A couple of years ago I received a serious-sounding email from a guy who was thinking too hard about whether to incorporate my daily musings into his diet of market-focused color commentary.
It wasn’t a long letter, but it was long as those sorts of inquiries go and included some background information about his professional career (he was a neurosurgeon) and that of his wife (she was a lawyer).
He wasn’t a stranger to my “insightful and entertaining” digital scribbles, but said he disengaged from active investing after the pandemic because “markets have become harder to gauge.”
Be that as it may, he was determined to get back in the saddle, which is to say he expressed a desire to actively trade a stock portfolio in-between… well, in-between operating on brains, apparently. (“Ding! Ding! Ding!” “Don’t worry everyone, that’s just my Robinhood notifications — the patient’s vitals are fine.”)
By the sound of it, this was a weighty decision. “How do you feel you have done with your analysis over the past few turbulent years since 2020?” he asked of me. “[It] would be helpful to know your honest assessment of your track record.”
I could’ve answered his question. (“Honestly,” I’ve done fine.) And I could’ve given him some numbers. (I’ve maintained more or less the same, middling average annual return since I was too young to have an account in my own name. Nothing changed in that regard following the pandemic.)
Not wanting to give the impression I’m peddling an investment advisory service (I’m avowedly not), I demurred. Besides, my “honest assessment” would’ve likely come across as quaint or even humdrum. When was the last time you paid for something — anything — which advertised itself as “middling”?
But that’s the thing about investing: If you can be consistently middling for decades, you’re going to do very, very well for yourself. And it’s not difficult — at all — to be consistently middling.
In fact, on a non-relative basis — i.e., if you just think in terms of what counts as a decent return on invested capital rather than pocket-watching, or otherwise concerning yourself with how much the next guy’s making on money that isn’t yours — it’s getting easier to be middling all the time. Hold that thought.
As discussed here on too many occasions to count of late, the proliferation of passive investing has created a kind of perpetual motion machine whereby cap-weighted benchmarks are driven inexorably higher on very narrow leadership to the deep chagrin of active managers who are bleeding AUM.
On some vectors and interpretations, choosing to index is a choice to be middling. Put differently, a choice to forego greatness. The irony is that the more people who make that choice, the greater the returns on the benchmarks tracked by index funds and the harder it is for active managers to be great.
I revisited this most recently in “Passive Investing Is (Still) QE For Stocks,” in which I noted that active funds are on track for a record annual exodus in 2025, while equity ETFs are on pace for record inflows. Fast forward a few days and Bloomberg ran a feature piece on the exact same topic. (That happens more often than it should, by the way.)
The figure above plots the annual net flow to/from active equity mutual funds with the share of such funds beating their own benchmark (the Bloomberg piece compares performance versus the S&P, which works for illustrative purposes but isn’t technically accurate).
The most important takeaway from the visual is that it’s exceedingly rare for more than half of actively-managed funds to outperform. This isn’t just about the Mag7. It’s not a recent phenomenon. Active management’s a mug’s game, and anyone who tells you different is lying. Why do you think indexing became so popular in the first place? There’s a reason Vanguard gathered so much AUM.
Suggesting, as Bloomberg inadvertently did, that indexing everywhere and always precludes diversification is to gloss over the underlying wisdom of passive investing: It works almost regardless of what you’re tracking.
Pick a sector or style that can be mirrored by a widely-used benchmark, invest in a low-cost tracking product and chances are, you’ll outperform an actively-managed strategy focused on the same sector or style, particularly given the fee disparity. (For example, Vanguard lists the average expense ratio of large-cap value funds at 0.85%, more than 15 times higher than the token charge for the Vanguard Value Index Fund.)
Nothing says that, as an indexer, you can only own SPY or VOO. You could own VOO and a collection of low-cost index ETFs tracking widely-followed benchmarks for everything from large-cap US value stocks to emerging market shares. If that sounds daunting in terms of deciding how to allocate, trust me it’s not.
Imagine you have $100 to invest in stocks, and assume you’re going to put $40 into the S&P 500. You have $60 left to invest. You might try $20 to a passive product tracking developed market equities excluding US stocks, $10 to an index product tracking the most widely-followed emerging market index, $10 to an AsiaPac equity index fund, $10 to a Russell 2000 fund and index the remaining $10 to US mid-caps.
Or whatever. It doesn’t really matter. As long as you overweight the S&P 500 then employ some common sense in choosing how to allocate your non-S&P 500 equity investments and distribute that money among passive index products managed by a reputable firm with all dividends reinvested, you’ll do fine. And over a long horizon, fine’s more than enough.
That strikes at the heart of my own thinking. I don’t mind underperforming the S&P 500 during any given year if it means being diversified or, as has been the case for the last several years, holding a lot of cash which naturally blunts volatility. What I don’t want to do is pay someone else to underperform, not because they held “too much” cash, but rather because they wouldn’t (or, in a lot of cases, couldn’t) buy enough Mag7.
It remains my steadfast contention that anyone possessed of average intelligence who endeavors to manage their own money using simple, low-cost, passive ETFs will quickly intuit how to adjust portfolio weights to achieve a comfortable balance between risk and reward. It’s not complicated. Really it isn’t, particularly not when cash yields are meaningfully positive and considering you can always make concentrated bets when the opportunity presents itself (e.g., when a bear market provides you with opportunities to pick up your favorite blue-chips at discounts large enough that you don’t need a lot of research to determine if it makes sense to take a flyer.)
Remember: You’re not an active large-cap equity mutual fund manager. Your employment status doesn’t depend on besting a cap-weighted benchmark increasingly dominated by a handful of tech stocks. And unless you’re just hopelessly petty, you don’t measure your investment success based on someone else’s — rather, you base that assessment on whether you generated a meaningfully positive return for a risk level you deem appropriate for your circumstances and psychology.
That’s what I meant above when I suggested it’s best to think about your returns on a non-relative basis. And why I said it’s getting easier all the time to do fine. In an environment where the largest US companies — which every individual investor is going to be overweight in one way or another — are driven inexorably higher, the bar to clear to achieve, say, a 12% annual return on a diversified portfolio is lower.
The only people who should care that 12% isn’t 17% or 20% are people for whom that disparity is the difference between having a job and not. All you need to stay on the right side of Piketty’s inequality equation is a return that outstrips growth. No advanced economy (and really no emerging market either) has any hope of growing at anything like a 12% clip in perpetuity.
If you can return between 9% and 12% on a diversified portfolio year in and year out (which, again, is made a lot easier when the one thing you have to hold — the S&P 500 — returns 20% or more) and you’re lucky enough to achieve the average life expectancy for an advanced economy, that’s success. And no small measure of it either.
To reiterate: Anyone can do the investing part of that. All you need is a mundane suite of very basic index ETFs. The living to 75 or 80 bit, that’s the hard part.
In my response to the good doctor mentioned here at the outset, I wrote that in my opinion, “strangers shouldn’t be giving financial advice to other strangers.” Besides, I told him, “if you’re a brain surgeon and your wife’s a JD, I’m highly confident in your capacity to manage your own money without anyone’s help.”
As one goes into pre-retirement and transitions to the real deal (62 for my wife and I) cash income has been my target. Since the dot.com mess that income has enjoyed growth every year (by a middling 5-6%). I’m very happy with that result. My needs are fully met. Mr. Bogle studied the data you showed in your graph and found that when all is said and done even an index fund typically doesn’t beat its own index.
+1.
If I consistently beat 8%, I don’t cry.
I don’t cry much.
On my 70/30 trading account I beat the S&P this year. I’m having a good year as a gambler.
I lightened up in February March and went
60/40. And then brought back in 80/20. Year end at 60/40, sold off some losers to make up for the capital gains in February and March. So now I go shopping with 10%, get a real pull back and I got 40% to shop with.
Every gambler knows you shouldn’t play with scared money.
My 401 I let the bank just take care of it, I’m sure at some point they’ll best me. Cause we all know the highly training professionals don’t gamble like us day traders.
Wait, wait! I can’t remember – what was the name of that book? Oh yeah, “A Random Walk Down Wall Street.” I think I read that (a few decades ago) while getting my MBA. Assigned reading in an Investments course. That fact alone should tell you something.
Amen to the above!
I have noticed a Bloomberg article “lag effect” on your posts.
It’s absolutely real, and it sticks out like a sore thumb to me because there’s no such phenomenon w/ WSJ or FT — which is to say if I were seeing it everywhere, I’d know I was imagining it. But it’s only BBG. What’s a bit annoying about it is that there isn’t a single @bloomberg.net address in my entire subscriber base, and although I won’t claim to know the names of everyone who works there, nor will I claim to have ever gone through by own subscriber database line by line looking for names I recognize, I don’t remember an instance of anyone there ever subscribing, which means they’re getting the articles for free somehow, or at least sharing a login, which is a really penny-pinching thing to do. Particularly given how much money I pay them for their products and services, and how assiduous I am in linking back to their coverage which is basically free promotion (not that they need it).
And not for nothin’ — and without mentioning any names — it’s glaringly obvious that BBG only started paying attention to a certain couple of strategists because I name-dropped them incessantly here. We’ve seen that movie before: Marko K. and Zoltan P. became famous in the mainstream financial media because they were mainstays on another independent, market-focused web portal with a huge readership. Unlike that portal, I don’t have a huge readership, but the dynamic was the same.
I need to hear this lesson again and again. Along with the truly excellent https://heisenbergreport.com/2023/12/09/dopamine/
Thanks for posting that link. I tried to find that article earlier and couldn’t.
That post was a Heisenberg classic! Not much has changed for me (investment or otherwise) since that post, other than I changed my name from Emptynester to SeaTurtle. Still appreciating a good night’s sleep, a nice long walk, and reading- my current obsession is Jack London- his short stories are really, really good. 🙂
Jack London – top of my list.
That’s a nice re-read.
I found a portfolio mix of passive ETFs that has a track record of returning 3-4% above the inflation rate over almost all 10 year periods since the early 70s. It is completely left in the dust by the SP-500 but its volatility is so much lower that I sleep well at night regardless what the markets are doing. Hence, this piece rings especially true for me. I am happy with the risk/reward balance because it suits me psychologically.
I’d love to share this article with my children but won’t without your express permission.
Yes, feel free to share the article with your children.
If you really want to increase your fortune, increase your lifespan. 1 in 3 people die of cardiovascular disease, and if you can prevent that, you can live another 7.5 years longer. That’s some real compounding gains. For a lead I offer up the cheap as chips generic drug Ezetemibe. For some reason most doctors don’t know or care to prescribe it. Best to all.
Sage advice. I’m a 69 year old runner taking Ezetemibe along with statins, just started Repatha as I’m not tolerant of statins.
I’ve been taking a statin for a couple of years now. That’s for my health. I invest basically as this article describes. That takes care of the pocketbook. And I read H religiously. That’s to keep the grey matter from seizing up.
And often to provide a great laugh. The wit and snark are extraordinary
It seems the new thing to avoid are thieving funds and private equity exit funds. A friend with a teachers retirement account asked me about their investments. I was shocked that her universe of allowed funds included many with 5% loads (remember those?!) and 1.5% expenses! We consolidated into an SPX fund, out of her 5% loads ESG fund and I told her to put the rest in the most venal, evil and regressive company on Earth. This was 2021 and that evil company was PLTR. Recently she told me she sold it to fund an AirBnB as it gained well over 1000%. Who said evil doesn’t pay?
All investors should know this, and that is, that 20% of all stocks account for the entire gain of the S&P over long periods of time, give or take certain periods in history. That means that the other 80% for the most part give no return at all. There are studies that have proven this, so you can go and find this information on the Ai Inter-Webs. Being cap weighted the S&P 500 is the largest momentum strategy there is.
Just knowing that allows you to decide how to properly allocate your money.