You hear that often, but if you squint your eyes, the entire idea of index funds is just that: they outperformed stock-pickers in the past, so you should put money into them to get higher returns in the future. There's no fundamental index fund investment thesis other than "past performance is indicative of future returns".
That thesis is at least to some extent self-fulfilling, because there's so much money flowing into index funds that prices of all the underlying assets keep moving up, and there's probably not enough money trying to bid against that / arbitrage the excesses away.
A similar thing could happen with AI. Markets are efficient only if the world isn't in some sort of a trance.
That's not the idea behind index funds. It's arithmetic. The aggregate return of active investors, before fees, is the market return. Once you subtract fees, it's below the market return. While some active managers' performance less fees is higher than the market return, it's very difficult to predict which will perform this way. So your best bet is to own the market through a broad index fund that has almost no cost.
If you want to read about this, see Sharpe (1991), The Arithmetic of Active Management.
In a spherical cow sense sure. But no one is buying the market return when they buy even a total market index fund. Other commenter is right, they are expecting past performance of these index funds to be indicative of future returns. But then again they aren't really actively investing either. Automatic contributions pervert a lot of the efficient market hypothesis ideas I think since these people are buying, routinely, maybe as long as they are alive, with no information in front of them.
> So your best bet is to own the market through a broad index fund that has almost no cost.
There's also the fact that index funds have de facto become pension funds in most of the Western world, so Western politicians are trying to do their damn best to keep the stock exchanges afloat (i.e. always going up) in order to keep those aged 45-50 and older on their side when it comes to voting. We've last had a market crash in 2008-2009 (the covid thing was just a blip), I don't see today's politicians allowing a crash like that to happen if they can help it.
So in fact putting one's money into index funds is betting on the current political system continuing doing its thing, no need to involve any advanced maths.
No, the investment thesis is that there is a risk premia associated with investing in equity (as opposed to cash) that you will be compensated for - if this risk premia exists the way to harvest it is to be as diversified as possible (hand waving).
The relative performance of different baskets of equity is of course much more subtle / prone to behavioural effects and so on.
> There's no fundamental index fund investment thesis other than "past performance is indicative of future returns".
(Not a finance guy) But isn’t it that buy and hold index funds minimise trading fees, and those savings compound to produce better long term performance than nearly all active funds?
(The “Acquired” podcast episode covering the history of Vanguard and Jack Bogle goes into it in detail)
I don't think that's a particularly accurate assessment of the idea behind index funds.
The point of index funds isn't "these outperform all pickers, so they'll outperform all pickers in the future."
I think the idea is more around a combination of:
- you'll have much lower risk trying not to pick the right picker (or pick the investments yourself)
- the median picker is probably not very good (approached in two directions: sizable pickers that hit on an edge will likely be copied until the edge is gone, and smaller pickers are extremely unlikely to have enough specialized info or skills to excel).
> you should put money into them to get higher returns in the future.
Higher returns than what? I thought the whole point of buying broad market index funds was to simply get the market returns. For this thesis to make sense, you simply must assume that companies, in aggregate, make money - not that any particular company will follow past performance. If you don't think companies make money, then what are you doing buying equities?
Might not work for long holds but for short daytrading I feel like getting enough data for a model, not llm but any model, is the real golden goose moat of most ibs. Pajama traders at home have to set up heuristics for what they believe is a bull flag and maybe develop even a refined gut sense of spotting say a bull flag.
But imagine a quant at Jane street. They see the same candlestick pattern as the pajama guy but their model is giving them actual odds ratios instead of gut instinct. They can now score their putative bull flags in real time and make investments that might be more likely to pay off than not.
A big reason why this works is that technical analysis is a self fulfilling prophecy. Many people are looking for and trading on the exact same signals and this is enough to see a pattern in the candlestick data actually be one associated with market movement. Whether the market movement is 'genuine' or manufactured by other quantitative technical traders in this self fulfilling prophecy doesn't matter, you've made your money and really don't care about the underlying asset at the end of the day, only its delta.
WIthin markets the idea "it implies correlation" may be enough to shift your odds from 50/50 to 60/40, which is enough that people with "implying only" are usually fine to dare to enter a position.
You hear that often, but if you squint your eyes, the entire idea of index funds is just that: they outperformed stock-pickers in the past, so you should put money into them to get higher returns in the future. There's no fundamental index fund investment thesis other than "past performance is indicative of future returns".
That thesis is at least to some extent self-fulfilling, because there's so much money flowing into index funds that prices of all the underlying assets keep moving up, and there's probably not enough money trying to bid against that / arbitrage the excesses away.
A similar thing could happen with AI. Markets are efficient only if the world isn't in some sort of a trance.
That's not the idea behind index funds. It's arithmetic. The aggregate return of active investors, before fees, is the market return. Once you subtract fees, it's below the market return. While some active managers' performance less fees is higher than the market return, it's very difficult to predict which will perform this way. So your best bet is to own the market through a broad index fund that has almost no cost.
If you want to read about this, see Sharpe (1991), The Arithmetic of Active Management.
In a spherical cow sense sure. But no one is buying the market return when they buy even a total market index fund. Other commenter is right, they are expecting past performance of these index funds to be indicative of future returns. But then again they aren't really actively investing either. Automatic contributions pervert a lot of the efficient market hypothesis ideas I think since these people are buying, routinely, maybe as long as they are alive, with no information in front of them.
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> So your best bet is to own the market through a broad index fund that has almost no cost.
There's also the fact that index funds have de facto become pension funds in most of the Western world, so Western politicians are trying to do their damn best to keep the stock exchanges afloat (i.e. always going up) in order to keep those aged 45-50 and older on their side when it comes to voting. We've last had a market crash in 2008-2009 (the covid thing was just a blip), I don't see today's politicians allowing a crash like that to happen if they can help it.
So in fact putting one's money into index funds is betting on the current political system continuing doing its thing, no need to involve any advanced maths.
No, the investment thesis is that there is a risk premia associated with investing in equity (as opposed to cash) that you will be compensated for - if this risk premia exists the way to harvest it is to be as diversified as possible (hand waving).
The relative performance of different baskets of equity is of course much more subtle / prone to behavioural effects and so on.
> There's no fundamental index fund investment thesis other than "past performance is indicative of future returns".
(Not a finance guy) But isn’t it that buy and hold index funds minimise trading fees, and those savings compound to produce better long term performance than nearly all active funds?
(The “Acquired” podcast episode covering the history of Vanguard and Jack Bogle goes into it in detail)
I don't think that's a particularly accurate assessment of the idea behind index funds.
The point of index funds isn't "these outperform all pickers, so they'll outperform all pickers in the future."
I think the idea is more around a combination of:
- you'll have much lower risk trying not to pick the right picker (or pick the investments yourself)
- the median picker is probably not very good (approached in two directions: sizable pickers that hit on an edge will likely be copied until the edge is gone, and smaller pickers are extremely unlikely to have enough specialized info or skills to excel).
> you should put money into them to get higher returns in the future.
Higher returns than what? I thought the whole point of buying broad market index funds was to simply get the market returns. For this thesis to make sense, you simply must assume that companies, in aggregate, make money - not that any particular company will follow past performance. If you don't think companies make money, then what are you doing buying equities?
The stocks in the index funds are picked, just by a committee. And there are a few competing index funds.
They're picked (mostly) using very mechanical rules though so e.g. hedge funds actively speculate on which stocks will be added to the index
Might not work for long holds but for short daytrading I feel like getting enough data for a model, not llm but any model, is the real golden goose moat of most ibs. Pajama traders at home have to set up heuristics for what they believe is a bull flag and maybe develop even a refined gut sense of spotting say a bull flag.
But imagine a quant at Jane street. They see the same candlestick pattern as the pajama guy but their model is giving them actual odds ratios instead of gut instinct. They can now score their putative bull flags in real time and make investments that might be more likely to pay off than not.
A big reason why this works is that technical analysis is a self fulfilling prophecy. Many people are looking for and trading on the exact same signals and this is enough to see a pattern in the candlestick data actually be one associated with market movement. Whether the market movement is 'genuine' or manufactured by other quantitative technical traders in this self fulfilling prophecy doesn't matter, you've made your money and really don't care about the underlying asset at the end of the day, only its delta.
Answering this aphorism with a demonstration of your wrongheaded idea about timing the market is embarrassing stuff.
Nothing I wrote is about timing the market. It is just about making a decision based on data, or not.
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It is though, it just doesn't guarantee it.
Same as "correlation doesn't imply causation" - it actually does imply it, it just doesn't prove it.
WIthin markets the idea "it implies correlation" may be enough to shift your odds from 50/50 to 60/40, which is enough that people with "implying only" are usually fine to dare to enter a position.