Post New

After careful consideration, I have sadly concluded that it's challenging for the average investor to outperform the stock market by more than a small amount, with a few exceptions. The reason is that we are at an informational disadvantage compared to professional investors, who can afford to pay upwards of $100,000 per year for exclusive data that is not available to us.

However, there is one way that the average person can potentially do better than the market, and that is to buy during times of great fear. If I had purchased stocks during the market downturns of 2000-2001, 2008, and the COVID-19 crisis, I would have seen significant returns. The challenge is that it's challenging to invest when the world appears to be on the brink of collapse.

To overcome this challenge, I recommend developing a written plan that takes your risk tolerance into account and requires careful consideration. For instance, you could consider buying 2% of an index fund for every 10% drop in the market. However, my plan will be more sophisticated than that, customized to my unique risk profile and financial goals. I will take the time to research and develop a strategy that works for me. This will include setting clear investment objectives, establishing criteria for selecting stocks, and deciding when to buy and sell. By having a well-defined plan, I hope to be able to make rational investment decisions especially in uncertain times.

I agree it's very hard to beat the market over time.

Coincidentally I just recently calculated my own long term returns.
My portfolio is up by a grand total of $13034/year in the last 22 years, which is about as close to a perfect zero as I could manage.

Since I have been retired since then, I simply spent all the returns.

Jim

If I had purchased stocks during the market downturns of 2000-2001, 2008, and the COVID-19 crisis, I would have seen significant returns. The challenge is that it's challenging to invest when the world appears to be on the brink of collapse.

No, the biggest challenge is one you ignored.
To wit: Where does the money come from for you to buy big in the downturn?

Easy to ignore when you are working and have a paycheck coming in regularly. Just assume that the money will (somehow) be available.

To have money on hand, that means that you will build up/maintain a large cash hoard when the market is *not* in a downturn. That is, when the market is going up. But when the market is going up is exactly the time when you want to have your money invested, not sitting in cash.

You cannot look only at the gains you'd get after a downturn.
You also have to look at the gains you missed out on by having a large cash allocation during the non-downturns.

My portfolio is up by a grand total of $13034/year in the last 22 years, which is about as close to a perfect zero as I could manage.

Since I have been retired since then, I simply spent all the returns.

I was recently talking finances with my (adult) kids, and pulled out some figures.

Since we retired, from Jan 2007 to Jan 2023 we have withdrawn 49% of the Jan 2007 portfolio value. Even so, the portfolio value on Jan 2023 stood at 99% of the Jan 2007 value. (Currently it's at 12% greater.)

I am Toying with retiring but afraid of taking the leap. Im 40, expat in Switzerland. My current annual expenditure would be 2.9pct of my stock portfolio and 2.4pct of my total net worth (equity in house + lumpsum pension)

I'd put that in the 'winning' column.

You navigated two very large downturns...'09 meltdown and covid.

Well done. 16 years of post retirement living and you haven't dipped below your starting point. Keep on keepin' on!

If i may ask, what is your draw-down strategy (broadly)?

m

I would say the average member posting on these boards is not the average investor. At a minimum we're familiar with asset allocations, stocks and bonds, and withdrawal rates.

I picture the average investor as someone primarily putting money aside for their typical 65+ age retirement while working a non-financial job. To someone unfamiliar with the role of bonds in a portfolio, the sudden realization that they would have lost less money in the crash if they'd held more (some?) bonds drives them to sell stocks and buy bonds - the exact opposite of the rebalancing behavior that properly established asset allocation would have you engage in.

The behavior of a rush to safety in a stock market crash is also a challenge to professional investors running funds. Just as the market has gotten cheaper, and presumably brought *more* investments opportunities, fund investors have gotten scared and are withdrawing funds leaving the professional investor with *less* investment funds. .

The measurement of the performance of the stock market - say the returns of the S&P 500, would coincide with the returns of a very disciplined investor - one who leaves their money invested in the market no matter how large the crash. That behavior is different from most investors, and that's why I think matching the market is not a bad result for the average investor.

For instance, you could consider buying 2% of an index fund
Index funds are *huge* buying 2% of an index fund like VOO would cost you $6.5 Billion. I'm sure you mean something like 2% of your net worth, or 2% of you investment portfolio.

No, the biggest challenge is one you ignored.
To wit: Where does the money come from for you to buy big in the downturn?

Easy to ignore when you are working and have a paycheck coming in regularly. Just assume that the money will (somehow) be available.

To have money on hand, that means that you will build up/maintain a large cash hoard when the market is *not* in a downturn. That is, when the market is going up. But when the market is going up is exactly the time when you want to have your money invested, not sitting in cash.

You cannot look only at the gains you'd get after a downturn.
You also have to look at the gains you missed out on by having a large cash allocation during the non-downturns.<i/>

Perhaps I was unclear. I have about a 70/30 portfolio between stocks and fixed income. In a downturn, I would sell some bonds, to rebalance, and then perhaps, add 2% more of my portfolio for every 10% drop. So after a 10% drop, I would have a 72/28 portfolio.

Jim inspires me to also attempt to figure out my long term returns. I keep most of my equity investment (~90%) with one major broker so I am just going to read off from that one performance page instead of making my own calculation. Over the years I deposited and withdrew capitals from the account so it might as well be biased data. I think my investment portfolio outperforms the market a little but having moved money in and out of the account might have made it ambiguous (?). I just have little interest tracking the correct handle of my return.

My portfolio is up by $380,000+ per year (if I include YTD result as full year result for 2023) over the last 19 years. I had withdrew a net of 4.2 mil+ from the account during the period. I think I had paid less than 100k in equity capital gain tax ever given my being under an advantageous tax jurisdiction that only taxes local income. It says on the performance page that my cumulative return was 307% (vs S&P's 235%) over 10 years. The brokerage data seems to have been contaminated pre-2004 (in terms of P/L calculation) when the broker updated their system so I stripped out my gain pre-2004. I only had a relatively small portfolio earlier and any of my gain is pure blind luck pre-2004 anyway.

As for my background - I retired 23 years ago after working 11 years in the financial industry post grad school. I had most of my money tied up in unvested company shares and a syndicated lending facility initially and only started to invest more seriously about five years into my retirement. My portfolio ramped up from Mar 2005 when I shifted my holdings into equity while always keeping a decent buffer in cash. I never ever had any meaningful borrowing except when I borrow cheap yen for 10 years from 2008 to invest in Japanese stocks.

Well done. 16 years of post retirement living and you haven't dipped below your starting point. Keep on keepin' on!

If i may ask, what is your draw-down strategy (broadly)?

I assume it's me you are asking, not Jim?

Anyway.....my withdrawal strategy was Guyton-Klinger. Initially with 4.5% guardrails. 2009 was scary because our portfolio was down by 35% from the 2007 starting value.

In 2018 I reset to 5.5% guardrails, in recognition of the 11 years of life expectancy that was behind us.

We did a LOT of expensive-ish traveling in the first several years of retirement, and drew much more than the scheduled G-K withdrawal. The overage was carried over to the next year and the new scheduled draw was reduced accordingly, as were under-withdrawals, so that the long-term actual withdrawals averaged out to about the scheduled amount.

A couple of years ago I stopped bothering to take the (adjusted for under-draws) scheduled monthly withdrawals because that scheduled amount was much larger than what we needed. For 2023, our adjusted (adjusted for under-draws) scheduled monthly withdrawal is almost twice the raw non-adjusted amount. And we don't even need or take the non-adjusted amount, so the underage just grows bigger every year.

Financial freedom is being able to walk into a car dealer and when they ask what your target budget is you say "I can buy anything here I want to. For cash."

I have about a 70/30 portfolio between stocks and fixed income. In a downturn, I would sell some bonds, to rebalance, and then perhaps, add 2% more of my portfolio for every 10% drop. So after a 10% drop, I would have a 72/28 portfolio.

That's not going to have much effect. An additional 2% in stocks is not enough to make a significant difference.

Also, you didn't say anything about a plan to move money back out of stocks into bonds. Your plan has to account for _all_ movement of money----which is where a number of my tentative plans have foundered.


********************************************************
In a downturn, I would sell some bonds, to rebalance, and then perhaps, add 2% more of my portfolio for every 10% drop.

Well, did you?

From 2/10/2020 to 3/16/2020 the S&P500 dropped -30%. That's 3 10% drops.

From 12/27/2021 the S&P500 dropped -11% on 3/7/2022, then went up a bit then dropped to -22% on 6/8/2022. That's 2 10% drops.

It is a lot harder to actually execute your planned strategy than to create it.

William Bernstein:
Successful investors need the emotional discipline to execute their planned strategy faithfully, 
come hell, high water, or the apparent end of capitalism as we know it. 
' Stay the course ' : It sounds so easy when uttered at high tide. Unfortunately, when the water 
recedes, it is not.

Wall Street is littered with the bones of those who knew just what to do, but could not 
bring themselves to do it.

abnormalreturns.com:
The challenge is not for most investors in coming up with a workable investment strategy, 
but in trying to implement that strategy on an ongoing basis. The problem arises that there 
is always a plausible reason NOT to do something our strategy is telling us to do. 
The smarter someone is the more plausible a story they can come up with telling them their system is incorrect.

---------
This thread really belongs on the MI board, where you cross-posted it, not the BRK board.

Well, did you?


Only a tiny bit. That is why I want to have a written plan. I can keep this to the MI board if people want. I see a lot of non brk conversations here, so that is why I posted it here. The Bill Gates being a pedophile especially stands out. If other people want me to keep it to the MI board, than I will. Remember it is 2% per 10% drop. So I would add 1 - 2% more when it is down 20....

I see a lot of non brk conversations here, so that is why I posted it here. ..

Not that my opinion matters, but I for one am fine seeing a few "drawdown" conversations here, marked OT.
It's not wildly off topic, and this board has a number of participants who understand that valuation matters enough that a lot of conventional wisdom about annuitization is, well, bunk.

The likely range of outcomes of any given stock/bond allocation or withdrawal rate is NOT primarily a function not of the historical distribution of outcomes.
The primary driver is the prospective real returns of the investments in question based on their valuation levels the day you start.

If real bond yields are currently around (say) around zero but averaged (say) 3.5% in the history you're considering, you should not think the historical outcomes are a useful guide to the likely distribution of future outcomes.
Or you should be prepared develop a taste for dog food.

This view is so different from the usual advice that you'd get drummed out of a retirement forum for raising it.
On a forum where people are used to the radical notion that price and value can differ, it doesn't raise too many hackles.

Jim

Thank you Jim, yes, you are write, I should have labeled it OT. So, the drawdown I am starting from is less important than the CAPE I am starting from?

Jim
My portfolio is up by a grand total of $13034/year in the last 22 years, which is about as close to a perfect zero as I could manage. Since I have been retired since then.

Your post prodded me into spending a few hours reevaluating my last 22+ years.
I too have been retired for 22 years, actually 23 ½ years. I've plotted my portfolio after living expenses, compared to the S&P500, VWENX (Vanguards 60 to 70/40 to 30 fund) and inflation since retirement.
The excellent from 2000 to 2007 a combination of first day trading major market short term predictions and mechanical investing my investments after living expenses and inflation increased at 21.6% per year.
The bad from 2008 thru 2011 limited the sharp downturn in 2008 but was over cautious form '09 thru '11, portfolio returns after living expenses and inflation were down 11%/year!
From 2012 till present, I've only outperformed the S&P after living expenses taxes and inflation by slightly less than 2% per year.
Over the entire 23 1/2 years my total investments have increased 6% per year after living expenses, taxes and inflation.

RAMc

Mark19 makes perfect sense.
The point of a 70/30 (or any other balanced portfolio) is that you automatically buy low and sell high... when inflation is moderate.
Nobody here, or in real life, is a gifted stockpicker who will pick the 4% of stocks that contribute to most if the stock market returns. Except in hindsight of course.

One thing worth mentioning is diversification within your fixed income. ST and LT, in ST include a few floating rate ETFs like TFLO and FLOT.

Everyone hopefully knows about stock diversification.

For most of us here, accepting market returns offer the best chance of success. Bitter pill for the ego but sweet for the wallet.

Nobody here, or in real life, is a gifted stockpicker who will pick the 4% of stocks that contribute to most if the stock market returns.

This number presumably comes from the much-quoted but never-understood recent study.
Though you're right that it's unlikely that any given person is likely to pick one of the few very big long run winners, owning one of those stocks is by no means necessary in order to do very well.

The reason is simple:
Most stocks make a profit most years, so it is dead easy to do well over time even without the luck of picking a few outstanding long run winners.
The chances of a random US stock having a positive real total return in a one year period since 1960 is 56.5%.
This is pretty far from the 4% in the study that got so much press, and a much more useful and meaningful number.

Consequently a diversified portfolio of randomly selected stocks which is reconstituted from time to time almost always does just fine even without the few long run superstars.
In fact your chances of beating the S&P 500 this way over the long run are remarkably high, not low.


One thing worth mentioning is diversification within your fixed income. ST and LT, in ST include a few floating rate ETFs like TFLO and FLOT.

I think another thing worth mentioning is never to buy a bond or bond fund with a negative prospective real return.
Which is almost all of them in the recent era.
There is no reason to take on return-free risk. Disregard out-of-date advice that hasn't adjusted to the times.

To be fair, at least the real yield on TIPS ladders is positive now.
You can build a 20 year one which generates constant real income (in CPI-adjusted US dollars, anyway) with IRR of 1.86%.
Current cost $16.66 for each annual real $1 in annual income for 20 years, if this calculator is to be believed
https://www.tipsladder.com/
Not an attractive investment return compared to what you get in equities, but it certainly wouldn't cause sleepless nights. Unlike most bond funds.

Jim

I am curious to know that if you put all of that money into Berkshire Hathaway 23 1/2 years ago, how would that compare to your current results?

From March 2000, the returns are pretty solid. From memory the A shares got very close to $40k each.

I am curious to know that if you put all of that money into Berkshire Hathaway 23 1/2 years ago, how would that compare to your current results?


Your post prodded me into spending a few hours reevaluating my last 22+ years.
I too have been retired for 22 years, actually 23 ½ years. I've plotted my portfolio after living expenses, compared to the S&P500, VWENX (Vanguards 60 to 70/40 to 30 fund) and inflation since retirement.
The excellent from 2000 to 2007 a combination of first day trading major market short term predictions and mechanical investing my investments after living expenses and inflation increased at 21.6% per year.
The bad from 2008 thru 2011 limited the sharp downturn in 2008 but was over cautious form '09 thru '11, portfolio returns after living expenses and inflation were down 11%/year!
From 2012 till present, I've only outperformed the S&P after living expenses taxes and inflation by slightly less than 2% per year.
Over the entire 23 1/2 years my total investments have increased 6% per year after living expenses, taxes and inflation.

WEB436:
I am curious to know that if you put all of that money into Berkshire Hathaway 23 1/2 years ago, how would that compare to your current results?

Took me a while look over my spreadsheet and:
Although It's obvious BRK had a good record over the period it's obvious that I did much better. To end up with my current portfolio I would have had to live on less than 1% of my investments per year.
Given another 23 years I'm convinced there is a very low probability I could come close to the returns from mechanical screens and daily trading many of us achieved 15 plus years ago.

I just advised an economically successful daughter that wanted me to manage her investments to put some in VWENX some in BRK and forget it.

RAM

The chances of a random US stock having a positive real total return in a one year period since 1960 is 56.5%.
This is pretty far from the 4% in the study that got so much press, and a much more useful and meaningful number.

Consequently a diversified portfolio of randomly selected stocks which is reconstituted from time to time almost always does just fine even without the few long run superstars.
In fact your chances of beating the S&P 500 this way over the long run are remarkably high, not low.

I think you skipped over some salient details here. For example:

How much positive? Enough to beat S&P or total US stock market weighed my market cap?

What's the magic about one year? How about same stock held for three months or five years or some other random period? Still beats broad index?

When do you rebalance (or reconstitute as you more accurately termed it?) You seem to imply one year (I am guessing). Why sell part or all of winners after a year instead of letting them run?

I concede to your statistics but as stated they are wholly inadequate to good old "buy and hold a market cap weighted index".

Took me a while look over my spreadsheet and:
Although It's obvious BRK had a good record over the period it's obvious that I did much better. To end up with my current portfolio I would have had to live on less than 1% of my investments per year.
Given another 23 years I'm convinced there is a very low probability I could come close to the returns from mechanical screens and daily trading many of us achieved 15 plus years ago.

I just advised an economically successful daughter that wanted me to manage her investments to put some in VWENX some in BRK and forget it.


That is awesome! :). It was obvious to me that your returns over those 23 1/2 years were outstanding and way in excess of BRK or any US index.


Cheers,

Brian

palmersq: .... my being under an advantageous tax jurisdiction that only taxes local income.

Taxing local income only instead of worldwide income: May I out of curiosity ask what country that is?

I think Hong Kong is like that

I think another thing worth mentioning is never to buy a bond or bond fund with a negative prospective real return.
Which is almost all of them in the recent era.
There is no reason to take on return-free risk. Disregard out-of-date advice that hasn't adjusted to the times.

All this is good advice. Never buy anything with almost-certain projected negative real returns.
I just want to caution, don't buy bonds for UNcertain positive returns either. A lot of junk bonds and funds looks good if you consider only the last 10-15 years' performance. But that is because unltra-low interest rates helped not only with the interest rate risk but with default risk as well. That won't be true if interest rates are normal.

To recap, bonds have these risks:

Interest rate risk: risk that REAL interest rates will rise. Mitigation: keep some cash or close-to-0 duration bonds (like floaters).
Inflation: risk that inflation and hence NOMINAL interest rates will rise. Mitigation: same as above but better yet, buy some stocks (broad index ETFs/funds, of course :-))
Default: risk that your bonds won't pay 100c on the dollar. Mitigation: buy AAA (typically < 4% default, good recovery in default) or slightly worse investment grade bonds, avoid junk bonds, buy treasuries unless Trump will be president (he was OK with US defaulting, big surprise!)
Liquidity: only a theoretical risk now, that your bonds won't find buyers when you want to sell. But the GFC proved that bond funds DO provide liquidity even when individual bonds do not, even under stressful conditions. So just make sure to NOT buy bespoke bonds or bond funds.
Maturity: risk that you lock up your money longer term and can't take advantage of short term rate fluctuations. Mitigation: spread durations in your bonds or bond funds.

All well-known to everyone here on the board, of course. Bonds are for ballast, stocks are for speed, don't chase yield, yada yada.
My hidden agenda is to just get y'all thinking about fixed income as a viable alternative (not in terms of returns but in terms of intangibles) to stocks. This is a recent development for most of us, after the long "Greenspan put" era from 1995 to 2021. (Bernanke did try raising rates in 2004-5 but backed down quickly and went back to his helicopter.)

The chances of a random US stock having a positive real total return in a one year period since 1960 is 56.5%.
This is pretty far from the 4% in the study that got so much press, and a much more useful and meaningful number.
Consequently a diversified portfolio of randomly selected stocks which is reconstituted from time to time almost always does just fine even without the few long run superstars.
In fact your chances of beating the S&P 500 this way over the long run are remarkably high, not low.
...
I think you skipped over some salient details here. For example:
How much positive? Enough to beat S&P or total US stock market weighed my market cap?
What's the magic about one year? How about same stock held for three months or five years or some other random period? Still beats broad index?
When do you rebalance (or reconstitute as you more accurately termed it?) You seem to imply one year (I am guessing). Why sell part or all of winners after a year instead of letting them run?
I concede to your statistics but as stated they are wholly inadequate to good old "buy and hold a market cap weighted index".

The last point is probably sensible for a gut feel--but it simply doesn't seem to be true. It doesn't fit the data.
When you try it with a research database, a periodically reconstituted monkey-with-a-dartboard portfolio has over a 90% chance of beating the S&P 500 over time.
(maybe only 60% or 80%, depending on precisely how the test is structured)
Not that dartboard portfolios are particularly special.
There are LOTS of ways to have a skewed and seemingly sensible subset or weighting of a broad portfolio, sometimes called smart beta or just smart indexing.
It's not so much that any of those strategies are particularly brilliant, but that capitalization weight is such a strong outlier from the pack...to the downside.
Almost any other weighting/sampling approach is better over the long run because of the inherent drags built into cap weight.
The best reading I would recommend is Bob Arnott's research paper, "The Surprising Alpha from Malkiel's Monkey and Upside-Down Strategies"
It's easy to find with a search, but hard to post a link to it.
The shortest possible summary: a broad index portfolio works well, but make sure it's anything but cap weight.
And low in fees, of course.

One specific example:
Buy all S&P 500 constituents which happen to be covered by the SI Pro database. Statistically that's all of them, but I mention it for completeness.
Test 1:
Buy equal dollar amounts of all of them. Hold for a month (21 trading days), check the list again, and repeat.
Once each three months (three holding periods), rebalance all positions to equal weight. These are pretty liquid stocks, so I allow 0.2% round trip trading costs.
(the reason for the one month hold is that any cash from buyouts will get reallocated at the end of the next month, not waiting for the end of the quarter)
Total return 2000-01-03 through 2023-03-10: 9.1952%/year, average across the 21 possible sets of trading dates in the first month.

Test 2:
Buy capitalization weighted dollar amounts of all of them. Hold for a month, check the list again, and repeat.
Once each three months (three holding periods), rebalance all positions to capitalization weight. Same 0.2% round trip trading costs.
Total return 2000-01-03 through 2023-03-10: 6.5696%/year, average across the 21 possible sets of trading dates in the first month.

The difference is 2.6256%/year.
This result might be a bit better than typical because some very large caps did quite badly in the first couple of years I chose, but the equal weight version did better in most of the individual calendar years.
Normally I'd expect a gap in the 1% to 2% range.
But of course, that's also the whole point of the test: the very very largest caps often do quite poorly.
(an equally weighted portfolio of the 5 largest stocks by market cap, reconstituted monthly, underperformed the S&P 500 by 2.86%/year since 1986)

Management fees and trading costs are very important.
But a "monkey with a dartboard" portfolio is a sampling from test 1, so, excluding those costs it will have returns which asymptotically approach the test 1 returns as the number of positions rises towards 500.
(the sampling result does depend on how you handle carryovers from one period to the next...do you throw the dart again or merely rebalance the current pick?...the trading costs will differ a bit, but the range of pre-trading-cost returns will be otherwise the same)

The performance of any given dartboard portfolio will certainly diverge from the all-500-equally-weighted test, but half of them will be higher and half lower.
With the bell curve centred 2.6256% higher than the cap weight return, the chances of beating the S&P are quite high, especially with larger numbers of stocks which narrows the dispersion.


Another rather obvious example:
Even with the drag of very much higher management fees, RSP (S&P 500 equal weight) has beat SPY (float-adjusted cap weight) since its inception 20 years ago.
From inception to end 2022, RSP led by 1.12%/year.

Another test:
I tested a slate of 150 randomly selected stocks from the Value Line 1700 database, requiring them to be stocks with the "Timeliness" criteria populated (some financial history and not currently with a merger/bankruptcy pending).
On average 1493 eligible stocks. Essentially all large caps, a good fraction of midcaps, and a smattering of small stocks.
Hold for a quarter and repeat, no allowance for trading costs in this test.
Out of 20 random runs 2003-2022, the 150-stock random portfolio beat the S&P 500 20 runs out of 20.
Out of 20 random runs 1986-2022, the 150-stock random portfolio beat the S&P 500 19 runs out of 20.


As to your other question, no, there's nothing magical about rebalancing once a year.
I often mention it because a lot of Americans read the board, and there is apparently a tax advantage for longer holds unlike most other jurisdictions.
Yes, generally all the other rebalance periods also beat cap weight. Shorter holding periods generally work better if your trading costs are well constrained, but it's not a big thing.

Based on the evidence one should avoid cap-weight, provided you maintain good control of the fees+trading costs.

If nothing else, equal weight is vastly lower risk.
Apple is 0.2% of RSP but 7.7% of SPY.
Measured by peak capital at risk in a single company, $100 of SPY has the same risk as $3845 worth of RSP.

Jim

My hidden agenda is to just get y'all thinking about fixed income as a viable alternative (not in terms of returns but in terms of intangibles) to stocks. This is a recent development for most of us, after the long "Greenspan put" era from 1995 to 2021.

Speaking of which, current high nominal yields might not last.
(some real yields are up, others are down, that's a different story)

Inflation is something worth considering, and unfortunately something you almost HAVE to make a guess about, despite being pretty unpredictable.
I keep an eye on Divisia M4 as the best measure of the broad US money supply.
It is generally a good leading indicator of where inflation is headed.
(particularly during stretches that interest rates aren't zero across the whole term spectrum causing the underlying math to get messy)

Its year-on-year rate of growth cracked 20% by April 2020, well before the inflation impulse hit around 2021-Q2, so that was a good warning shot.

Anyway, I mention it because the year-on-year change in Divisia M4 is now down to -2.465%.
One might speculate that a drop in inflation is coming, perhaps even a drop in core inflation which has been stickier, still at 5.3% year-on-year.

Jim

Anyway, I mention it because the year-on-year change in Divisia M4 is now down to -2.465%.
One might speculate that a drop in inflation is coming, perhaps even a drop in core inflation which has been stickier, still at 5.3% year-on-year.

A drop in inflation is still positive inflation so maybe not that great news for "fixed fixed income" i.e. long term fixed rate bonds. Floaters (and ultra-ST bonds) should still keep floating nicely.

A drop in inflation is still positive inflation so maybe not that great news for "fixed fixed income" i.e. long term fixed rate bonds.

It might be...if the current price assumes higher inflation than ultimately arrives.
If it's an 8% nominal yield long bond because the market expects 6% inflation but we get 1% inflation, a real return of 7% is pretty darned nice.
There are quite a few companies refinancing at 12% at the moment. Not the good ones, admittedly.

Jim

The best reading I would recommend is Bob Arnott's research paper, "The Surprising Alpha from Malkiel's Monkey and Upside-Down Strategies"

I haven't read Arnott's paper, but an easy related read is one of Joel Greenblatt's books, "The Big Secret for the Small Investor." That's the one that Greenblatt claims is still a big secret because nobody bought it. Lol

https://www.amazon.com/Big-Secret-Small-Investor-I...

Based on the evidence one should avoid cap-weight, provided you maintain good control of the fees+trading costs.

I currently have a large chunk of my portfolio in QQQE, based in part on conversations on these boards.
However...

QQQ has outperformed QQQE by quite a bit since QQQE inception (2012-03-21):
QQQ -> 457%
QQQE -> 294%

Also, QQQ has outperformed QQQE in 73.8% of rolling years (252 trading days).
The mean outperformance is 2.5%/yr
Median is 2.3%/yr.

Question for Jim :), or anyone else who has thoughts.
* Would this be accounted for by valuations? Perhaps on 2012-03-21 QQQ was undervalued compared to QQQE, and now is more richly valued?

I believe Jim has been a proponent of QQQE vs QQQ, and I believe sees better current valuation metrics for QQQE.

Just to note that the two can have wildly different daily performance, I'm sure people noticed that Monday daily return was
QQQ -> + 0.03%
QQQE -> + 1.80%

QQQ has outperformed QQQE by quite a bit since QQQE inception (2012-03-21):
...
* Would this be accounted for by valuations?

My best explanation is this:

QQQE is how that sector of companies is doing.

QQQ is that return, plus or minus a VERY large random number, depending on the recent luck (good or bad) of a tiny number of very large firms.
To make a long story short, Apple's stock has done very well.
Four companies make up a whopping 40% of the fund.

So, if QQQ does better than QQQE, for a short while or a long while, it can't be extrapolated as a structural advantage.
It was good luck, and congrats to the people who had the benefit of that luck. But investing by relying on luck isn't a sustainable choice.

If you are truly able to value that tiny number of gigantic firms well enough to have a position in them, then buy them. No need for QQQ.
If you are NOT truly able to value them, you shouldn't have a big concentration in them. No need for QQQ.
So, for almost everybody, what you want is either something like QQQE or something entirely different.

Note, a side effect of the lack of concentration in QQQE is that it is vastly easier to value.

Jim

So, if QQQ does better than QQQE, for a short while or a long while, it can't be extrapolated as a structural advantage.

I beg to differ. QQQ, being weighted by market cap, has a structural advantage over QQQE by design. Microsoft is essentially a monopoly, with an unfair advantage over all other software companies because Windows and Office are ubiquitous. Similarly, Google has an unfair advantage over all other advertising companies because they are #1 in Search. These companies know how to print money, and they use their optionality and leverage to add new multi-billion dollar revenue streams in cloud services and AI (which is just getting started).

As an investor, I most definitely want to be overweight these companies. So I'll take QQQ any day over QQQE.

It was good luck, and congrats to the people who had the benefit of that luck.

It's not luck if you truly understand the nature of these businesses. But I'll take your congratulations, thanks.

QQQ, being weighted by market cap, has a structural advantage over QQQE by design. Microsoft is essentially a monopoly, with an unfair advantage over all other software companies because Windows and Office are ubiquitous. Similarly, Google has an unfair advantage over all other advertising companies because they are #1 in Search. These companies know how to print money, and they use their optionality and leverage to add new multi-billion dollar revenue streams in cloud services and AI (which is just getting started).

As an investor, I most definitely want to be overweight these companies. So I'll take QQQ any day over QQQE.

Or you could just go ahead and buy the top 10. The top 10 holdings of QQQ are 59% of the total assets. Might as well be hung for sheep as for lamb.

Oddly, the top 10 of SPY are almost the same as the top 10 of QQQ.

And they both hold both GOOG and GOOGL. Weird, why do they hold both issues instead of just one?

GSPY also has almost the same top 10, just with different weightings.

I beg to differ. QQQ, being weighted by market cap, has a structural advantage over QQQE by design...

Sure, it is by design.
(QQQ isn't cap weight, by the way, but it's similar)
Cap weight was designed on purpose so that there would be minimal trading, not because it's the optimal way to invest for the investor with capital at risk.
As prices go up, there isn't any trading to do, so it's cheap and easy to run a fund. That's the reasoning.

The thing is, the very largest firms are generally the worst investments.
If anything large is currently wildly overvalued, it will be found among the very largest cap firms.
There are companies and years that are exceptions, but that's the general rule over time: that's where you go to look for stuff that's overpriced.

The S&P 500 is (basically) cap weighted, and suffers from this problem a lot. That's why almost any other weighting from the same firms works better.
But the largest 5 firms do even worse than cap weight of the whole set.

Figures done with a proxy database, might be off by 0.1% or so:
Not bad: the S&P 500 equal weight, all 500 equally weighted, CAGR since '97 = 9.32%
Bad: the S&P 500, float adjusted cap weighted, CAGR 8.49%
Worst: the biggest 5 of those by market cap, then equally weighted: CAGR 8.08%

It's not luck if you truly understand the nature of these businesses.

For sure.
As I mentioned, if you truly understand the nature of the very largest businesses and like their prospects and pricing, I agree, buy them.
I have owned some of the largest ones.
But then, in that situation, why buy the other 90-95 stocks? What's the point of QQQ?
Surely someone who knows the few giants very well will know which of them is really the pick of the litter, so you wouldn't want all of them.
I don't know what the future returns of (say) Alphabet and Nvidia are from here, but I imagine they are going to be quite different.

A cluster of very large cap firms, simply because they are the largest, is a very poor wager indeed, despite recent good results.
As was the case 25 years ago, I find it best never to confuse recent history with a law of nature.
If there is a general law of nature, it's to avoid the very largest.

Jim

First of all, the equal weight QQQE ETF wasn't even available to investors before 2012.

I used PortfolioVisualizer.com to compare investing $100K in QQQ versus QQQE starting on April 2012, which is when QQQE first began trading. My backtest shows that QQQ beat equal weight over these past 10 years by a huge margin. The QQQ investor would have $608K today, whereas the QQQE investor would only have $436K.

Here are the figures in detail.

April 2004 to present
Portfolio   Starting Balance Ending balance  CAGR   Sharpe ratio.  Max drawdown
QQQ         $100,000         $607,629        17.40%   0.96          -32.6%
QQQE        $100,000         $435,615        13.97%   0.82          -29.0%  

As you can see, QQQ investors got a 17% annualized return vs only 14% for equal weight QQQE investors. The Sharpe (reward to risk) ratio was better, too.

Secondly, it's easy to do the same backtest comparing SPY vs the equal weight RSP. The first full calendar year that RSP traded was 2004. Between then and today, RSP has returned 9.6% compared to 9.4% for SPY. That's not a significant difference in return, and SPY also has a better Sharpe ratio (0.6) than RSP (0.55). RSP was actually more volatile (std dev = 17%) than SPY (SD = 14.8%).

Not to mention that an equal-weight ETF like RSP is not even an option when you're looking at investment choices for a company 401K plan. Whereas it's easy to find an index fund there.

Using GTR1, it appears that S&P 500 does better using equal weight and Nas 100 does better using market cap

CAGR 9.91% ^S5T (market cap S&P500 and prior SP 90)from 19251231
CAGR 11.27% ^S5TE (equal weight S&P500 and prior SP 90) from 19251231

CAGR 10.29% ^S5T (market cap S&P500 and prior SP 90)from 19721214
CAGR 12.25% ^S5TE (equal weight S&P500 and prior SP 90) from 19721214

CAGR 12.49% ^N1T (Nas 100) from 19721214
CAGR 10.54% ^N1TE (Nas 100 equal weight) from 19721214

https://gtr1.net/2013/?s19721214::!S5TE

Craig

Cap weight was designed on purpose so that there would be minimal trading, not because it's the optimal way to invest for the investor with capital at risk. As prices go up, there isn't any trading to do, so it's cheap and easy to run a fund. That's the reasoning.

There is another important and rational reasoning besides the reduced trading costs: Market cap weighting distributes your capital exceeding more equally between each constituent income source within all firms across your investment, compared to equal weight indexing.

To explain, imagine two firms. Firm A owns 10 houses, and firm B owns 1000 houses. Let's assume all houses are largely indistinguishable and on average pay the same rent and are thus also equal in value. Ideally - thinking like a business owner - you want to be invested equally across all the houses. (For simplicity we consider assets but in the general principle applies equally by substituting houses with 'sales channel', 'dollar of earnings' or even 'customer' - as the business as a whole doubles in economic size we want to be investing double the amount.)

With market cap weighting you have 100 times more capital places in firm A but the same amount of capital across each house.

With equal weight investing, you are placing 100 times more capital in all the houses owned by firm A compared to firm B, despite the houses being indistinguishable. Furthermore you are almost not invested in firm B if your prism of view is on a per house basis.

Economically your investment is radically unequal with the equal weight index. Sorry to break the news given the attractiveness of the word 'equal'.

If you do want to invest (ie. expose) an equal amount of your own capital across each house, you would need to invest with a market cap weighting. That isn't perfect as some firms are overpriced and I will get to that, but it is relatively close to equal on a per house basis, rather than being out by two or more magnitudes which you get to when allocating equally merely on a stock symbol basis.

Despite this, equal weight indexing outperformED (uppercase added for emphasis) market cap weighting by about 1.5% the last 100 years. This must be reconciled however with the huge trading costs during most of the 20th C. Once the historical trading costs are added to the comparison, and tax is accounted for, some of the performance advantage with the equal weight index over most of the 20th C erodes.

Yet there is one good rationale for the outperformance and it is the one I referenced in the Manlobbi's Descent book - it continually forces capital away from firms temporarily overpriced into firms underpriced, especially useful when they are equally competitively.

(The other genuine equal-weight pro is moving capital away from market saturated sales lines into sales lines with a larger runway ahead. However that equal-weight pro is offset by the following equal-weight con: The smaller businesses are on the whole less competitive (try starting a small sugar drink firm) than large firms with their various network effects and the effect of lobbying/bribery (the same word, but difficult for small firms to do). So this it may be convenient for these pros and cons to be considered as exactly cancelling each other out such that we are left with the earlier mentioned equal-weight indexing pro - continually allocating capital (and sometimes as much as half the entire value of a firm such as when it doubles in price from popularity alone without any change to the business) from temporary overpriced situations into temporarily underpriced situations.)

There is a theoretically (but not practically) lower risk with equal weight investing - if - you frame the argument as a market speculator might think: You won't lose suddenly on a large position if just that position falls in price much more than the market as a whole. But - thinking like a business owner the converse risk is higher - the larger risk is with the equal weight indexing because of the exceedingly high concentration of you capital on a 'dollar per project' basis in the very smallest firms.

In truth the risk is not importantly different between equal weight and market cap weight index funds and what matters more to true investors is the relative long term value accumulation. The answer to that isn't trivially conclusive, once trading and taxation costs are added depending on where you live and how the fund is structured.

But owing to the 'overvalued capital moving to undervalued capital' argument alone, and less upon the long term backtesting showing a small advantage to equal weight (as that may not repeat with our present conditions of very low trading costs - akin to trading like Ben Graham no longer working) I do marginally favor the equal weight indexing over market cap weight.

- Manlobbi

Firm A owns 10 houses, and firm B owns 1000 houses. Let's assume all houses are largely indistinguishable and on average pay the same rent and are thus also equal in value. Ideally - thinking like a business owner - you want to be invested equally across all the houses. (For simplicity we consider assets but in the general principle applies equally by substituting houses with 'sales channel', 'dollar of earnings' or even 'customer' - as the business as a whole doubles in economic size we want to be investing double the amount.)

With market cap weighting you have 100 times more capital places in firm A but the same amount of capital across each house.


But market cap is not the same as the company assets. One is the opinion of the stockholders (actually, the opinion of the person who made the most recent trade of the stock), the other is the hard assets of the company.

I do marginally favor the equal weight indexing over market cap weight.


That was one of the questions in this thread. I would be interested to hear your view on a different question; IF you decide you want to reallocate capital from a company with a high valuation, relative to your estimate of its value in 10 years, then one might wonder how finely tuned such a readjustment should be. For instance, if a stock is trading at 5 times your estimate of its intrinsic value in 10 years, and drops to 4.9, it is a slightly less good deal, and it would make sense to me to very slightly reduce exposure to it, reallocating it to something that has maybe gone from 4.9 to 5.0, for instance. And then again, if it drops to 4.8, an so on. The alternative would be to wait for a much bigger drop, like from 5 to 4, before reallocating. I'm guessing the former is a lot more trouble for about the same result, but I think you might theoretically gain a small amount from doing the rebalancing more frequently. Maybe not enough to be worthwhile, but positive nevertheless. But I would be interested to hear your opinion on this question.

If you decide you want to reallocate capital from a company with a high valuation, relative to your estimate of its value in 10 years, then one might wonder how finely tuned such a readjustment should be. For instance, if a stock is trading at 5 times your estimate of its intrinsic value in 10 years, and drops to 4.9, it is a slightly less good deal, and it would make sense to me to very slightly reduce exposure to it, reallocating it to something that has maybe gone from 4.9 to 5.0, for instance. And then again, if it drops to 4.8, an so on. The alternative would be to wait for a much bigger drop, like from 5 to 4, before reallocating. I'm guessing the former is a lot more trouble for about the same result, but I think you might theoretically gain a small amount from doing the rebalancing more frequently. Maybe not enough to be worthwhile, but positive nevertheless. But I would be interested to hear your opinion on this question.

I have posted the reply to you on the Manlobbi's Descent board (and my first non-introductory post there since commencing the programming of Shrewd'm late last year) as everything that you write here is so beautifully idiosyncratic to that subject:
https://www.shrewdm.com/MB?pid=627078766

- Manlobbi

May I out of curiosity ask what country that is?

Singapore, Hong Kong, Panama, and Bahamas operate a territorial tax system. Furthermore, UAE and Bermuda dos not tax personal income.

Furthermore, UAE and Bermuda do not tax personal income.

And a few other places. Monaco.
No income tax return, no tax ID number.

Jim

I revisited this old post and am confused by this.

If you managed a near perfect zero profit over 22 years (assuming your portfolio size is much bigger than your annual profit), doesn't it mean you are underperforming the S&P 500 index by more than 10% per annum?

I must be grossly misreading this?

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