Short answer re: investing in active managers (based on my many years listening to rationalreminder.ca) is that, if you eliminate some of the worst active managers, the average returns net of fees are the same. However, eliminating the worst managers is challenging (but not impossible) to do ex-ante. Even then, you’re only getting the same average returns as indexing, not better. Plus, you will experience a higher dispersion with active managers (greater chance of extreme negative or positive outcome), which is not desirable. Because of these two issues, It’s definitely better to pick an index fund.
Re: picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Active managers can only beat the market gross of fees because they employ large teams of people to do a lot of work to gain a small edge (stuff like predicting retail sales numbers from satellite images of store parking lots).
This is my attempt at summarizing a whole field of research in a few sentences. There are many more nuisances. I highly recommend listening to the Rational Reminder podcast if you’re curious about this sort of thing. They interview a lot of academics.
There's more dimensions to an investment than average returns.
Volatility adjusted returns (or Sharpe ratio) for instance, will tell you how much returns you have per unit of risk you take. This is important because getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility. You can only compare investments at equal amount of risk.
An other factor to take into account is diversification. If you have an alternative investment to compare to your base, and it's average returns is lower than your base, but it is un correlated, then you actually get an increased volatility adjusted average returns by investing in both.
That's just two dimensions to take into account, there are many others, but overall:
- Don't compare investments based on annualized returns alone, it really doesn't make any sense.
- Don't compare investments one against an other, instead look at the addivity of one on top of another.
> getting 10% average annual returns with 10% annual volatility is worst than getting 5% returns with 1% annual volatility.
Doesn't this depend on how long you're planning on investing for, and what your criteria for selling your investments are?
If you're planning on investing for at least 10 years, and you're willing to give yourself a 2-3 year window for selling your investments once they reach a threshhold you decide on ahead of time, isn't the 10%/10% investment better?
(e.g. if retirement is 20 years away, you might consider putting your funds in that sort of investment for 10 years, with a view to moving them to something less volatile in the 5 years after that, as soon as they cross a 10% annualised return threshhold during that window.)
If you consider that "you don't know any better" and returns are normally distributed (i.e. you don't have some secret sauce nobody else knows about), then there is no dimension in which the 10/10 is better.
You can convince yourself intuitively by imagining how you would maximize each strategy. The amount of money you have is a factor of the risk you take, because if you want to do something risky you will not be able to borrow much, whereas if you want to do something safe you can easily borrow.
That is, you objective is to maximize your expected return, under the constraint of not breaking your risk limit.
Suppose you have a 10% annualized volatility risk tolerance. That's your budget.
If you invest it all in a 10% average return / 10% annual vol strategy, that's it.
Now if I propose you a 5% average return / 1% volatility strategy, you just have to go to the bank and borrow 10x your capital. You will have the same risk exposure (in dollar), but 5x the expected returns.
Is 10x borrowing even an option if we are talking retirement savings?
I don't know much about finance. I guess that at that point (you borrowed 10 times your net worth). This is no longer your investment, it's your lender's investment. They will adjust interest rate to match the riskiness of whatever you are doing, leaving you with net zero.
> Is 10x borrowing even an option if we are talking retirement savings?
Of course it is, though not exactly by "borrowing money" in a "mortgage" sense. Margin trading is a way to take leverage, derivatives is another. The former is simpler but costly, the latter is cheaper and allows you much more than 10x leverage, though it requires some high school mathematical thinking.
What you're saying sounds right. But in practice, no one is going to lend me, a nobody, 5x my money. At least outside real estate, that's it's own crazy alternate reality.
> - Don't compare investments based on annualized returns alone, it really doesn't make any sense.
>- Don't compare investments one against an other, instead look at the addivity of one on top of another.
I don’t think either of these matter to 90% of investors whose goal is to build up a nest egg for retirement which means not spending for decades in the future.
Sharpe ratios and all those “risk” adjusted calculations all involve assumptions that may or may not be true.
Comparisons of just annualized returns over long periods of time seems fine for broad market index funds, especially if you are assuming the federal US government will provide a backstop.
> Sharpe ratios and all those “risk” adjusted calculations all involve assumptions that may or may not be true.
On the contrary, these risk adjusted measures assume nothing more than a normally distributed random variable.
If you just look at annualized returns, then go ahead and invest in CDOs ETFs.
More seriously, the S&P for instance has around 20% annualized vol, which IMHO is way above what you would want for a retirement fund. I would target something closer to 10%.
> Comparisons of just annualized returns over long periods of time seems fine for broad market index funds
Do you have any sort of reasoning or is it just a gut feeling?
>However, financial assets are often not normally distributed, so that standard deviation does not capture all aspects of risk. Ponzi schemes, for example, will have a high empirical Sharpe ratio until they fail. Similarly, a fund that sells low-strike put options will have a high empirical Sharpe ratio until one of those puts is exercised, creating a large loss. In both cases, the empirical standard deviation before failure gives no real indication of the size of the risk being run.
>Do you have any sort of reasoning or is it just a gut feeling?
The reasoning is that their volatility is negligible over the long term due to political forces. Of course, it is also an assumption that could be wrong, but the mechanisms for government policy (democracy, aging demographics, and voter participation trends) seem to favor reducing purchasing power of currency rather than letting broad market equity prices stall or slide down.
> >However, financial assets are often not normally distributed, so that standard deviation does not capture all aspects of risk
Volatility not being a full measure of risk obviously does not imply that volatility should be ignored.
The former statement about returns not being normally distributed is a, trivially verifiable, factual mistake. Daily stock returns are normally distributed with a slight positive kurtosis. This remains true on any period over the last 30 years.
I am bot arguing either that the Sharpe is an all encompassing measure, some strategies have a returns distribution that is not well explained by Sharpe. I don't think it matters in this argument though.
I think when stating your opinion against 40 years of econometrical research, including multiple Nobel prizes in economy, you should feel enticed to explain your opinion a bit more than "no I don't think so"...
Please quote a Nobel prize (well, there's no Nobel prize in economy, but surely we understand each other) winner explaining that stock prices are, in actual reality, random variables.
As for the quotes, I encourage you to strongly think about the meaning of the work of Sharpe, Black & Scholes and Markowitz applied to non normal distributions (both Nobel prizes, we understand each other).
In particular, try to articulate the relevancy of sharpe ratios between two non normally distributed portfolios.
If one is a random variable, so is the other. It's a simple change of variables. What's your point?
> As for the quotes, I encourage you to strongly think about the meaning of the work of Sharpe, Black & Scholes and Markowitz applied to non normal distributions (both Nobel prizes, we understand each other).
Could you quote the part where they say that actual, real-world stock prices (or returns, whatever) are random?
> If one is a random variable, so is the other. It's a simple change of variables. What's your point?
Not sure I follow your reasoning. Prices are positive only, and non stationary. That is very much not the same for returns. Usually prices are log normal, leading to normal (log) returns.
> Could you quote the part where they say that actual, real-world stock prices (or returns, whatever) are random?
It is not said, but rather implied. Take the Sharpe ratio for instance, it is a measure that:
1) is used to compare different assets / portfolio returns
2) rely on the 2nd moment of the returns.
The standard deviation is less relevant the further away from the normal distribution you go, so since this is a comparison metric, it can only be reasonably applied to compare normally distributed returns.
If you believe the returns are not generally normal, then you reject the use of the Sharpe ratio as a relevant measure of comparison.
I don't have a B&S reference at hand, and I did not read it since 15 years, but I'm pretty sure it assumes lognormals prices as well.
> Not sure I follow your reasoning. Prices are positive only, and non stationary. That is very much not the same for returns. Usually prices are log normal, leading to normal (log) returns.
Perhaps we should take it back to the beginning. What do you believe "random variable" means...?
This is absolutely absurd. Economists including Nobel prize winners, including even Eugene Fama who proposed the Efficient Market Hypothesis, does not think the stock market is normally distributed.
At best, using a normal distribution is something that undergrads use as a tool to learn about the stock market and make some simplifying assumptions for pedagogical purposes, but it most certainly is not something that actual professionals or researchers in the field genuinely believe.
Come on, don't create a trial of nitpicking. I am not saying returns are a law of nature meant to teach us normality.
My point is that, for all intent and purposes, you should assume normal distribution of returns.
If you don't, you're obviously on either end of the spectrum: not knowing the subject at all, or nitpicking expertise on the internet.
The subject of the matter here is convincing someone that risk adjusted measures should be considered when comparing portfolios. This is the basic underlying modelisation that 99.99% of the finance world makes, "compare sharpes", "compare volatility adjusted returns".
I'm stating 1+1=2 and you're arguing it doesn't hold in Z/2.
> At best, using a normal distribution is something that undergrads use as a tool to learn about the stock market and make some simplifying assumptions for pedagogical purposes
Implicit normality assumptions are everywhere. I encourage you to think hardly about your model and question whether anything you do would work on non normal distributions, you will most likely find that you have millions of these assumptions in your linear combinations, sample renormalization, regressions, sharpe weighters and optimizations.
Now of course you could refine that with students, lognormals, and whatever, but this is more _refinement_ than anything.
>assume nothing more than a normally distributed random variable
But look at something like systemic risk: it’s not necessarily normally distributed. The S&P returns skew left. I’m sure there are other risk metrics that break this assumption as well.
Right, risk is often fat tailed, but unless we enter an expert discussion, for which HN is hardly a good medium, it is safe to assume 99% of strategies out there yield normally distributed returns. Non normally returned strategies are rarer and sophisticated.
The level of discussion that HN is a good medium for has absolutely no bearing or causal relationship with whether or not the actual stock market is normally distributed.
Imagine really thinking that the nature of a discussion forum can somehow influence the distribution of stock prices, as if stock prices examine comments on the Internet to determine their behavior.
I dont have a dog in this hunt but that seems like a strangely aggressive response. Perhaps the comment meant nothing more than that plaintext HN is a difficult place to start having a discussion that really requires some mathematical machinery, and therefore, since we cant throw around sigmas and integral signs here, we will make some assumptions.
Attacking the comment with sarcasm isn't in the spirit of HN even if you think that is a dumb idea.
>I dont have a dog in this hunt but that seems like a strangely aggressive response.
Well I do and as someone who has seen his other posts on this subject as well, he has a tendency to try to dismiss differing points of views on the basis that he has 20 years of experience and knows better than everyone else but can't be bothered to explain it.
Someone who has experience and wants to flaunt that experience should do so by coming up with good arguments, pointing people to good resources, and making a good effort to inform rather than pulling rank as a way to dismiss the conversation under the guise of sophistication and pretention.
I too have decades of experience working at a quant firm, and guess what... many people who post on HN have subject matter expertise and frankly I don't think many of us would agree with the idea that the stock market is normally distributed, or that you need a great deal of mathematical machinery and sophistication in order to demonstrate that fact.
Math models reality, reality does not model math. Whether or not stock prices or portfolios, even the portfolios of those on Hacker News, follow a normal distribution has nothing to do with the nature of the discussion of those portfolios.
Also, policing people's tone is also against the spirit of HN as well, but here we are. If you want to police how I speak, flag my comment and/or downvote it.
The meaning of quantitative changes a bit with time and context.
I would say the more "bayesian / sell side / derivative pricing" kind of meaning exists since the late 70s, the more "frequentist / buy side / let's hire 100 physics PhDs" meaning came prominent in the early 2000s. (as a general feeling).
> he has a tendency to try to dismiss differing points of views on the basis that he has 20 years of experience
I surely will concede I have this tendency, now you have to keep the context in mind. You are on an internet forum focused on CS, and emerges a comment thread on personal investments. The very subject of this thread is whether it makes sense to consider risk adjusted returns or just any kind of returns for your investments.
My argument is based on the fact that risk adjusted returns should be used, and you should assume normal distribution. I am not saying this is a law of nature, but rather that this is a fine and widely used assumption for both practitioners and academics, which allows the argument and explanation to go further without entering an experts debate (like you are trying to start).
So I stand by what I said: for all intents of this discussion, assuming normal distribution should be a given. If you want to dance around it and demonstrate that a students distribution or whatnot is a better fit, go ahead. I think this is more armful than helpful here.
> try to dismiss differing points of views on the basis that he has 20 years of experience
I think this is important on the contrary. What is lost on a forum like HN is the context of people answering comments. When someone comments "I don't think risk adjusted returns are important", it makes a hell lot of a difference if it's just the opinion of a random guy, or someone with actual experience.
Now while it takes 1 sentence to wrongfully dismiss a scientific fact, it can take 100 pages of an expert to prove that it's true. Look at a proof that 1+1=2.
That is where credentials are important IMHO. Some debate tengents are not interesting in a discussion, and will only lead to an expert explanation serving no purpose other than confusing a reader, and making the expert proud of himself. In these situations, just stopping the tengent is the best reaction IMHO.
So I apologize if you take my comments as dismissing, but try to assume good intent. When someone asks why you should use risk adjusted returns to compare investments, I think the saner thing to do is to tell him to assume normal distribution, because that's the far more likely scenario, most of the research do take this overall assumption, and you can proceed to the demonstration that makes sense, which I showcased in my previous comment about 10% returns on 10% annual vol versus 5% returns on 1% annual vol.
To re take the example I posted above, when the discussion is about 1+1=2, I don't think you're doing any good contradicting that it doesn't hold on Z/2.
Assuming normal distribution of returns is a pretty standard base for comparing investments. It is a base shared by many models and metrics. Sharpes don't make a lot of sense on non normal distributions, mean variance optimization either.
Modeling (and possibly economics, especially) is rife with simplifying assumptions that break down in practice. You can find many economists who think modeling individuals as rational agents is a "fine and widely used assumption" while also finding many economists and psychologists showing where this assumption can get you into trouble. There is a big difference between "this assumption is made because it reflects reality" and "this assumption is made because it makes my life as an economic modeler not suck." The latter is still fine, but only if you're upfront about its limitations.
>it is safe to assume 99% of strategies out there yield normally distributed returns.
I don’t know that I agree. If the market as a whole doesn’t have normally distributed risk, it implies even the simplest strategy of buying SPY and holding will also not have normally distributed risk.
Except this is a myth. You will not win the lottery without taking crazy amounts of risk. The active managers who do beat a major index for a long, long time almost do not exist in retail space, and they beat the market by a tiny amount (~1%). In my era Legg Mason was the most famous, but even they fell too.
Buffet isn’t a passive investor. Berkshire Hathaway have often taken a very active role in the running of their acquisitions - appointing managers, setting strategy, merging/splitting off subsidiaries, etc. This is as much managing as investing. If Buffet was a pure stock picker, then he would be an interesting case in the active vs passive investment debate.
When you own one billionth of a company you are just along for the ride. When you buy a 10% or more stake you can influence the running of the company. Another aspect is he has offered liquidity to distressed companies like GE and got richly rewarded for it with favorable terms.
Yeah, I have tried to simulate this several times under different conditions. Given zero sum game and random odds, there is always going to be small percentage who have a lot and most will have below what they started with. It is easy to explain as well, if you for example start with $1000 and you have 50% odds of winning 10% every time. If you win and lose 50% you are going to be below what you started.
If you always win after lose and lose after win, then it would go like this:
1. $1000
2. $1100
3. $990
4. $1089
And so on... After 100 turns you would have only around 600 - 700.
But it's a zero sum right. Where does the 300 - 400 go? It goes exponentially to select few who by random chance have more wins than losses.
In fact the longer it goes on, the higher odds of there being outlier with a lot - you might expect that everyone would converge around $1000, but that is not the case.
I did an example run with 10 000 investors, each doing 1000 trades, each trade they bet 10% of their portfolio, with 50% odds of winning.
First investor had 562 wins and 438 losses, with $1,666,061.
Median investor had only $7 left with 500 wins and 500 losses.
Top 10th percentile investor had $364 with 520 wins and 480 losses.
So interestingly even an investor that had 40 wins more than losses, lost 2/3 of portfolio.
> How does that explain Warren Buffet’s spectacular success?
Buffett buys “cheap, safe, high-quality stocks” with leveraged “financed partly using insurance float with a low financing rate” [1]. TL; DR He’s doing private equity with discipline.
For most people who are saving for retirement between the ages of (say) 30 to 65, that's most of their investing lifetime, and such underperform could radically effect the life they can live once they start working. Do you want risk your proverbial Golden Years simply because you chose not to take the market average returns?
2. While Buffett is a better-than-average investor (and certainly better than me), the main reason why we know him is because he's so rich, but as Morgan Housel notes, the vast majority of that wealth has come from compounding:
> As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s. Warren Buffett is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation.[16] What if he was a more normal person, spending his teens and 20s exploring the world and finding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $84.5 billion. $11.9 million. 99.9% less than his actual net worth. Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time. That’s how compounding works. Think of this another way. Buffett is the richest investor of all time. But he’s not actually the greatest—at least not when measured by average annual returns.
The key is that for every Apple, there are a ton of companies we don’t even remember the names of that went out of business or otherwise did not beat the SP500.
Put another way - if you can reliably pick the next Apple before anyone else, you should go work in finance and make tons of money.
> Put another way - if you can reliably pick the next Apple before anyone else
Problem is that it might take years to verify that.
> The key is that
That doesn't change the fact that there are plenty (in absolute numbers) of individual investors who consistently beat the market. Whether that's because of luck or something else is rather hard to tell.
> That doesn't change the fact that there are plenty (in absolute numbers) of individual investors who consistently beat the market. Whether that's because of luck or something else is rather hard to tell.
It's actually not very hard to tell; if it was because of something other than luck, you'd expect that beating the market in the past would have some predictive value of their ability to beat the market in the future.
Individual traders beat the market all the time, it’s not impossible. But you can’t expect to do it reliably, because in practice it’s essentially gambling, unless you’re Warren Buffett, or those firms that utilize sophisticated quantitative or algorithmic trading.
So for all intents and purposes, the takeaway for regular investors should be that they cannot expect to beat the market (but they can gamble on it if they like).
Lots of people "play the market" as a mostly total game of chance. They might just as well join a giant pool that tries to guess the ratio of alphabetic characters within each morning's top headline of their favorite newspaper.
Warren Buffet buys the newspaper and has significant control of the editor. That's not the same game at all.
There's a lot of talk here about active fund management. Active ownership is playing on a completely different level.
You do know there are thousands of stocks right. how many people dump their entire savings into one stock. 20 years ago you wouldn't have known apple was going on to do so well. If people did know it would have been bid up in price at the time
And a lot of the Apple run-up happened relatively late in the game. Don't get me wrong. Apple--and what I was able to do with the money--was good to me. But so was a late 2010s Microsoft purchase and I don't think a lot of people are highlighting Microsoft as a stock they missed out on during the last 10 years.
That claim is not phrased like that, so why would we interpret that way?
> average
So what? It's like saying that since an average person can't run a marathon it wouldn't make sense for any individual to even try it. How does that make sense?
> cherry picked
If we agree that 50% of all investors can't beat the market, what proportion can? 1%, 10%, 30%? Because there is a massive difference.
How do we even define that group? Is it any random person buying random stocks with pocket change? Is it above a certain portfolio size? etc.
"Average" is a bit misleading word when it comes to the market.
If you're a top investing expert, you do things carefully in the right way, and you don't make mistakes, you can expect average performance. Because the market primarily consists of experts like you.
Of course, investing is a random process, and you often beat the market by being lucky. But luck doesn't last indefinitely.
There are basically two ways to beat the market consistently. One is trading based on information not available to the rest of the market. This is sometimes banned, because it makes the market less fair and less efficient. It can also be a crime. The other is finding a market that's small enough or obscure enough that it's not interesting to the professionals.
But there is no investing stat that allows you to beat the market. Life is not an RPG.
> Investment is hardly a zero sum game. If it were nobody would make anything buy investing passively either. So how is that a reasonable analogy?
I think you’re reading too much into the analogy, which is maybe my fault for using an analogy. The point was just that it’s not that you can’t win, just that you very likely don’t have an edge - not because it’s mathematically impossible like in blackjack with a shoe that’s continuously shuffled, but because it’s so difficult.
> Sure, I can't. But assuming that it's not entirely random chance some proportion of people certainly can.
And if you put your house on 26-black and it came up you'd be doing great too.
Take 100 people randomly throwing darts at the companies on the SPY, and a fair few will do better than the SPY overall. Doesn't mean they can expect to beat the market
Yeah. And 20 years ago, there was no iPhone and an only somewhat interesting MP3 player compared to other brands. I did OK with Apple but not suggesting it was much other than luck.
> picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market.
Is there? It would make sense if an average individual trader can't expect to beat the market. Claiming that there are no individual investors who did/can do that over a reasonably long period is both objectively false and rather absurd.
Read the GP carefully.Expect to beat is very different than beat. You don't expect to beat the casino in roulette, but some people will luck out. That doesn't mean they could expect to win in advance: They should expect a small loss, depending on the table, and be surprised when luck smiles upon them.
> You don't expect to beat the casino in roulette,
Do you believe that investment is entirely random and there is absolutely no skill involved?
Because if not, that's a nonsensical analogy. You should use a a both both luck and skill based game like poker (probably not the casino variety, though) etc.
Otherwise if you can reasonably expect to beat 50% of all "players" (of course it takes much more time to verify that in the market) then you can expect to make more than the average.
The problem is that any active trading strategies now need to beat the market by the cost of a fund manger, the cost of their research, the cost of regular trades, and the cost of short-term capital gains taxes on those trades.
These add up significantly. Instead of having to beat the market at all, you have to beat it by an extra half of a percent or more every year. And you have to do it year after year after year.
All the evidence shows that actively-managed funds are a weighted (against you) coin flip. Less than half will beat the market in a given year. And the results from any given year are independent of the next.
Yeah managed funds sucks big times. They rip people off with fees, quite some have insane performance fees and they just don't beat the market.
Then I suspect that even with all the supervision in place, quite some manage to also do Hollywood accounting.
Not to mention the friend of the cousin of the fund manager's niece who happened to buy x shares of y or options before, shocker, the fund invested in y.
We know these people cheat. If they were so good they wouldn't need to leech on fees.
I live in a tiny country where lots of fund are managed (only second to the US). I know the drill. Most of them by very far are about suckering people's money in, no matter what the fund is about.
Creat 16 funds, after four years show the prospectus of the one fund that performed best. Rinse and repeat.
Actively managed funds are a scam.
Also depending on where you buy it, anywhere from zero (good) to 1% entrance and exit fees.
> Do you believe that investment is entirely random and there is absolutely no skill involved?
The skill involved is more just "best practices" that let you match the market: Buy-and-hold, diversify, basically, do what the index funds do and you will be roughly +0 to the market. Beyond that, it's a totally random distribution that adds between -X and +X which allows some participants to beat the market and causes some to underperform. You can't tell beforehand which participants will beat the market, even having full knowledge of their strategies and skill. If you think you can, please tell me which active funds will beat the market in the next 10 years based on their skills. I'll invest in them.
> You can't tell beforehand which participants will beat the market, even having full knowledge of their strategies and skill
I never implied that I can. That fact doesn't prove that it's somehow fundamentally impossible to do that. The problem is that it's impossible to tell if you "strategy" is working until a significant amount of time passes and by that point the markets conditions might have changed to such an extent that you don't longer have an edge (add to that the fact that it's hardly possible to determine what part of your success was luck/skill). So there is always a huge amount of uncertainty.
Albeit if we look back by ~10-15 years it's rather obvious that it was possible to beat the market by a very significant e.g. there were clear rational reasons to believe that Nvidia would do better than its competitors like AMD or Intel and that there would be significant growth in GPU compute/ML/AI (of course accurately estimating the extent and exact timing but that wasn't necessary at all to get above market return) same applies to many companies in adjacent and unrelated sectors. Was I or the overwhelming majority of investors capable of realizing that and more importantly acting on it? Certainly not. But looking back it obviously wasn't random.
The efficient-market hypothesis is clearly false, at least in the short to medium term. That in no way means that most investors are even remotely capable of utilizing this fact.
It must have been nice in the early 2010s to be so smart to predict AI would be a huge hit (after a couple previous AI winters) and that GPUs would be the key and that NVIDIA specifically would reap the benefits. But I'm sure you're smarter than me and a lot of other people. And AMD also did pretty well during much of that same period although I sadly sold my modest holdings after they went nowhere for years after spiking with some adoption by the big server makers. It would probably have made more sense to bet on Intel during that period.
Exactly. The point is that the only way you can know that a particular "strategy" was market-beating is by looking back after the fact. Just like you can only know who is a good coin flipper after running 10 trials and looking back at who flipped heads 10 times. And the strategies will be similarly repeatable.
We expect some individual traders to beat the market (and some to do much worse than the marker); that's variance. But each individual trader should not expect to beat the market, because they don't know if they're one of the lucky ones.
> But each individual trader should not expect to beat the market
In aggregate sure. But unless we believe that it's entirely random some individual investors can still certainly expect to beat the market, they just can't verify that in advance.
I offer you a bet. We flip a perfectly fair coin. On every heads you gain 10% on top of your bet. On every tails you lose 10%.
It is fair to say that after 100 flips you may profit. If one million people play this game, someone almost certainly will. But you can expect to lose money on this game. By the end, the average person will have about 60% of their original holdings (0.9^50 * 1.1^50).
In this game it’s possible for winners to exist. It’s not even uncommon! You only have to get at least 53 out of 100 flips as heads. Unfortunately there’s also no function that lets you determine a winner in advance, and the longer you play this game the greater the expected loss.
All of the available evidence shows that publicly-available actively-managed funds are essentially playing this game. As expected, many have incredible winning streaks… right until they don’t.
Yes, Ren Tech’s Medallion Fund exists. But you can’t contribute to it; they don’t want your money. Because that requires scaling market inefficiencies and that in and of itself is an intractable problem. Novel strategies ripe for profit don’t have unlimited capacity. They rapidly exhaust alpha.
That’s not what “expect” means in statistics. If we’re rolling 100-sided dice (each person rolls once), no person should expect to roll a 1, even though 1% of people will in practice roll a 1. Likewise, no one should expect to beat the market, even though many will in practice.
> Likewise, no one should expect to beat the market, even though many will in practice.
My only point is only that not every investor is rolling the same dice. It's just that it is effectively impossible to every verify whether you were rolling a 90-sided dice or a 100-sided one. It's rather clear that at least in the short to medium term (e.g 2-3 years) the stock is not even remotely perfectly efficient (that doesn't mean that the overwhelming majority of investors are somehow capable of utilizing that fact or that a significant proportion of those that did seemingly manage to do that weren't just lucky)
Re: picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Active managers can only beat the market gross of fees because they employ large teams of people to do a lot of work to gain a small edge (stuff like predicting retail sales numbers from satellite images of store parking lots).
This is my attempt at summarizing a whole field of research in a few sentences. There are many more nuisances. I highly recommend listening to the Rational Reminder podcast if you’re curious about this sort of thing. They interview a lot of academics.