Price weighed index fund rebalances regularly and never misses out those best-performing four percent. Actively managed fund manager might do a good job valuing companies and might catch some success stories, but it's unlikely that they catch them all consistently.
Index funds might have been a good investment in the past, before wallstreet has figured out how to exploit it like they're doing today.
I'll stick with Vanguard.
Good luck with Vanguard.
As the paper points out - holding individual stocks is far riskier and inefficient than that of holding an index stock. Hence my point that while you may have different motivations for writing your piece - in the end, you are advocating for a worse potential outcome for most people.
Wall Street would love nothing better than have many people play the stockmarket and try to outsmart the index funds.
What I was really referring to is someone else doing nothing more than buying a Vanguard ETF and then adding their fees (perhaps an order of magnitude higher) on top of those fees - just to "manage" your money.
It's generally agreed that index funds are going to eventually destroy the stock market because they are the free market reinvention of a central planning economy relying on fee riding on the valuation work of a shrinking number of active investors, but that's a different problem.
I'm not saying the buyer's do. The selection criteria of the index fund may include it.
> It's generally agreed that index funds are going to eventually destroy the stock market
Or, like I've been saying, companies will find says to adjust their figures to get selected for index funds. And then eventually implode, due to the cost of doing so, which in most cases is quite a lot, taking down the investors along with them.
By whom? Money managers? But of course!
Guess what - if you think index funds are not optimal, deploy your own optimal strategy then profit bigly.
Their shareholders, which includes management. Buybacks are essentially dividends in another form. Buybacks have the upside of not being expected to go up indefinitely, and there are no dividend cuts to upset investors.
That works for now, but as soon as those interest rates tick up...
I agree with you, when rates go up a large amount of zombie companies being held up by cheap money are going to go bankrupt, and it will have large ripple effects.
If half beat the market in a year and half don’t, i’ll Still have one that goes up every year after 10 years, and sell it for a fortune.
As per this article, that wouldn't happen: more than half of the bots would fail to beat the market.
This article finds that the vast majority of the positive return is explained by relatively few stocks, leading to a positive skewness. The median random choice has a below-mean outcome.
But I think people appreciate a story about picking the right stock more than the right stocks, which helps that problem.
Most index funds are actively managed.
For instance, when an institutional investor gives SPDR say, $300,000,000 for a million shares of SPY, the fund goes out at purchases the underlying stocks in proportions that match the composition of the S&P 500, and then issues the SPY shares and holds the underlying and dividend payments in trust. SPDR does not have the option to choose the shares, they purchase a basket that replicates the S&P 500.
This is passive management, there is no one actively picking stocks, and when to buy/sell them.
ETFs do have additional liquidity risk that mutual funds lack. If liquidity is lacking, it could lead to the bid falling below NAV, potentially quite significantly, and investors who chose to sell at that point in time would be losing additional money.
Mutual fund sales are processed at NAV at the end of the market day when the sale takes place, which ensures you will receive the NAV when you sell.
ETFs allow more flexibility, with the drawback of possibly trading below NAV or above NAV, which can be good or bad depending on if you are buying or selling.
If the price of the ETF falls too far below NAV, big traders will scoop up the ETF shares to redeem for the discounted underlying stocks as an arbitrage play, bringing the ETF's price closer to the NAV.
I suppose the waters are muddied somewhat by consolidation, in 1927 there were 10s(?) of thousands of car companies, today we're basically down to 20(?). No doubt many went bust, but many also got subsumed.
The fact that 3/7 companies have outperformed Treasuries since 1927 is the surprising thing for me, not that 4/7 havent.
The paper isn't comparing "Company A that was in existence from 1926-1944" vs. "Treasury Bills from 1926-2018". It is comparing "Company A from 1926-1944" vs. "Treasury Bills from 1926-1944".
So the average lifetime of a company is irrelevant.
I also don't follow why you think the waters are muddied by consolidation? The paper explicitly discusses how it handles "merger, exchange, or liquidation (CRSP DLSTCD with 2, 3, or 4 as first digit)". If Company B is founded in 1931 and merges with another in 1943 then its lifetime is 1931-1943 and it is compared against Treasury bills over that period, so there's nothing muddied.
If the company has gone bust (which I would suggest is most of them) it has probably underperformed treasuries, it is of course possible that dividends could make up for the total loss of capital though.
A company that exists from 1926 - 1944 has seen its value go from 0 to X and back to 0, whereas the Treasuries haven't.
Consolidation muddies the waters because you have potentially 10s of companies into 1. You've highlighted 1 way of accounting for that, there are other legitimate ways of doing it though. I was though thinking more that you can't look at a current list of stocks and a 1926 list of stocks, you aren't necessarily comparing apples to apples.
I.e. you can plot them on different scales, so that they both start at the same position. Then you easily see which stock outperformed. But what if you want to see when it was a good time to switch as well?
Then you can compare two stocks by looking at their return at T1 relative to their price at T0. This solves the problem that you’re better off investing in a $5 stock going to $10 than a $100 stock going to $115, since it normalizes it to 1 going to 2 and 1 going to 1.15 respectively.
For switching you may need something more complicated, like looking at the price at Tn divide by the price at Tn-1.
Conversely, for EUR based fund managers you’ll likely be better of sticking to negative yielding EUR denominated bonds vs treasuries.
Here's the beginning of the abstract, which only takes four or five seconds to read:
"The majority of common stocks that have appeared in the Center for Research in Security Prices (CRSP) database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explain the net gain for the entire US stock market since 1926, as other stocks collectively matched Treasury bills."
What part of that does your 5 second backtest show?
But that isn't surprising either, on a long enough timeline everyone's survival rate drops to zero (hence most individual stocks die, eventually). Also, stock returns are Pareto distributed, which means that a small fraction represents the majority of the gains (hence there will always be massive outperformers that dominate the space). Nothing surprising here.
Yields have been collapsing since 1981 (Volker inflation arrest):
BTW: a similar thing happened to stocks, but with far more volatility:
(Not that the paper is trying to do something like that. It is more about the performance problems of individual stocks. It is not claiming that treasuries outperform a stock market index.)