year debunking this stuff?
Firstly, the market consists entirely of stock pickers and passive funds (the latter being by definition neutral)
So for every active stock picker who wins there must be a stock picker who loses.
The claimed “edge” is therefore a mathematical impossibility.
Secondly, you might ask why indexing is growing in popularity in the UK, where as I say our leading index is yet to recover from the past two bear markets?
The answer might be that at least some of those who tried active funds have discovered they were scant protection from the bear market in 2008 and 2009.
Market ups and downs are unknowable, but costs are nailed-on.
Why is this so hard for people to grasp?
Not quite a road to nowhere
Anyway, while the woeful headline performance of the FTSE 100 over the past 15 years seems about as good an advert for tracking an index as North Korea’s economy is for collectivism, it’s not been quite as bad as all that.
Why?
Dividends, dear boy, dividends.
Hargreaves Lansdown notes that:
‘It is easy to look at the level of the FTSE 100 and to conclude the market has gone nowhere for 15 years, but even someone who invested £10,000 in the UK market at the worst possible time would now be sitting on £17,206 with dividends rolled up.
That said, it has been a white knuckle ride at times, encompassing the tech crash, the global financial crisis and two bull markets. But despite all that, the equity market has delivered significant returns ahead of inflation for long term investors.’
The other thing to stress is a properly diversified passive investor would only have a portion of their assets in UK equities.
You’ll have made good elsewhere while the FTSE 100 has wobbled nowhere, just as the US markets will likely one day disappoint and the FTSE 100 prosper.
What nobody should be doing is looking for silver bullets.
As Ben Carson writes:
“There are no shortcuts to the process. It’s never going to be easy. No one is ever going to be able to guarantee you an extremely high return number year in and year out. The markets just don’t work that way.
But some people really want to believe that it’s possible. They want the Holy Grail of investing with all of the upside but none of the downside.”
You want 15% a year guaranteed? Get thee to a fraudster!
Here’s to another year of investing ups and downs.
From the blogs
Making good use of the things that we find…
Passive investing
- The folly of forecasts – Canadian Couch Potato
- Ready to increase global equities [Pretty active-ish?] – Rick Ferri
Active investing
- Investing on auto-pilot – The Escape Artist
- “Buy Europe” – The Reformed Broker
- How to invest like Sherlock Holmes – Millennial Invest
- The drivers of 0% rates and low wage growth – Investing Caffeine
- Another deep dive into the decline in the oil price – Econbrowser
Other articles
- The trouble with ‘socially responsible’ funds – Bankers Anonymous
- It’s winter: Get outside and enjoy it! – Mr Money Mustache
- How money can sometimes buy happiness – Nerd’s Eye View
- 3 powerful lessons from lifestyle guru Tim Ferris – Addicted 2 Success
- Far too many strong articles around for blogging comfort! – Rockstar Finance
Product of the week: Halifax and Lloyds Bank – owned by the same company, of course – have launched new 34-month 0% offers on credit card balance transfers, reports The Guardian. Such deals can be handy for helping manage down debts (or even for generating a profit in nimble hands) but don’t use them as an excuse to rack up more problems.
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1
Passive investing
- There will be active decisions in a passive world – Bloomberg View
- Huge John Bogle interview [I missed this before Christmas!] – ETF.com
- And also this Buron Malkiel interview [Hey, it was hectic…] – ETF.com
- Swedroe: The shorting premium [Warning: A bit technical] – ETF.com
Active investing
- Neil Woodford’s views on 2015 – Guardian
- A wiser approach to alternative investing – Think Advisor
Other stuff worth reading
- 14 meaningless stock market phrases – Business Insider
- Average Bank of Mum & Dad deposit hits £18,505 – Telegraph
- More on house buying in 2015 – Telegraph
- 8 secrets of success from early retirees – Market Watch
- What’s your number? – The Certifiable Planner
- Cancer is “the best way to die” says doctor – Telegraph
Book of the week: The science of spending is getting more nuanced. Happy Money
Like these links? Subscribe to get them every week!
- Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” [↩]
Comments on this entry are closed.
“So for every active stock picker who wins there must be a stock picker who loses.” Why’s this? Cet par, if every company suddenly doubled their earnings wouldn’t everyone win? It isn’t a zero sum game, especially when you factor dividends: you can make a capital loss and still be up overall. Or, if you go long and the price increases, are you referring to the seller losing? There are lots of reasons for sales. It probably isn’t a major factor but, for example, estates are liquidated all the time and stocks and bonds will be dumped with no consideration of anything.
Hmm, FTSE100 going up while US markets tank. Well here’s the thing, it rarely seems to happen, they go down in tandem but the US seems to eek out better gains when they head up over a period.
My FTSE100 trackers are the only ETFs I have still in negative territory since switching to an all-ETF (plus 1 investment trust) portfolio.
What I like most about them is the higher than world average 3%+ dividend yield, but this index stubborness in getting near its 15 year old high is getting a bit tedious. Still people are writing scare articles that a new crash is imminent as the market has peaked after an “unprecedented” 5 year bull market, I just can’t see the FTSE100 bucking the trend if that does happen even though its already been feeble in the last year.
Thank the lord for index linked gilt ETFs though, they’ve done great.
@Willem — Morning! I think you are confusing the return from the market with the return from active investing?
The market is not a zero sum game; active stock picking must be a zero sum game.
Imagine if you have a market with just three investors in it. One is a passive follower of the index, the other two are active stock pickers, A and B.
The passive index investor just holds the market.
Let’s say Stock Picker A believes a particular company, Monevator Industries (MI), is going to go up more than Stock Picker B believes it will.
The only way this can be expressed is A acquires shares off B.
So now they all have the market, except that A has more exposure to MI than B does. A is overweight MI versus the market. B is underweight.
If MI goes up, A will do better than B. If MI goes down, B will do better than A. It’s a zero sum game.
In practice it’s worse because both A and B will charge fees for their talents, which will detract from their returns versus the market (which is held more cheaply by the passive investor) and yet only one of A or B will outperform; the other must underperform.
Obviously this is a simplification and in reality there are millions of investors and tens of thousands of securities, but this is how it works, scaled up. See the videos under the ‘Is This’ link above for more details.
@semipassive — Over the long-term the US market has indeed beaten the returns from the FTSE 100. I don’t have the figures to hand, but it’s a couple of percent extra real return per year over the past 100 years or so, from memory.
Over the short run remember that the UK market yields more than the US — about 2% more — while the main indices are capital only indices.
I think the US has had too many good years versus the rest of world on the run to keep outperforming in the medium term; over the long-term if I was forced (I’m not! 🙂 ) to buy just one market in the whole world I’d probably choose the US, even at this valuation, because of its dynamism and diversification.
But this is all scurrilous speculation from someone who explains that stock picking is a zero sum game, while active investing himself. So take it FWIW! 😉
@semipassive&TheInvestor
http://www.schroders.com/static/images/TVP/tvp-why-graph.gif Cumulative return from low and high yielders within the Top 100 UK stocks, 1900-2010
The market is efficient or not? It doesn!t matter for an average investor. The question is can an average investor beat the team of Goldman Sachs or Schroders?
> So for every active stock picker who wins there must be a stock picker who loses.
It’s an edge case, but I have to challenge the logic of this universal assumption. You’re implying buyers and sellers in a fixed total sum – Benjamin Graham’s voting machine. I am an active stock picker, though I do have index fund to muddy the waters too. In general I try not to sell – I am building a HYP. You can make the case that I might gain less than were I to use an index fund (so far not proven in the case of the FTSE All-share that would be my alternative) but I don’t see the loser. I turn up in the market, ideally at lows like the halcyon years of 2009 and 2011, and, hopefully, 2015, and proffer cash in return for a bit of some firms.
I’m looking to buy a slice of other people’s work, eventually taking the dividend as income and roughly letting capital gain look after inflation. I am not trying to get ahead at somebody else’s expense. In an infinitesimal way I am capitalising hopefully productive enterprise, intending to benefit from the return.
Isn’t that what the stock market is meant to be for? We have added a lot of sturm und drang with trading and high frequency whatnot and hedge funds, but you don’t have to take part. Indeed, there is probably more implicit trading in the index fund section of my portfolio than the HYP individual share section.
Not all the activity in the market is trading. By far the majority is, probably. But some of it does reflect real companies making goods and services that people want to buy, and it appears that the value of this activity creeps up over the long run. All this is sat on top of a shocking level of noise and hum and volatility due to the voting machine, but Graham’s weighing machine is still in there. Much smaller than in his day, not doubt, but without that essential component the stock market becomes like a branch of Ladbrokes.
Hi TI
Happy New Year!
“Yet our leading market – the FTSE 100, down again in 2014 – is still below its peak achieved in 1999” demonstrates nicely that if you buy an over priced asset you can expect under performance against the average in the coming years. The question then is simply ascertaining over/undervaluation and how you can benefit from knowing that information… 🙂
I’m still waiting for some fund laggards to stump up their divi’s for 2014 before certainty of 2014 portfolio performance but I estimate 2014 will have stumped up 5.6% for me. So divi’s plus a diversified portfolio is still working for me.
Cheers
RIT
It is interesting to read Mr Woodford’s views in The Guardian, even if the link claims to be to The Telegraph! Thanks for a great blog and wishing everyone a prosperous New Year.
> So for every active stock picker who wins there must be a stock picker who loses.
Only the grand total of winnings and the grand total of losses (compared to the market as a whole and ignoring the transaction costs) made by active stock pickers are equal. Your statement implies that the number of winners equals the number of losers, which does not have to be true and is very unlikely to be true. This does not really matter as far as your overall argument is concerned, but still…
as i only started properly investing 2014 , its good to hear that the ftse 100 hasnt moved much in the past 15 years . so buying in now at non inflated prices means theres a good chance it could take off at some point ,so good capital gains too. but in the meantime youve got the dividened payments . as i keep reading DONT chase last years winners!
my uk property fund held within aviva pension has done very well this year up about 10%
ive had a 3% div return from my HYP sofar but thats only at 6 months of investment.
hopefully i may get to 5% div return by the time 1 year is completed.ill know for sure next june.
when isa opens next april i plan on buying more trackers. cant decide between van ftse uk equity income or SPDR uk div aristocrats . but im still keeping my HYP of mainly defensive stocks .
Happy New Year everyone.
@ermine — We’ve been through this before when you wrote something similar, but perhaps you never saw my reply.
If you’re saying that you own index funds and also individual shares because you enjoy a nice dividend yield and that suits your habits / plans / style fine, then that’s great, no argument.
If you’re saying that you believe this combination will beat the market, then that’s fair enough too. This particular argument today isn’t about whether we/one can beat the market or not. 🙂
But if you’re saying you’re not engaged in a zero sum game, then I believe you’re wrong.
Simplifying, you own the market (your index funds) plus some other shares that pay a high yield. That is your ’tilt’ away from the market. To obtain this tilt, money out there *must* be tilted the opposite way (‘they’ own fewer than the market’s allocation of your higher yielding shares).
If your shares plus the index do better than the market, than somewhere out there someone (… see below!) does worse.
It’s just maths. 🙂
All the share trading / activity / etc stuff is a red herring from the ‘zero sum game’ point of view, it’s not relevant. (It *is* relevant to the “active investing is a bad bet because it’s a zero sum game MINUS COSTS” argument).
Finally, you may well do better than the market because your high yield shares are a way of betting on value, and as T.A. has explained at length recently, the value premium exists. A classic explanation would be you’re taking on more risk, too.
@oldthinker — Yes, quite right, I was using shorthand but I can see it could be confusing. Basically we’ve written over 1000 articles of over 1000 words each, so over a million words, so (a) I think we can be excused the odd shortcut and (b) as evidenced by comments above, around and around we go anyway.
Finally, it’s clumsy to write out the long-form all the time from an understanding POV, too.
@paulypips — Oops, fixed now.
@RIT — Cheers, Happy new Year to you too.
@Dawn — happy new year!
@Gregory — Good point. HNY!
The market cannot be a zero sum game as the amount of money entering the market will theoretically be growing through regular personal investments and pension fund regular purchases. Therefore there will never be a zero sum game event as in a normal situation there is always share price growth as more money entering the market pushes for share price gains. There may be zero sum games with single shares but across the market as a whole it cannot be zero sum and single share movements due to big changes in sentiment.
@Matty — Yes, the market isn’t a zero sum game for various reasons. Active stock picking is.
I don’t think your argument is quite correct though. From memory there are times when there are net outflows of funds from the market, though I can’t quite recall if the data is only for mutual funds. (I’m on the tube!)
Greetings. Been a reader for a few years, but I believe this might be my first comment.
I agree with your article almost in it’s entirety. But I must side those arguing against this line: “So for every active stock picker who wins there must be a stock picker who loses.”
Simply not true (in all cases). One active picker can buy a stock at say $10 (I’m in the US). Hold it for 2 years, then sell it at $15. And pick up some nice dividends along the way. Then another active stock picker buys it and holds it for a few years. He eventually sells it at $20. That buyer holds it for a few years, then sells it at $25.
They have all been net winners.
The first two owners are only possibly losers if you consider opportunity cost. But even then, they may have actually done better by investing their profits elsewhere.
I like reading about passive investing. It is a bit boring but very important. Boring is good because passive investing is not about hot tips. It is like a religion. You go to church, take part in ceremonies to reinforce Your faith. I read articles about passive investing, visit blogs like this and write comments to reinforce my faith in passive investing.
@All — I am getting bored of this now. 🙂
I did not say that investing in the stock market is a zero sum game.
The phrase “Zero Sum Game” was introduced in the first comment on the article by a reader.
I did imply that “Active stock picking” is a zero sum game. As I said in my reply to oldthinker, this was shorthand, but it is shorthand for “all market-beating active investment must come at the expense of market-losing active investment”.
You guys are all discussing the returns from investing in the stock market or from owning companies not the returns from stock picking Fund A versus Fund B versus the market.
My point isn’t even debated by the active guys. It’s self-evident.
I’m not even saying here that nobody can beat the market, or that the market is efficient. I am simply saying here that if someone (/some weight of money) beats the market, it’s at the expense of someone who does less well.
In the case of @JayJay’s comment above, the market (/an index fund) owns that example company with the growing dividend, and benefits from its growth and income.
The person who owns *more* of the successful company than the market might do better. If s/he does then the person who owns less of it (a person who must exist, for the other person to own more of it) *must* do worse, because they don’t own as many shares than the market, or as the other investor.
I think the confusion may come from people (not me!) who do say “investing is a zero sum game” as shorthand.
For instance, in this otherwise good explanation from Vanguard, they saying “investment markets” when they really mean “trying to beat the market is a zero sum game”.
https://www.vanguard.co.uk/documents/adv/literature/zero-sum-game-2013.pdf
E.g. From that article:
I suppose the word ‘market’ has sufficient ambiguity to make their statement correct, but it is confusing.
Here’s another more academic explanation from some Noble prize winners. Feel free to prove them wrong and pick one up for yourself.*
http://www.dimensional.com/famafrench/essays/why-active-investing-is-a-negative-sum-game.aspx
If you want to argue with my points, you need to argue that active management/stock picking is not a zero sum game, NOT that investing in the market is. I never said it was. In fact, I’d have to be crazy, utterly stupid, and very poorly equipped to write an investment blog to do that.
I’m the guy who was reminding people in the depths of the bear market that the stock market has delivered strong positive real returns over the long-term. Of course the market delivers a positive return over time (except in cases of revolution/suspension/hyper-inflation, such as Germany, China, Russia at various points, but that’s yet another argument).
(*Note: The thing you have to prove wrong is the equilibrium, not the idea that prices are always efficient. (Robert Schiller won his Noble for at the least introducing doubt in this area). The debate on this article is NOT about efficient markets. It’s simply and entirely about whether market-beating returns can be generated out of thin air in the absence of equivalent market losers. They can’t. It’s maths).
@The Investor It is very simple, I agree with You. Is it possible to beat the market? YES. Is it simple for a common guy to beat the market? NO.
Here it is a quote from a “famous” active investor:)
” It’s a zero sum game, somebody wins, somebody loses. Money itself isn’t lost or made, it’s simply transferred from one perception to another.” Gordon Gekko
@Gregory — Yes. But the point is even if it *was* simple for some cohort of investors, say readers of Monevator or particular hedge funds or long-term dividend investors or whatever you like, it would still be a zero sum game.
For them to beat the market, an equivalent amount of money would have to lose to the market.
End of story.
Passive investing is very boring. I don’t mind. Be patient and live long:
http://www.aaii.com/files/images/articles/9298-figure-1.jpg
@ The Investor A Market consists of investors. Investors contend with each other but the market has no competitor. There are a lot of investors and only one Market.
And of my story.
@The Investor The zero sum game argument can be difficult to understand, it is not intuitive to most people unless carefully explained, so please be patient with those who question it and say “what about this case..” 🙂
The rubbish output about active management will never stop as so many livelihoods depend upon suckering private investors in, so please keep up the good fight.
Regarding the FTSE 100 delivering lousy returns, my response would be so what, the FTSE 100 is less than 10% by value of globally investible equity markets. It is poorly diversified, unfortunately heavy in precisely the sectors that have done badly, so why overweight it in a passive portfolio? Last year my equity portfolio (boring trackers), delivered a return of more than 10% with very little of it coming from my UK trackers. But that is OK as I had no way of knowing in advance that the returns from the UK would have been so poor. If I could get an overall return of 10% every year but lousy returns from a few of my trackers I would be very happy indeed.
Next week I will balance up, mainly by reducing US equities and gilts which had a good year. Some of the proceeds will go into the FTSE 100, as for all I and anyone else knows this could be the year it shines.
One point about the low dividends on US shares. It is worthwhile pointing out that a lot of US companies earnings are returned to investors as share buybacks, rather than dividends. The cash going into buybacks is in many cases more than the dividends. I don’t have a precise figure, but if last year’s S&P 500 share buyback cash had come in the form of dividends then the historic yield may be more like 4% than 2%. However, most investors would end up paying 15% or more tax on the dividends, which is probably one of the reasons that US companies favour buybacks.
Also, chasing after higher dividend yields, as these HYP and other dividend strategy investors do can be a dangerous game. It can tilt a portfolio to value, which may give higher returns in the long run, but there is no free lunch here. Investors who do this are taking on increased risk and reducing diversification. Risks which may not pay off for decades, especially if the popular equity income stocks become overbought.
Happy New Year one and all.
Picking up on the FTSE100 comments, have coincidentally just been drawing together an end of year review, part of which reads :-
“Pity the UK investor who put all his funds into the FTSE100 in December 1999. Such an investor has yet to break even. Even at year end 2014 they would be 6% nominal (41% real) below water with only the dividend income to show for the efforts. The FTSE100 is in any event rather a curious collection of companies, heavily biased to banks, oil, mining and pharmaceuticals. Could 2015 be their year?”
Unquote
Over that period using intelligent/dynamic (value orientated) asset allocations suggest an investor should comfortably have at least doubled maybe tripled their capital in nominal terms, even after drawing an income.
Still, could be worse, look at the Nikkei since 1989!!
Prosperous 2015 to us all!!
I realize I might be splitting hairs here, and I apologize if it gets tedious. But I think this is an important topic, and one that many people don’t understand. And it keeps some people from investing in stocks altogether.
I agree completely that if someone gets gains in excess of “the market”, then some else necessarily got gains less than the market.
Or if “beta” is the market return, and “alpha” is excess return earned by someone, then someone else had to earn beta-alpha.
My point is that “beta-alpha” can still be a positive number.
Many people don’t get that. They hear the term “zero sum game”, and think that any profit made by an investor comes from some other investor’s pocket. One person “bet right” and won money from another person who “bet wrong”. AKA, the Wall Street Casino.
Yes, this should be obvious to anyone who has passed Investing 101. But I’ve had to explain it to newbies over and over again!
@Jay Jay, if you really want to split hairs, it would be more precise to say that if “beta” is the market return, and “alpha” is excess return earned by someone, then the aggregate earnings of all other market participants has to be beta-alpha before costs, but beta-alpha can still be positive 😉
Yes, Naeclue, you are correct!
Thanks!
Yes, perhaps a new post explaining it via ((beta+alpha / beta-alpha) minus costs) is called for. That is an elegant way of putting it, provided one is prepared to explain again the terms/concepts beta and alpha first I suppose.
I’d love to do it in 500 crisp words that are easily digested. I wonder if it’s possible?
I agree that it’s ironic that half the time we’re trying to persuade ‘sophisticated’ investors that active management cannot in aggregate do what it universally promises (not to say some can’t/won’t beat the market, but in total it cannot, for reasons we’ve gone through a dozen times above) and on the other hand there are all those never-investors out there who believe the naysayers who shriek it’s a winner takes all casino.
Oh well, gives us all a reason to keep on keeping on. 🙂
Thanks for the further thoughts.
I just read the 14 meaningless stock market phrases. Hilarious, but I realised I used the word “overbought” in a previous comment. Sorry about that, but just goes to show how easy it is to accidentally slip into gibberish.