Stock Market Experts of the 1930s
If you have even the slightest interest in investing, you probably notice stock market experts everywhere, whether they appear on CNBC, write for newspapers or blogs, or even serve as your advisor. Readers of this blog know to be very skeptical of their advice. We’ve already exposed the disappointing results of using Morningstar mutual fund ratings, mutual fund managers, and Wall Street earnings forecasts.
But has it always been this way? These studies generally use performance over the last few decades to support their conclusions. The stock market and its experts have been around a lot longer than that.
Trading in Volatile Markets
From the May 2010 newsletter:
You may be wondering what trading I’ve done over the last few weeks with the recent volatility in the stock markets (S&P 500 below).
Well, my answer is very simple, I have done very little. When I point out evidence showing that very few investors succeed in beating the market by picking stocks or timing the market, I am not exempt from that reality–no matter how smart my wife tells me I am every night.
Costs of Active Trading
I am not a fan of active trading. It may be fun to trade like Jim Cramer, but I certainly would not bet my retirement or my kid’s college education on it. We already know mutual fund managers have a horrible record of beating the market, and that study only considers transaction costs and fund expenses! If we add taxes to the study, their performance would be even worse.
So let’s explore the costs of active trading, specifically transactions costs and taxes. The following chart shows the effect of those costs based on holding periods ranging from 3 months to 10 years under a few assumptions (see end of post).
Trying to Beat the Market
The NY Times recently highlighted an academic study that estimates the proportion of mutual fund managers that can truly outperform the market. These types of studies have been conducted countless times, and all show that beating the market is very difficult. The results of this study using data from 1975 to 2006 are:
The researchers’ tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability — far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It’s just that they can’t come out ahead after all their funds’ fees and expenses are paid.
Invest Like a Googler
Before Google’s IPO in 2004, the company felt responsible for preparing their employees to manage their upcoming IPO wealth. So Google hosted a few experts in finance and economics to speak to their employees about personal investing. Some of the speakers were:
- William Sharpe: 1990 Nobel Laureate economist and professor emeritus of finance at Stanford’s Graduate School of Business
- Burton Malkiel: former dean of the Yale School of Management, now a professor of economics at Princeton, and author of the classic “A Random Walk Down Wall Street”
- John Bogle: founder and retired CEO of The Vanguard Group, the first company to offer index funds to retail investors
Why Indexing Is So Hard
The most counter-intuitive part of indexing is the avoidance of action, especially in an effort to beat the market. We generally associate hard work and hours of effort with success, however in investing it turns out to be exactly the opposite. All those costs incurred by action (commissions, bid-ask spreads, and realized capital gains) make beating the market that much harder.
This “action bias” to do something has recently been documented in the decision making of goalkeepers during penalty kicks. Although data shows that they could be more successful by staying in the middle (no action), they still jump to either side (action) over 90% of the time.
