Insights, Ideas and News
Active vs. Passive: The Illusory Debate
Every time I read about the “active vs. passive debate” I can feel my blood pressure go up.
There is no “debate”. The only people perpetuating this myth are those who make a living touting active management and those who don’t know the facts.
Proponents of active management like to muddy the waters by talking about how markets aren’t “perfectly efficient” and asking “What about Warren Buffett?”
There may well be inefficiencies in the market, but it’s unlikely you can exploit them. You have a lot of competition, including institutional investors, with vast resources, who account for upwards of 80% of trading. They will probably be on the other side of your transaction. Are you smarter and better informed than these sophisticated investors?
It’s not impossible to beat a portfolio of index funds. But the odds of doing so are so small (especially after taxes) it makes no sense to try.
If you had access to Warren Buffett, he would tell you to invest in index funds and avoid those who claim the ability to “beat the market.” That’s precisely the direction he gave to the trustee of his estate.
Don’t believe it when you’re told there are “good arguments on both sides.” There aren’t.
The perpetuation of the active vs. passive debate myth is the single biggest obstacle standing between you and retirement with dignity.
Don’t fall for it.
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The content of this post was by permission from Dan Solin. You can read the original at https://danielsolin.com/the-illusory-debate/
Simple 60-40 Portfolio Beats All Ivy League Endowments over 10 years
A new report shows that the complex and expensive endowment model hasn’t proved its worth since the financial crisis.
The performance of Ivy League endowments has trailed a passive portfolio of 60 percent U.S. stocks and 40 percent bonds over the past ten years — and has been more volatile to boot, according to a new report from research and analytics provider Markov Processes International.
MPI says this is the first time in the 16 years that it has been collecting data on all the Ivies that Yale, Harvard and the other elite colleges have lagged the indexed portfolio when looked at over a decade. The firm looked at performance for the period between July 1, 2008 and June 30, 2018.
What’s more, MPI found that the volatility of the endowment model — which includes large allocations to private equity, real estate, infrastructure and other illiquid investments — is significantly higher than that of a simple mix of stocks and bonds.
The performance of Ivy League and other college endowments is closely watched by the industry, as other institutional investors have been adopting some version of the portfolio allocation model — often referred to as the Yale Model, pioneered by Yale CIO David Swensen — since the early 2000s. The perennial question has been whether the addition of expensive alternative investments, including hedge funds, is worth the trouble, given the cost, illiquidity, and underperformance of many of these funds.
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Source: Institutional Investor
Bad Times for Active Stock Pickers
Almost no active managed funds have beaten the market/their benchmarks over the past 15 years.
Some 66 percent of large-cap active managers failed to top the S&P 500 in 2016. Performance actually got worse over longer time frames, with more than 90 percent missing benchmarks over a 15-year period. For the first time, the scorecard tracked 15-year performance to capture what it considers a “complete market cycle.”
In that period, 92.2 percent of large-cap managers missed their marks, while the number was 95.4 percent for mid-caps and 93.2 percent for small-caps. It’s probably no wonder, then, that more than 58 percent of U.S. equity funds either folded or merged during the 15-year time frame.
Talking Risk: Emotion vs. Data
We tend to base our assessment of risk on emotions (how we feel about it), and then rationalize (or try to) that we have done so using objective data.
Our Reactions
We overreact to risks we can’t control (like the fear of natural disasters) and under react to risks we can (like one’s health, or how we drive a car). We particularly overreact to risks that are uncontrollable, have catastrophic or even fatal consequences and involve “one group taking a risk and a separate group reaping the benefits.
Probability Estimation
We overestimate small probabilities and underestimate large ones. It’s we purchase lottery tickets and why we continue to eat more and more poorly than we should.
Another perception factor is “ease of imagination.” We can easily imagine the horror of being attacked by a shark while at the beach. Consequently, we have a heightened fear of such an occurrence, even though the rate of shark attacks is only one in many million beach goers.
Familiarity Distorts Risk Perception
We are tolerant of risks that are familiar, frequently encountered or part of a well-understood system, like the stock market. This makes it more difficult for investors to take this risk seriously. We perceive unfamiliar risks, like school shooters or terrorism, with a heightened sense of fear and anxiety. Unfortunately the probability data doesn’t support this conclusion.
Questions To Ask Yourself
Are you concerned about stock market risk? If so, why? If not, why not?
Are you comfortable with the plan you have in place to deal with this risk? If so, why? If not, why not?
What kind of risk keeps you up at night?
Now think about:
how you might be under reacting or over reacting…
how well you are informed about the true probabilities of these events happening …
how your sense of each risk is modified by your sense of familiarity with each event…
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