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Top investor Warren Buffet agrees with this "dogma." He just won a bet that index funds would outperform hedge funds during 2007-2017. [1] Trust him, not /r/personalfinance.

[1] https://www.cnbc.com/2018/01/03/why-warren-buffett-says-inde...




The advice to use index funds is sound and most people should follow it. But that “bet” is a very weak argument for it. Buffett bet against a particular hedge fund manager who as far as I can tell was only in it for the publicity.

There are plenty of hedge funds which beat the market so significantly and so consistently over long timespans (even decades) that choosing any single one of them would have handily won the bet. But the bet was for a “fund of funds” approximately tracking the aggregate hedge fund industry, not any particular one. Buffett wouldn’t have taken a bet involving any of the single superlative funds because he understands this point already.

The core thesis vindicated by that bet is simply this: most participants in the market don’t do well. You didn’t really need a public bet with a famous investor to prove this - the stats have been available for quite a while. Buffett obviously believes people can beat the market, or he wouldn’t be in the business he’s in.

Therefore, the point stands. It’s dogmatic to act as though beating the market is impossible. It’s not necessarily advisable to try it because it’s quite difficult, but throwing around citations of Buffett’s bet don’t really improve honest education. Most people aren’t going to become pro athletes either, so you shouldn’t bank your future on it. But that doesn’t mean it’s impossible or that you can’t (responsibly) pursue it.


This post is disingenuous. What percentage of hedge fund managers would beat an index fund? What percentage of people have access to said hedge funds?

And even if you can beat the market, how much time, money and energy are you going to use to beat it? Taking into account the margins by which you may beat it by, is it worth it? Probably not for a single individual even thinking about this question.

Common now.


My comment isn’t disingenuous. I’m neutrally presenting the reality that it is possible to beat the market. I’m not saying most people should try it, and in fact I specifically stated most people should stick to index funds. I also specifically admitted most people who beat the market are outliers, just like professional athletes.

The point here is that it’s dogmatic to continually say, “you won’t beat the market, don’t even try, look what Buffett says about it”. I have laid out, in this thread and others I’ve linked to, how it is possible to beat the market in principle. No, not everyone will do it, but people will want to try anyway, so in my opinion they may as well be equipped for success, insofar as they can be.

I haven’t tried to undermine the position that index funds are the best option for most investors. I’m just providing perspective for those who understand that and want to try actively trading anyway. I dislike the blind advocation of index funds in a matter of fact manner - it doesn’t actually improve financial education as poignantly as discussions such as this one do. A complete presentation should include the subject in entirety, not the, “We know what’s best for you” version.


The part that is disingenuous is this:

> There are plenty of hedge funds which beat the market so significantly and so consistently over long timespans (even decades) that choosing any single one of them would have handily won the bet

You say there are plenty that would beat the market, OK, sure. How many would not? What percentage of the funds would win? The way you frame the conversation is disingenuous, given this entire conversation (grand parent and post before that) are about retirement strategies, presumably for average folks.

Beating the market may not be strictly impossible, but no one here other than you claimed that. The fact that it is improbable is just that, a fact. So yeah, disproving a claim no one made and denouncing dogma is pretty disingenuous, imo.


I’ll repeat, I never made a claim that any percentage other than outliers beat the market. Let me restate my point succinctly for you: I consider it dogmatic to frame the conversation as the grandparent comment did, which is saying, “Don’t even try, you’ll lose.” That is dogmatic, which is dentrimental to financial education in general - the reasoning of facts is as important for independent learning as the facts themselves. I provided nuance in the discussion by explaining how it’s possible to beat the market, without ever disagreeing that the best course of action is to simply invest passively. I’ve actually reiterated several times now that most investors should just invest in index funds.

I’m not sure what in particular you’re arguing against, because it doesn’t appear to be relevant to my central point as I’ve explained it in this thread. You act as though I’m saying that it’s easy to beat the market, when my entire thesis here has been that it’s not correct to declare people will fail out of hand. If anything, I think I’ve taken rather extreme pains to tediously and explicitly point out the caveats so as not to be disingenuous in my points.

In fact, I literally made a comparison to professional athletics in my first comment, which is (statistically) a lottery. If that isn’t enough, what more do you want? More pertinently, I am focused more on complete education that allows people to be self-sufficient: would you advocate saying to kids, “Don’t even bother trying to go pro, you’ll fail.”, or would you advocate explaining to them the honest chances, encouraging them to have fallback plans for their careers, and then providing them with the best chance they can have for what they already want to do? People respond far more favorably to neutral, complete presentations of facts than they do to imperative statements that don’t provide a clear context for their justification.


I'm not arguing anything. I'm just expressing an opinion that the comment you made is disingenuous since it's entirely centered around a claim around impossibility that no one made other than you.

The original comment that said "you will lose" is in jest, obviously. Someone who's confident that they wouldn't lose wouldn't be here reading a step by step plan to become a millionaire as they'd already be far beyond that.


If they're "outliers", their success can be explained by chance. With many people tossing coins, some will do very well by the laws of probability.

The other problem is you're measuring success in hindsight, not from the beginning. (You could restate it as if from the beginning if you had the full list of initial hedge funds - including those that no longer exist).

The point is that you can't predict which funds will be successful.

Buffett beats the market - but he does it by understanding the businesses behind their stocks, their value and prospects, compared with their present price. He buys value for money, and generally holds it for the long term. He isn't an active trader, which to him is speculation.


You're both right. There are traders who beat the market in a way that's clearly statistically significant and doesn't involve selling tail risk or other cheats. However, they can stop being successful at any time.

To give a concrete example, GETCO circa 2009 was the premiere HFT firm trading 19% of US equities market volume and earned high 9 figures in trading profits on a tiny capital base. They were doing millions of little trades daily and made profits almost every day, if not every day. The odds of someone doing that due to chance are infinitesimally small.

They had been doing this since the early 2000s, quietly building an empire, and the people there were incredibly bright. They had their pick of the litter from every top school and one of the toughest interview processes. Retention was impressive, too, as the firm made many employees into millionaires in their early 20s and gave them plenty of autonomy. You'd look at this operation and expect it'd never end.

But it did, and quite quickly. Competitors eventually learned what they were doing and saturated the market. Their market share plummeted, as did profits, while the cost base grew. High speed data and microwave lines became a new cost of doing business. Layoffs happened. Once loyal employees defected and with them went even more of the firm's ideas.

Eventually they got a soft landing by buying out KCG, and the entire operation was later acquired by Virtu, but from what I understand, few of the original GETCO trades still exist or make any profits.

So I believe they won due to skill at the time, not luck, but more skillful competition came along to replace them. Some small group will always beat the market, but I'd need more evidence to believe one group would do it for a long time. Brain power and guarding IP are necessary but not sufficient.


> If they're "outliers", their success can be explained by chance. With many people tossing coins, some will do very well by the laws of probability.

No, they cannot be. I meant outlier in the sense of a probability distribution with e.g. standard deviations, not to imply randomness. I’ll start by quoting what I wrote the last time this topic came up on HN:

“Virtu only lost money trading one day out of 1278 trading days between 2009 and 2014. In the most uncharitable analysis (1278/2; or the lost day happened in the middle), they had a 0.5^639 chance of doing that.

Maybe you disagree with 0.5 per day. Let's make it 0.9!

...But that's still 5.7 x 10^-30. How many firms do we need to exist for this to emerge by chance?”

Draw up a probability space for me and actually quantify what you’re asserting. What is an event? Is it a single trade? A trading day? A trading year? How many of these events are there, total, in that timespan? Of those, how many win? Can you map each of these events to a boolean function, such as a coin toss, or are the chances more nuanced? This is before we even get to the issue of quantifying risk as a metric.

How about we make the event a trading year; how many funds would need to exist to explain hedge funds like RenTech or Baupost? Moreover, can you explain three decades of extraordinary returns in a single fund as an outcome consistent with a uniform distribution across all eligible hedge funds?

This armchair probability analysis turns up every so often on HN, but to be blunt, the onus is on the analysis to actually make it empirical. You can’t just say “well, they’re doing this by chance, we can expect some of these to eventually emerge because statistics and coin tosses” without formally proving that there are actually sufficiently many hedge funds and criteria to satisfy that claim.

> Buffett beats the market - but he does it by understanding the businesses behind their stocks, their value and prospects, compared with their present price. He buys value for money, and generally holds it for the long term. He isn't an active trader, which to him is speculation.

This is false. Buffett is, by his own admission, an active investor. He picks stocks - what is your definition of an “active investor” if not someone who makes active decisions about how to invest? His letter, “The Superinvestors of Graham and Doddsville”, specifically outlines his investing and describes it as an active strategy.[1] In fact, the way you’ve described his work is an investment thesis consistent with modern trading strategies. At their core, statistical arbitrage and high frequency methods seek to identify price inefficiencies just as Buffett does, but on much smaller timescales. It’s a difference of degree, not category.

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1. https://www8.gsb.columbia.edu/rtfiles/cbs/hermes/Buffett1984...


You misquoted me with "active investor"; I said he wasn't an "active trader". As I reinforced by saying he was long term, he is an investor rather than a trader.

Select your set of traders today. Make predictions on how they will perform. Compare with what happened.

Of course we should expect them to be better than pure chance. This article itself is about insider trading, which should give an edge. And yet, the hedge fund average is indeed worse than chance investment in the market (which approaches the index). The point is: we don't know who will do well. We only know in hindsight.

Hedge funds also have management fees (higher than index funds), and pay more in brokerage for their active trading.

> statistical arbitrage and high frequency methods seek to identify price inefficiencies just as Buffett does, but on much smaller timescales. It’s a difference of degree, not category.

A difference is the sustainability of the inefficiencies identified. Perhaps if Buffett was purely an old-school value investor, picking up discarded cigars for a few puffs, there's an argument for similarity. But (as I carefully stated in my comment), he also looks at prospects, not just value. A business with a long-term sustainable economic moat makes money at a compounding rate.

Now, I think we could have a largely semantic argument about whether buying a business with those prospects is just identifying price inefficiencies. To be honest, I can't really forsee how that argument would turn out, because of course you can view it as mispricing. Perhaps I can submit: more of the work is in evaluating the prospects, than the price (maybe you can argue the same for trading); simply because of the time-scale of long-term investing, you get to keep it longer, so it's more stable (but you can argue that that's covered by difference in timescales).

PS. Also, I do wonder that Buffett also has better information. His dad was a senator, and he knows lots of influential people. I don't think it explains away his success, but it would be some help.


Isn't this basically the Texas Sharpshooter Fallacy? There are how many thousands of hedge funds? Of course some of them will beat the market. (And some will not beat the market, and all of them will charge fees far greater than an index fund.)

If most of them don't beat an index fund and there's no way to tell winning funds from losing funds in advance, then the smart money is to never invest in a hedge fund.


No, it’s not the Texas Sharpshooter Fallacy. See my response to the other commenter in this thread forwarding (essentially) the same argument. You cannot claim that some event is reducible to chance just because it’s in a small minority of successes out of many more failures. There are stat arb funds which have beaten the market for decades consistently. HFT firms make millions of trades per day with a consistently positive win rate. No matter what you define as a trading event, the probablity analysis is not going to hold up.


I do absolutely agree with dsacco even though I had my share of arguments in the past with him...

You can absolutely beat the market, but you have to work on it and put the effort, same as you can heal people (as be a doctor), create awesome businesses (as entrepreneur), etc...


Sure, an index fund may win over time, but part of what a hedge fund is supposed to do is to hedge against the market. A lot of hedge fund customers are pension funds, people close to retirement, etc. For these people, the long term health of fund is of course important, but they can't afford the volatility - if their investment loses 10% of its value in a year, they may not be able to make the payments or subsist on the income as much as they wished.

As a result it's not really fair to compare the long term performance of a hedge fund with an index fund. Index funds are more aggressively invested and thus more volatile.


OK, but what about the (many) hedge funds that are volatile? There are indeed funds that are better than index funds, but they're inaccessible to the average person, and therefore irrelevant.


You're right, there are volatile hedge funds, although it might be accurate to say that there are more and less volatile funds than indices. Moreover, there are plenty of bad funds that only exist to dupe clueless retail investors into giving them their money. I wouldn't say that all hedge funds are good, and in fact regular people are probably screwed when it comes to picking a good one (in part because some hedge funds are what I like to call "20/20 funds" and are just statistical testaments to the fact that some fraction of poorly managed funds will still do well).

Volatility isn't a binary thing. Although the less-volatile more-return funds are out of reach for regular people, the less-volatile less-return funds are not, and these still have a lot of value for people who are less tolerant of risk.


Calling someone disingenuous is a very strong claim you didn't even attempt to justify. The only argument you offered is aimed at a strawman: GP never disputed that beating the market is really hard and trying it is probably dumb.

While I'm here, it's "c'mon, now".


How long can the index fund advice be sound as index funds are moving from following the market to making the market?

The sheer magnitude of success of the various index funds that invest proportionally to the market cap of the top 500 stocks, in aggregate, could have the effect of perpetuating the status quo, masking indicators from non-index investor activity.


My understanding was that Buffet invited a bet from any hedge fund manager, and the guy he ended up betting against was the only fund manager in the industry willing to bet on his own product.


That’s not correct. The actual bet was always for a “portfolio of funds of hedge funds.”[1]

If the bet had been for a single fund, Simons or Klarman or any other hedge fund manager who has been beating the market by a large margin for 20 - 30 years could have won easily. But that bet wouldn’t have been instructive, because the world really doesn’t need to be shown that there are a minority of funds capable of winning the bet - on the contrary, it’s helpful to show that a representative sample of them fares poorly on average. Moreover, being a fund manager himself, Buffett would have been silly and hypocritical to actually support the former type of bet.

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1. http://longbets.org/362/


I noticed that the stocks that ETFs and stock screening algorithms like moved had much higher correlation with the indexes during last week’s correction.

This is just based on a quick spot check, but I’m worried the passive investment craze has weakened the link between business fundamentals and pricing for the stocks in the most popular indexes.

If so, that increases correlations in the pricing of assets that were explicitly chosen because their prices have no or negative correlation with each other.


Check out https://heisenbergreport.com/. Hes was talking about this last year a lot.


Mr. Buffet has made his whole fortune beating the index. What he bet on was on average returns across hedge funds would be beaten by the index. Constituting this average will be some funds who make a lot of money for their investors consistently and some that lose money.


Why doesn't Warren Buffett follow this strategy himself? Clearly there are other factors at play.


(copy from a comment I made half a year ago)

"The way to become rich is to put all your eggs in one basket and then watch that basket." - Andrew Carnegie

The way Buffett invests is by reading all day, everyday and once in a while making a very informed investment. Most people haven't even reached the level of staying away from 'sure things' and panic selling during bad news.

How many people would've been able to stay away from IT stocks during the dotcom boom, to even not invest in the company of one of your friends. (Bill Gates and Buffett have known each other since '91)

How often do you, as a 'master', break rules that you would tell a 'apprentice' are immutable?


Buffett is essentially following the strategy - a diversified portfolio of long-term value assets. He's able to beat the market in part because the mere hint of his involvement in a stock causes it's value to go up.

You and I don't have that ability.




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