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pages: 356 words: 51,419

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns by John C. Bogle

asset allocation, backtesting, buy and hold, creative destruction, diversification, diversified portfolio, financial intermediation, fixed income, index fund, invention of the wheel, Isaac Newton, new economy, passive investing, Paul Samuelson, random walk, risk tolerance, risk-adjusted returns, Sharpe ratio, stocks for the long run, survivorship bias, transaction costs, Upton Sinclair, Vanguard fund, William of Occam, yield management, zero-sum game

In order to achieve such a 50/50 government/corporate bond portfolio, investors who require a higher yield than the total bond market index fund (yet still seek a high-quality portfolio) might consider a portfolio consisting of 75 percent in the total bond market index fund and 25 percent in an investment-grade corporate bond index fund. The value of bond index funds is created by the same forces that create value for stock index funds. The reality is that the value of bond index funds is derived from the same forces that create value in stock index funds: broad diversification, rock-bottom costs, disciplined portfolio activity, tax efficiency, and focus on shareholders who place their trust in long-term strategies. It is these commonsense characteristics that enable index funds to guarantee that you will earn your fair share of the returns in the stock and bond markets, even as they do in all financial markets.

The evidence is compelling and comes down firmly in favour of investing in index funds. . . . Over the 10-year period 1988–1998, U.S. bond index funds returned 8.9 per cent a year against 8.2 per cent for actively managed bond funds . . . [with] index funds beating 85 per cent of all active funds. This differential is largely due to fees.” Chapter Fifteen The Exchange-Traded Fund (ETF) A Trader to the Cause? DURING THE PAST DECADE, the principles of the traditional index fund (TIF) have been challenged by a sort of wolf in sheep’s clothing, the exchange-traded fund (ETF). Simply put, the ETF is an index fund designed to facilitate trading in its shares, dressed in the guise of the traditional index fund. If long-term investment was the paradigm for the original TIF designed 42 years ago, surely using index funds as trading vehicles can only be described as short-term speculation.

In fact, after all of the selection challenges, timing risks, extra costs, and added taxes, ETF traders can have absolutely no idea what relationship their investment returns will bear to the returns earned in the stock market. These differences between the traditional index fund—the TIF—and the index fund nouveau represented by the ETF are stark (Exhibit 15.1). Exchange-traded funds march to a different drummer than the original index fund. In the words of the old song, I’m left to wonder, “What have they done to my song, ma?” The creation of the “Spider.” EXHIBIT 15.1 Traditional Index Funds versus Exchange-Traded Index Funds ETFs Broad Index Funds Specialized Index Funds TIFs Investing Trading Broadest possible diversification Yes Yes Yes No Longest time horizon Yes Yes No Rarely Lowest possible cost Yes Yes Yes* Yes* Greatest possible tax efficiency Yes Yes No No Highest possible share of market return Yes Yes Unknown Unknown *But only if trading costs are ignored.


pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

asset allocation, backtesting, Bernie Madoff, buy and hold, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

The number of active fund portfolios that beat the index fund portfolio by 0.5 percent or more hardly budged, while the number that underperformed by 0.5 percent or more remained very high. The Real Deal Finally, I conducted an independent real-world test of a randomly selected actively managed fund portfolio versus an all index fund portfolio. I used the actual fund returns from three fund categories going back 15 years. I constructed an index fund portfolio using the funds and weights in Table 6.7. My test compared this index fund portfolio to thousands of randomly selected active funds from the Morningstar list, in the correct weightings. Table 6.7 Model Index Fund Portfolio Used in the Live Study Index Fund Name Percent Allocation Vanguard Total Stock Market Index Fund 45% Vanguard Total International Stock Index Fund* 15% Vanguard Total Bond Market Index Fund 40% * The Vanguard Total International Fund had its first full year under management in 1998.

See Uniform Prudent Management of Institutional Funds Act (UPMIFA) U.S. equity index U.S. equity index funds U.S. Equity mutual funds U.S. News & World Report U.S. Securities and Exchange Commission (SEC) U.S. small cap funds U.S. stocks U.S. Treasury bonds Value investing Value stocks van Dijk, Mathijs A. Vanguard 500 Index Fund: 15-year tax cost ratio for 25-year study on active funds and domestic equity funds of launch of proven record of sales load, lack of Vanguard Bond Market Fund Vanguard First Index Investment Trust Vanguard Group: first index fund, launch of as global investment managers indexing, growth of international indexing analysis web site for Vanguard REIT Index Fund Vanguard S&P 500 index fund Vanguard Small Cap Index Fund Vanguard Total Bond Market Index ETF Vanguard Total Bond Market Index Fund Vanguard Total International Stock Fund Vanguard Total Stock Market Index Fund Vanguard U.S.

When the academics questioned the lagging performance relative to the markets they were quickly reminded by fund company spokesmen that “you can’t buy the market.”4 This was a true statement at the time. Index funds didn’t exist. Now You Can Buy the Market The world changed in 1976 with the introduction of a passively managed S&P 500 index fund by the Vanguard Group. This gave mutual fund investors an option; they could continue to invest in actively managed mutual funds that tended to underperform the market by a considerable amount, or they could buy very close to the market return through the First Index Investment Trust (later renamed the Vanguard 500 Index Fund). The introduction of index funds to the marketplace was an inflection point in mutual fund history. Not only did index funds give investors a choice, they forced active fund companies to redefine their purpose. When asked if Fidelity would follow Vanguard’s lead and offer index funds, Chairman Edward C. Johnson III stated, “I can’t believe that the great mass of investors are [sic] going to be satisfied with just receiving average returns.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

asset allocation, buy and hold, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, post-work, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

As 2012 begins, Vanguard administers 62 broad market index funds and 12 broad sector index funds, plus another four LifeStrategy Funds and eight Target Retirement Funds, both of which use our existing Vanguard index funds as their underlying investments. These two series of index-oriented asset allocation funds have grown rapidly, with aggregate assets totaling $130 billion as 2012 begins. Part II The Invasion of the ETF Today, Vanguard remains at the pinnacle of the index mutual fund field, as we have for 35 years, accounting for more than 50 percent of the industry’s index fund assets. While our growth in index fund assets from 1986 through the 1990s had come entirely from our traditional index funds (TIFs), most of our growth since then has been driven by “nontraditional” index funds known as “exchange-traded index funds.” ETFs have existed only since 1992, but by 2000 they had become a major force in index investing.

Given the skills and experience of Vanguard’s investment and administrative staff and the firm’s ability to operate at rock-bottom cost, we felt that we had the responsibility to continue to dominate the index fund field. So we quickly pursued a strategy of expanding the original indexing concept to broader uses. The process moved forward quickly and easily. In the years that followed the creation of our stock index fund, we moved first into the bond index area. Thereafter, we would build an index fund “family” that would greatly expand our mandate. Here are the highlights.10 Vanguard Index Fund Family Milestones (1976 to 1996) 1986: The Bond Index Fund. We took this obvious step to build on our reputation as an index manager. Its story is told in greater depth in Box 6.2. Box 6.2: The Bond Index Fund In 1986, the first decade of Vanguard’s stock index fund came to a close. Its assets would soon top the $1 billion milestone.

(Strine) Tower, Edward Trading cost of transactions Trading volumes Traditional index funds (TIFs). See also Index funds assets exchange traded funds versus future of growth in number of as portfolio core profile of trading volumes “Trafficking” in management contracts Transactions: cost of taxes on Trends Turner, Adair Turner, Lynn Turnover: actively managed equity funds exchange traded funds index funds mutual funds Stewardship Quotient and stock market Twardowski, Jan M. 12b-1 fees Value, corporate Vanguard: Admiral shares balanced index fund bond funds, defined-maturity cash flow emerging markets stock fund exchange traded funds “Extended Market” portfolio growth and value index funds history index fund family milestones international funds LifeStrategy Portfolios proxy votes REIT index fund small capitalization stock fund Stewardship Quotient structure and strategy tax-managed index funds Vanguard 500 Index Fund Vanguard Institutional Index Fund Vanguard PRIMECAP Fund Vanguard Total Bond Market Index Fund Vanguard Total Stock Market Index funds Vanguard U.S.


pages: 274 words: 60,596

Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School by Andrew Hallam

Albert Einstein, asset allocation, Bernie Madoff, buy and hold, diversified portfolio, financial independence, George Gilder, index fund, Long Term Capital Management, new economy, passive investing, Paul Samuelson, Ponzi scheme, pre–internet, price stability, random walk, risk tolerance, Silicon Valley, South China Sea, stocks for the long run, survivorship bias, transaction costs, Vanguard fund, yield curve

If you want to invest like Keith, you have two low-cost options: 1. You can buy the low-cost Toronto Dominion Bank Index Funds <www.tdcanadatrust.com/mutualfunds/tdeseriesfunds/index.jsp> (called e-Series Funds), which are—as of 2010—Canada’s cheapest regular index funds. Or, 2. You can open a discount brokerage account and buy Exchange Traded Index Funds. Let’s focus on the bank indexes first: Toronto Dominion Bank currently has the most competitively priced index funds in Canada. But if you try walking into a bank and buying them, one of two things might happen to you: 1. The bank representative might try convincing you to buy actively managed funds instead. Or, 2. The representative might try selling you high-cost index funds. <www.tdcanadatrust.com/mutualfunds/tdeseriesfunds/> (Yes, TD Bank sells high-cost indexes as well, charging nearly twice as much as the indexes I recommend below.)

Fee-based adviser, Bert Whitehead, says in his book, Why Smart People Do Stupid Things with Money, that there are many organizations (such as American Express) that offer supposedly fee-based services, charging a small fee for a consultation, but they actually stuff investment accounts with their own brand of actively managed mutual funds and insurance products.30 Actively managed mutual funds pad the coffers of investment service companies, so they are good for the businesses that sell you such products, but they’re not good for you. My hope, though, is that this book will give you every tool required to build portfolios of index funds yourself. Then you can hire a trustworthy accountant to provide advice on tax-sheltered accounts. Seeking an accountant’s advice, you’ll confidently avoid every conflict of interest corrupting the financial service industry—as long as your accountant doesn’t sell financial products on the side. For a review, however, let’s take another look at total stock market index funds and actively managed mutual funds with a side-by-side comparison. Table 3.1 Differences between Actively Managed Funds and Index Funds Actively Managed Mutual Funds Total Stock Market Index Fund 1. A fund manager buys and sells (trades) dozens or hundreds of stocks. The average fund has very few of the same stocks at the end of the year that it held at the beginning of the year. 1.

Stock Index Whether you buy the e-Series index funds from TD Bank or whether you opt for brokerage-purchased ETF indexes, you’ll beat the pants off the majority of the pros—just as Keith has. Indexing in Singapore—A Couple Builds a Tiger’s Portfolio in the Lion City Singaporeans looking to invest in low-cost indexes might Google their options online. But like hidden vipers in the jungles of the Lion City, there are snakes in the financial service industry waiting to venomously erode your investment potential. Googling “Singapore Index Funds” will bring you to a company offering index funds that charge nearly one percent a year. That might seem insignificant, and that’s exactly what marketers want you to believe. Paying one percent for an index fund can cost you hundreds of thousands of wasted dollars over an investment lifetime.


The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals by Daniel R. Solin

asset allocation, buy and hold, corporate governance, diversification, diversified portfolio, index fund, market fundamentalism, money market fund, Myron Scholes, passive investing, prediction markets, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund, zero-sum game

Low Risk Medium-Low Risk Medium-High Risk High Risk 20/80 40/60 60/40 80120 Average annual return (Geometric) 10.14% 10.89% 11.56% 12.15% Annualized standard deviation 7.51% 8.47% 10.25% 12.51% Worst single calendar year -2.07% -2.02% -7.99% -13.95% Worst two-calendaryear period 7.59% -2.71% -12.51% -21.80% Worst three-calendaryear period 13.32% 0.37% -12.74% -24.69% 180 Appendix B Composition of model portfulillS: 20/ 80 40/60 60/40 2% 10% 8% 80% iShares iShares iShares iShares CON CON CON CON Composite Index Fund (XIC) S&P 500 Index Fund (XSP) MSCI EAFE Index Fund (XIN) Bond Index Fund (XBB) 4% 20% 16% 60% iShares iShares iShares iShares CON CON CON CON Composite Index Fund (X1C) S&P 500 Index Fund (XSP) MSCI EAFE Index Fund (XIN) Bond Index Fund (XBB) 6% iShares iShares iShares iShares CON CON CON CON Composite Index Fund (XIC) S&P 500 Index Fund (XSP) MSCI EAFE Index Fund (XIN) Bond Index Fund (XBB) iShares iShares iShares iShares CON CON CON CON Composite Index Fund (XIC) S&P 500 Index Fund (XSP) MSCI EAFE Index Fund (XIN) Bond Index Fund (XBB) 30% 24% 40% 80/20 8% 40% 32% 20% Raw data used 10 produce performance numbers: iShares CON Composite Index Fund (XIC) =- actual fund retu rns 2002-2005, (TSX 300 Index-o.25% per year) 1977-2001 iShares CON S&P 500 Index Fund (XSP) '" actual fund returns 2002-2005.

See securities industry international stocks benefits of, 130-31, 169 in index funds, 19 Index 189 international Stocks in ETFs. Sa iShares CON MSCI EAFE Index Fund (XIN) investment banks. Set securities induSlry Investment Funds Institute of Canada. 147 investment newsleners and newspapers. Stt financial media investment portfolios benefits of, xii, 12 buying stocks on margin. 77-78 international stocks in. 19. 130-31,169 invcstment professionals. Su securities industry i$hares (ETF funds). website for, 15 &t also ETFs (exchange traded funds) iShares CON Bond Index Fund (XBB), 1\, 130, 180 iShares C DN Composite Index Fund (XIC). 15. 130, 180 iShares CON Income Trust Sector Index Fund, 135 iShares CON MSCI EAFE Index Fund (XlN). 15, 130. 180 iShares C DN S&P 500 Index Fund (XSP) . 15. 130, 180 rebalancing ponfolio$, 120, 132-33 risk and. 122-23 risk return comparison (01",,), 14,74--76 standard deviation to measure risk, 67-68, 85. 126. 138 value and small-cap equities in. 11 4 Set also asset allocation; Four-Step Process for Smart Investors investment portfolios. four model benefits of, 85-86. 144 chan, risk returns, 125 ETFs in, 15, 130-31 examples of, 85, 125--26, 130,180 how to choose, 124 risk and return summary, 179-80 Slandard d~ations in, 67-68,85, 126,138 Jensen, 153 Jog.

Randolph, 162 house funds, 77- 78, 163 Hyperactive Investors about Hyperactive Investors, 19- 20,25,30-33,75 as percentage of all investors, 29 reliance on financial media, 96 See also financial media; psychology of investing Hyperactive Managers about managers, 5 disadvantages of, 9 how to manage, 136-38 myths of, 9 research on, 150 use of fund rating systems, 55-56, 158-59 See also actively managed funds; securities industry Ibbotson, Roger G., 108 Ilkiw, John, 139 income trusts, 134--35, 169 index funds about index funds, 8 benchmark indexes and, 23-24 benefits of, 6, 150 costs and fees, 129, 147 DFA index funds, 112-14, 168 famous investors in, 107-9 four types of, 19 institutional investors in, 89, 105-7, 114, 168 list of Canadian index funds, 112, 167 market returns and, 12, 18 market segment funds, 113-14 regulations on buying U.S. funds, 89 research on, 147, 151, 168 See also ETFs (exchange traded funds) Index Funds, Advisors, 147, 182 Index Funds: The 12-Step Program for Active Investors (Hebner), 148, 150, 151, 182 Index Mutual Funds (Simon), 148 indexes, benchmark, 23-24 See also S&P Composite Index (U.S.); S&P/TSX Composite Index initial public offering (IPOs), prospectus for, 60 insurance companies.


All About Asset Allocation, Second Edition by Richard Ferri

activist fund / activist shareholder / activist investor, asset allocation, asset-backed security, barriers to entry, Bernie Madoff, buy and hold, capital controls, commoditize, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, Long Term Capital Management, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, stocks for the long run, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

Figure 15-1 compares the fee savings and five-year annualized return advantage of several Vanguard index funds compared to their representative Morningstar category averages. The average fee for the Vanguard index funds was 0.2 percent, and the average fee for the categories ranged between 1.0 and 1.4 percent. In every category, the no-load index funds saved a considerable amount in fees over the category average, and this led to higher returns for index funds in every category. Index funds have no sales commissions. However, many funds in the categories listed do charge a sales commission. In Figure 15-1 commissions have not been deducted, from the five-year average. Index fund returns would have faired even better had the commissions been included in the analysis. CHAPTER 15 304 FIGURE 15-1 Index Fund Fee Savings and Return Advantage Vanguard index fund fee savings over category average fee Vanguard index fund five-year return advantage over category advantage return 1.7% 1.4% 1.3% 1.2% 1.2% Foreign stock REIT funds 1.1% 0.9% 0.9% 0.8% 0.5% Bond funds U.S. total market U.S. small cap Source: Morningstar Principia, January 2010 It is clear to even the most casual observer that low-cost stock and bond index funds have a significant advantage over other funds that charge average fees.

Accordingly, market-matching index funds and ETFs are a logical investment choice for people who want to make the most of asset allocation analysis. Any deviation from index funds adds an element of risk that was not captured in the asset allocation analysis. Fees Matter in Asset Allocation Planning 313 2. Low expense ratios. In general, stock and bond index funds and ETFs have the lowest investment fees in the industry. The lowest-cost index funds and ETFs charge about 0.1 percent per year, which is well below the industry average of 1.4 percent. One word of caution: Not all index funds have low fees. Some investment companies charge over 1.0 percent to invest in exactly the same indexes as very low-cost funds. Let the buyer beware. 3. Low tax liability. Index funds generally have very low turnover of securities compared to actively managed funds.

A list is given in Appendix A. In addition, read All About Index Funds, 2nd edition, by Richard A. Ferri (McGraw-Hill, 2007) and The ETF Book, 2nd edition, by Richard Ferri (John Wiley, 2009). CHAPTER SUMMARY The cornerstone of any equity portfolio is a broadly diversified U.S. stock market index fund. There are several different total U.S. stock market indexes and index fund providers. The most complete U.S. stock market index is the Wilshire 5000 Composite Index. Other broad market indexes include MSCI, Russell, Morningstar, and Standard & Poor’s. Most of these indexes are tracked by a low-cost index fund or ETF. Microcap stocks represent only 3 percent of the total U.S. stock market and can add diversification to a broad market index fund. One problem with microcap stocks is finding a fund that gives you exposure to this niche market.


pages: 490 words: 117,629

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, buy and hold, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

Trading small-capitalization portfolios involves a significant level of costs. Index funds provide the exception to the mutual-fund rule of ridiculously high portfolio turnover and incredibly burdensome transactions costs. In 2002, index fund portfolio turnover amounted to a modest 7.7 percent, causing commissions to consume a mere 0.007 percent of assets. Ironically, index fund portfolio managers operate in an extremely tough trading environment. The transparency of index fund trades required for full replication and the promptness of execution demanded to match index characteristics combine to increase costs of market impact for index funds. Because market makers see the index portfolio transactions coming, Wall Street stands ready to take more than a fair share of the trade. In spite of the adverse market environment for index fund trading, low turnover causes overall index fund trading costs to remain small.

Morgan Stanley’s indefensible fee structure causes the firm’s S&P 500 Index Funds to fall far short of the index return. Over the five-year period, Class A shares posted an annual deficit of 0.74 percent relative to shortfalls of 1.50 percent for Class B shares and 1.49 percent for Class C shares. In contrast, Vanguard’s cost-efficient, shareholder-friendly management provided investors with a return of only 0.09 percent less than the index result. Comparing Morgan Stanley’s S&P 500 Index Fund results to other index-fund returns only adds to the firm’s shame. Consider the equal-weighted index of thirty leading index funds constructed by mutual-fund data provider Lipper, a Reuters company. By virtue of size, Morgan Stanley Class B shares, the poorest performing of the firm’s three share classes, earn a spot on the roster of Lipper’s index-fund team. With five-year results that fall 1.16 percent per year short of Lipper’s average, Morgan Stanley Class B shares reside decidedly in the fourth quartile.

In sharp contrast, Vanguard set the standard for the Lipper group, beating the average by 0.25 percent per year and generating returns that no other index manager came close to matching.18 Part of Morgan Stanley’s index-fund shortfall stems from the inferior nature of the product. The October 30, 2002, Morgan Stanley S&P 500 Index Fund prospectus noted that “the Fund’s portfolio is managed by the Core Growth Team.”19 In spite of paying ridiculous fees, for the first six years of the fund’s existence, Morgan Stanley clients failed to get a dedicated index-fund management team. In an optimistic development, the September 30, 2003, supplement to the prospectus announced that “the Fund is managed within the Index Team,” mitigating one of the many indignities inflicted on Morgan Stanley Index Fund shareholders.20 Of course, a green index team at Morgan Stanley managing a subscale portfolio poses no competition to the time-tested index-fund managers at Vanguard. Suppose a client wishes to invest in Morgan Stanley’s index funds, in spite of the long list of reasons to avoid the firm’s offerings.


pages: 194 words: 59,336

The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life by J L Collins

"side hustle", asset allocation, Bernie Madoff, buy and hold, compound rate of return, diversification, financial independence, full employment, German hyperinflation, index fund, money market fund, nuclear winter, passive income, payday loans, risk tolerance, Vanguard fund, yield curve

In the case of Vanguard, the funds held are all low-cost index funds. As you know by now, that’s a very good thing. The TRFs ranging from 2020 to 2060 each hold only four funds: Total Stock Market Index Fund Total Bond Market Index Fund Total International Stock Market Index Fund Total International Bond Market Index Fund To those four funds the TR 2010, 2015 and 2020 funds add: Short-Term Inflation-Protected Securities Index Fund As the years roll by and the retirement date chosen approaches, the funds will automatically adjust the balance held, becoming steadily more conservative and less volatile over time. You needn’t do a thing. The expense ratios range from .14% to .16%, depending on the fund. Not quite as low as a basic index fund like VTSAX (.05%), but very good considering the extra simplicity these offer.

So without Vanguard in your plan, the question becomes how to select the best option, which by now you know is a low-cost total stock and/or bond index fund. The good news is that—due to the competitive pressure from Vanguard—nearly every other major mutual fund company now offers low-cost index funds. Just like the variations you can find in Vanguard of VTSAX, you can in all probability find a reasonable alternative in your 401(k). Here’s what you are looking for: A low-cost index fund. For tax-advantaged funds you’ll be holding for decades, I slightly prefer a total stock market index fund but an S&P 500 index fund is just fine. You can also look for a total bond market index fund if your needs or preferences call for it. Most plans will also offer these. TRFs (Target Retirement Funds) are frequently offered in 401(k) plans and these can be an excellent choice.

To ignore inflation (too unpredictable), taxes (too variable between individuals) and fees (also variable and if you choose the index funds I recommend, minimal). If you want to see what the numbers look like including any of these variables, I encourage you to visit the calculators and run the numbers with your own specifications. Most often in running these scenarios, the period of time I’ve chosen has been January 1975 - January 2015, for these reasons: It is a nice, solid 40-year period and this book advocates investing for the long term. 1975 is the year Jack Bogle launched the world’s first index fund and this book advocates investing in index funds. 1975 happens to be the year I started investing, not that this matters to you. As it happens, from January 1975 - January 2015, using the parameters I chose above, the market returned an average of 11.9% per year.


pages: 482 words: 121,672

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

Those who need a steady income for living expenses could increase their holdings of real estate equities and dividend growth stocks, because they provide somewhat larger current income. A SPECIFIC INDEX-FUND PORTFOLIO FOR AGING BABY BOOMERS Cash (5%)* Fidelity Money Market Fund (FXLXX) or Vanguard Prime Money Market Fund (VMMXX) Bonds and Bond Substitutes (27½%)† 7½% U.S. Vanguard IntermediateTerm Bond (VICSX) or iShares Corporate Bond ETF (LQD) 7½% Vanguard Emerging Market Government Bond Fund (VGAVX) 12½% Wisdom Tree Dividend Growth Fund (DGRW) or Vanguard Dividend Growth Fund (VDIGX)† Real Estate Equities (12½%) Vanguard REIT Index Fund (VGSIX) or Fidelity Spartan REIT Index Fund (FRXIX) Stocks (55%) 27% U.S. Stocks Schwab Total Stock Market Index Fund (SWTSX) or Vanguard Total Stock Market Index Fund (VTSMX) 14% Developed International Markets Schwab International Index Fund (SWISX) or Vanguard International Index Fund (VTMGX) 14% Emerging International Markets Vanguard Emerging Markets Index Fund (VEIEX) or Fidelity Spartan Emerging Markets Index Fund (FFMAX) *A short-term bond fund may be substituted for one of the money-market funds listed.

Yes, there are exceptions. But you can count on the fingers of your hands the number of mutual funds that have beaten index funds by any significant margin. The Index-Fund Solution: A Summary Let’s now summarize the advantages of using index funds as your primary investment vehicle. Index funds have regularly produced rates of return exceeding those of active managers. There are two fundamental reasons for this excess performance: management fees and trading costs. Public index funds and exchange-traded funds are run at fees of of 1 percent or even less. Actively managed public mutual funds charge annual management expenses that average 1 percentage point per year. Moreover, index funds trade only when necessary, whereas active funds typically have a turnover rate close to 100 percent. Using very modest estimates of trading costs, such turnover is undoubtedly an additional drag on performance.

Unfortunately, active managers as a group cannot be like the radio personality Garrison Keillor’s fictional hometown of Lake Wobegon, where “all the children are above average.” Index funds are also tax-friendly. Index funds allow investors to defer the realization of capital gains or avoid them completely if the shares are later bequeathed. To the extent that the long-run uptrend in stock prices continues, switching from security to security involves realizing capital gains that are subject to tax. Taxes are a crucially important financial consideration because the earlier realization of capital gains will substantially reduce net returns. Index funds do not trade from security to security and, thus, tend to avoid capital gains taxes. Index funds are also relatively predictable. When you buy an actively managed fund, you can never be sure how it will do relative to its peers. When you buy an index fund, you can be reasonably certain that it will track its index and that it is likely to beat the average manager handily.


pages: 335 words: 94,657

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Here is the crux of the strategy: Instead of hiring an expert, or spending a lot of time trying to decide which stocks or actively managed funds are likely to be top performers, just invest in index funds and forget about it! As we discussed in Chapter 4, an index fund attempts to match the return of the segment of the market it seeks to replicate, minus a very small management fee. For example, Vanguard's Index 500 seeks to replicate the return of the S&P 500; the Total Stock Market Index seeks to replicate the return of a broad U.S. stock market index; and Total International Index seeks to replicate the return of a broad cross-section of international stocks. In addition to stock index funds, there are bond index funds that seek to replicate the performance of various bond indexes. There are also index funds of funds that hold various combinations of stock and bond index funds. WHY INDEXING IS SO EFFECTIVE Index funds outperform approximately 80 percent of all actively managed funds over long periods of time.

Paul Farrell, columnist for CBS Marketwatch and author of The Lazy Person's Guide to Investing: "So much attention is paid to which funds are at the head of the pack today that most people lose sight of the fact that, over longer time periods, index funds beat the vast majority of their actively managed peers." Richard Ferri, author of Protecting Your Wealth in Good Times and Bad: "When you are finished choosing a bond index fund, a total U.S. stock market index fund, and a broad international index fund, you will have a very simple, yet complete portfolio." Walter R. Good and Roy W. Hermansen, authors of Index Your Way to Investment Success: "Index funds save on management and marketing expenses, reduce transaction costs, defer capital gain, and control risk-and in the process, beat the vast majority of actively managed mutual funds!" Arthur Levitt, former chairman of the Securities Exchange Commission and author of Take on the Street: "The fund industry's dirty little secret: Most actively managed funds never do as well as their benchmark."

Jason Zweig, senior writer and columnist at Money magazine and coauthor of the revised edition of Benjamin Graham's classic, The Intelligent Investor: "If you buy-and then hold-a total stock market index fund, it is mathematically certain that you will outperform the vast majority of all other investors in the long run. Graham praised index funds as the best choice for individual investors, as does Warren Buffett." The next time some investment salesperson tells you, "It's a stock picker's market," or they tell you index funds are just going to earn mediocre returns, you may want to show the salesperson this list of quotes from noted authorities on investing. And if the salesperson counters by telling you that those people don't know the real truth about investing, you may find it useful to quote the words of Jack Nicholson in the movie, A Few Good Men: "You want the truth? YOU CAN'T HANDLE THE TRUTH!" HOW TO BUY INDEX FUNDS Not all index funds are created equal. There are a number of fund companies that sell index funds. Not surprisingly, many of them will also charge you a healthy sales commission and a high yearly management fee.


The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William J. Bernstein

asset allocation, backtesting, buy and hold, capital asset pricing model, commoditize, computer age, correlation coefficient, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index arbitrage, index fund, intangible asset, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, the scientific method, time value of money, transaction costs, Vanguard fund, Yogi Berra, zero-coupon bond

Using the above principles, the investor has decided on the following policy allocation: 15% U.S. large market 10% U.S. large value 5% U.S. small market 10% U.S. small value 5% European 5% Pacific 5% Emerging markets 5% REITs 20% Municipal bonds 20% Short-term corporate bonds 154 The Intelligent Asset Allocator Using Table 8-2 for the stock funds, he decides to use the following Vanguard funds and place them in the appropriate taxable or taxsheltered account: Taxable Account 15% Total Stock Market Index Fund 5% Tax-Managed Small-Cap Index Fund 5% European Stock Index Fund 5% Pacific Stock Index Fund 20% Limited-Term Tax-Exempt Fund IRA Account 10% Value Index Fund 10% Small-Cap Value Index Fund 5% Emerging Markets Stock Index Fund 5% REIT Index Fund 20% Short-Term Corporate Fund Notice how the investor has segregated the most tax-efficient assets into the taxable account, and the least tax-efficient assets into the IRA. Executing the Plan From a purely financial point of view, it is usually better to put your money to work right away.

For example, for the three-year period from 1992 to 1994, small stocks outperformed large stocks by 7.59% annually, and the Vanguard 500 Index Fund ranked in only the 46th percentile of its category, while the DFA 9-10 Small Company ranked in the 13th percentile of its category. Dunn’s Law There is in fact a relationship between asset-class performance and index-fund performance, known as Dunn’s law (after Steve Dunn, a friend with an astute eye for asset classes): “When an asset class does relatively well, an index fund in that class does even better.” 100 The Intelligent Asset Allocator The mechanism behind this is relatively straightforward. Let’s again take the performance of the DFA 9–10 Small Company Index Fund and the Vanguard 500 Index Fund as examples. An index fund takes the full brunt of an asset class’s excellent or poor performance relative to other asset classes.

But over many years, it takes a toll, as the SD of 25-year returns is only 1.6% (see Math Details). For large-cap funds, this means that the index-fund advantage, which has about the same 1.6% value, will result in a ⫹1 SD performance. Meaning that the index fund should beat 84% of actively managed funds. A small or foreign index fund with a 3.2% advantage should perform 2 SDs above the norm, meaning that it should beat 97% of active funds over a 25-year period. And an emerging-markets index fund with a several-percentage-point advantage should best all of its actively managed peers. Market Efficiency 97 Unfortunately, the real world is not nearly this neat, and it is worth looking at the actual data. We shall compare index-fund and activefund performance with the Morningstar Principia database. This nifty tool is worth some discussion.


The Permanent Portfolio by Craig Rowland, J. M. Lawson

Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

S&P 500 Index Vanguard S&P 500 Index Mutual Fund (Ticker: VFINX) State Street S&P 500 SPDR Exchange Traded Fund (Ticker: SPY) iShares S&P 500 Exchange Traded Fund (Ticker: IVV) Fidelity Spartan 500 Index Mutual Fund (Ticker: FSMKX) Schwab S&P 500 Index Mutual Fund (Ticker: SWPPX) Total Stock Market Index (TSM) Vanguard Total Stock Market Mutual Fund (Ticker: VTSMX) Vanguard Total Stock Market Exchange Traded Fund (Ticker: VTI) iShares Russell 3000 Index Exchange Traded Fund (Ticker: IWV) Fidelity Spartan Total Stock Market (Ticker: FSTMX) Schwab Total Stock Market (Ticker: SWTSX) This list is far from exhaustive, as many fund companies offer some type of index fund in their investment lineup. If you are at a brokerage or mutual fund company that offers its own index fund then you can use that as long as it meets the criteria outlined in this chapter. Which Type of Index Fund to Use? Given the choice between the two types of index funds described above, a total stock market fund offers wider diversification and tax efficiency when compared to S&P 500 index funds. A typical total stock market fund will hold thousands of stocks compared to the 500 stocks in the S&P 500 index. Total stock market funds also provide slightly better long-term performance. If, however, you only have access to an S&P 500 index fund, this will still work great for purposes of the Permanent Portfolio. Why Use an Index Fund? An index fund is a way of passively tracking a predefined basket of stocks.

Owning Stocks To profit during times of prosperity you should own a broad-based stock index fund that captures the returns offered by the stock market without trying to beat the market. A broad-based stock index fund is able to capture the maximum gains available to all investors. There are many stock index funds available today. Some are great, some are mediocre, and some are downright bad. Unfortunately, the term “index fund” has also been used in recent years to describe all kinds of investment products, some of which bear little resemblance to a true index fund. These products are easily avoided if you follow the advice laid out in this chapter. For purposes of the Permanent Portfolio stock allocation, you want to own the cheapest and most broadly based stock fund available. In selecting a stock index fund, consider ones that: Track a Total Stock Market Index or S&P 500 Index.

An index fund is a way of passively tracking a predefined basket of stocks. Index funds usually own stocks in proportion to the size of the company in the overall index. For example, an index fund tracking the U.S. stock market will typically own a larger number of shares of General Electric than a regional publicly traded utility company. The advantage of stock indexing is that an index fund doesn't need to engage in expensive activities associated with actively traded investment funds, such as research, analysts, advisors, and so on. Because an index fund owns the entire market, it is simply expected to earn the average performance of the market in any one year minus its management fees. Because an index fund owns the entire market, it is expected to earn the average performance of the market in any one year minus its management fees.


pages: 407 words: 114,478

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

asset allocation, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Harrison: Longitude, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, stocks for the long run, stocks for the long term, survivorship bias, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

But as Vanguard’s reputation, shareholder satisfaction ratings, and, most importantly, assets under management grew, it could no longer be ignored. By 1991, Fidelity threw in the towel and started its own low-cost index funds, as did Charles Schwab. As of this writing, there are now more than 300 index funds to choose from, not counting the newer “exchange-traded” index funds, which we’ll discuss shortly. Of course, not all of the companies offering the new index funds are suffused with Bogle’s sense of mission—fully 20% of index funds carry a sales load of up to 6%, and another 30% carry a 12b-1 annual fee of up to 1% per year for marketing. The most notorious of these is the American Skandia ASAF Bernstein (no relation!) series, which carries both a 6% sales fee and a 1% annual 12b-1 fee. Paying these sorts of expenses to own an index fund boggles the mind and speaks to the moral turpitude of much of the industry. There are other fund companies besides Vanguard well worth dealing with.

The smallest, American Greetings, has a market cap of $700 million, or 0.007% of the index—six hundred times smaller than GE. So an index fund which tracks the S&P 500 would have to own 600 times as much GE as American Greetings. What happens if GE plunges in value and American Greetings zooms? Nothing. Since an index fund simply holds each company in proportion to its market cap, the amount of each owned by an S&P 500 index fund adjusts automatically with its market cap. In other words, an index fund does not have to buy or sell stock with changes in value (unlike Wells Fargo’s ill-fated first index fund, which had to hold equal-dollar amounts of all 1,500 stocks on the New York Stock Exchange). This raises some important semantic points. When most investors say the words “index fund,” they are almost always referring to an S&P 500 fund. But the U.S. market consists of more than 7,000 publicly traded companies.

Steel, 147, 160 USA Today, 219, 220 Value averaging, 283–285 Value Line, 90 Value Line Fund, 90 Value stocks (“bad” companies) asset allocation, 120-122, 172, 248–255, 251–253 Graham on, 158 in portfolio building, 109, 120–122, 172 In Search of Excellence (Peters) on, 64 real returns on, 68, 69, 72 rebalancing, 289–290 returns on, 34-38 tax efficiency of, 263–264 Vanguard 500 Index Fund, 97, 98, 102–104, 215, 216 Vanguard GNMA Fund, 215-216 Vanguard Growth Index Fund, 249 Vanguard Limited Term Tax Exempt Fund, 261 Vanguard mutual funds fee structure, 210, 250, foreign indexed funds, 119 founding by Bogle, 213-214 as no-load company, 205 Vanguard Short-Term Corporate Fund, 261 Vanguard Small-Cap Index Fund, 99 Vanguard Tax-Managed Small-Cap Index Fund, 99 Vanguard Total International Fund, 255, 256 Vanguard Total Stock Market Fund, 104, 246 Vanguard Value Index Fund, 249-250 Variable annuity fund, 204 Variety, 145 Venetian prestiti, 10–13 Vertin, James, 96–97 Victoria, Queen of England, 143 Von Böhm-Bawerk, Eugen, 8 Wal-Mart, 34–35, 185 The Wall Street Journal, 85, 96, 98, 167, 211, 219, 222, 225 Wall Street Week (television program), 224 Walz, Daniel T., 231 Wellington Management Company, 213–214 Wells Fargo, first index fund, 96–97, 215, 245 Westinghouse, 133 Wheeler, Dan, 123 Where are the Customers’ Yachts?


pages: 250 words: 77,544

Personal Investing: The Missing Manual by Bonnie Biafore, Amy E. Buttell, Carol Fabbri

asset allocation, asset-backed security, business cycle, buy and hold, diversification, diversified portfolio, Donald Trump, employer provided health coverage, estate planning, fixed income, Home mortgage interest deduction, index fund, Kickstarter, money market fund, mortgage tax deduction, risk tolerance, risk-adjusted returns, Rubik’s Cube, Sharpe ratio, stocks for the long run, Vanguard fund, Yogi Berra, zero-coupon bond

An index fund of the S&P 500, for example, is made up of stocks from the 500 largest U.S. corporations. However, an index fund’s return is usually slightly lower than that of its index doppelganger, because the index fund has to pay fund-management expenses. Index funds are an easy and effective way to build a diversified investment portfolio. (Page 166 shows you just how easy it is.) In addition, over longer periods of time (5 to 10 years or more), index funds usually outperform actively managed mutual funds, primarily because their expenses are usually much lower than those of actively managed funds, as you learned on page 60. What index funds buy or sell is determined solely by their corresponding market indexes, so they don’t have to pay fund managers big bucks to make investment decisions. The table below shows several of the indexes that index funds commonly mimic. Index name Index type MSCI U.S.

Among the thousands of funds in the United States, you can find funds that cover the entire investment world or funds that invest in only a few dozen stocks. Index funds are so named because they mimic a market index (a collection of investments that represents a market segment; the S&P 500, for example, is an index of the stocks of the country’s biggest companies, while the Barclays Aggregate Bond Index is a broad bond market index). They’re the easiest and most cost-effective way to invest in funds. Although index funds still have fund managers, the funds practically run themselves, because they invest in whatever the index is made up of. If the S&P 500 drops a company from its list, an S&P 500 index fund does, too. Because of the way they invest, index funds don’t have to pay fund managers big salaries, and they don’t have to buy and sell holdings often. For both those reasons, index fund expenses are some of the lowest you’ll find (on average, about 0.25% per year).

Troubleshooting Moment Watch for Closet Index Funds When you invest in stock funds, avoid closet index funds. They charge the high fees of actively managed mutual funds, but invest much like a market index. All they do is charge you fees for performance you could get cheaper from a genuine index fund, whether a mutual fund or ETF. Spotting a closet index fund is simple. You compare the fund’s average P/E ratio, sector weightings, and average earnings per share to the values for the fund’s comparable index. The Morningstar fund Portfolio tab makes this easy, because it shows the ratio of a fund’s numbers to its comparable index, as you can see below. The closer the ratios are to 1 (which represents an exact match), the more likely the fund is a closet index fund. Here’s how you do it using the Portfolio tab on a fund’s Morningstar web page: 1.


pages: 357 words: 91,331

I Will Teach You To Be Rich by Sethi, Ramit

Albert Einstein, asset allocation, buy and hold, buy low sell high, diversification, diversified portfolio, index fund, late fees, money market fund, mortgage debt, mortgage tax deduction, prediction markets, random walk, risk tolerance, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, survivorship bias, the rule of 72, Vanguard fund

Just as the stock market may fall 10 percent one year and gain 18 percent the next year, index funds will rise and fall with the indexes they track. The big difference is in fees: Index funds have lower fees than mutual funds because there’s no expensive staff to pay. Vanguard’s S&P 500 index fund, for example, has an expense ratio of 0.18 percent. Remember, there are all kinds of index funds. International index funds are relatively volatile since they follow indexes that were just recently established. General U.S.-based index funds, on the other hand, are more reliable. Since they match the U.S. stock market, if the market goes down, index funds will also go down. During the financial crisis, many index funds plummeted as they matched the market, which underwent a global drop. But over the long term, the overall stock market has consistently returned about 8 percent. Let’s look at the performance from two sides: the downside (fees) and the upside (returns).

In short, mutual funds are prevalent because of their convenience, but because actively managed mutual funds are, by definition, expensive, they’re not the best investment any more. Active management can’t compete with passive management, which takes us to index funds, the more attractive cousin of mutual funds. Index Funds: The Attractive Cousin in an Otherwise Unattractive Family In 1975, John Bogle, the founder of Vanguard, introduced the world’s first index fund. These simple funds use computers to buy stocks and match the market (such as the S&P 500 or NASDAQ). Instead of having a mutual fund’s expensive staff of “experts” who try to beat the market, index funds set a lower bar: A computer matches the indexes by automatically matching the makeup of the market. For example, if a stock represents 2 percent of the S&P 500, it will represent 2 percent of the index fund. Index funds are the financial equivalent of “If you can’t beat ’em, join ’em.” And they do so while also being low cost and tax efficient, and requiring hardly any maintenance at all.

Ironically, this results in lots of taxes and trading fees, which, when combined with the expense ratio, makes it virtually impossible for the average fund investor to beat—or even match—the market over time. Bogle opted to discard the old model of mutual funds and introduce index funds. Today, index funds are an easy, efficient way to make a significant amount of money. Note, however, that index funds simply match the market. If you own all equities in your twenties (like me) and the stock market drops (like it has), your investments will drop (like mine, and everyone else’s, did). Index funds reflect the market, which is going through tough times but, as history has shown, will climb back up. As a bonus for using index funds, you’ll anger your friends in finance because you’ll be throwing up your middle finger to their entire industry—and you’ll keep their fees for yourself. Wall Street is terrified of index funds and tries to keep them under wraps with increased marketing of mutual funds and nonsense like “5-Star Funds” and TV shows that highlight action, not results.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Yes, there are exceptions. But you can count on the fingers of your hands the number of mutual funds that have beaten index funds by any significant margin. The Index-Fund Solution: A Summary Let’s now summarize the advantages of using index funds as your primary investment vehicle. Index funds have regularly produced rates of return exceeding those of active managers. There are two fundamental reasons for this excess performance: management fees and trading costs. Public index funds are run at a fee of less than 1/10 of 1 percent. Actively managed public mutual funds charge annual management expenses that average one percentage point per year. Moreover, index funds trade only when necessary, whereas active funds typically have a turnover rate close to 100 percent. Using very modest estimates of trading costs, such turnover is undoubtedly an additional drag on performance.

Those who need a steady income for living expenses could increase their holdings of real estate equities, because they provide somewhat larger current income. A SPECIFIC INDEX-FUND PORTFOLIO FOR AGING BABY BOOMERS Cash (5%)* Fidelity Money Market Fund (FORXX), or Vanguard Prime Money Market Fund (VMMXX) Bonds (27½%)† Vanguard Total Bond Market Index Fund (VBMFX) Real Estate Equities (12½%) Vanguard REIT Index Fund (VGSIX) Stocks (55%) U.S. Stocks (27%) Fidelity Spartan (FSTMX), T. Rowe Price (POMIX), or Vanguard (VTSMX) Total Stock Market Index Fund Developed International Markets (14%) Fidelity Spartan (VSIIX), or Vanguard (VDMIX) International Index Fund Emerging International Markets (14%) Vanguard Emerging Markets Index Fund (VEIEX) Remember also that I am assuming here that you hold most, if not all, of your securities in tax-advantaged retirement plans.

Unfortunately, active managers as a group cannot be like the radio personality Garrison Keillor’s fictional hometown of Lake Wobegon, where “all the children are above average.” Index funds are also tax-friendly. Index funds allow investors to defer the realization of capital gains or avoid them completely if the shares are later bequeathed. To the extent that the long-run uptrend in stock prices continues, switching from security to security involves realizing capital gains that are subject to tax. Taxes are a crucially important financial consideration because the earlier realization of capital gains will substantially reduce net returns. Index funds do not trade from security to security and, thus, tend to avoid capital gains taxes. Index funds are also relatively predictable. When you buy an actively managed fund, you can never be sure how it will do relative to its peers. When you buy an index fund, you can be reasonably certain that it will track its index and that it is likely to beat the average manager handily.


Playing With FIRE (Financial Independence Retire Early): How Far Would You Go for Financial Freedom? by Scott Rieckens, Mr. Money Mustache

Airbnb, cryptocurrency, effective altruism, financial independence, index fund, job satisfaction, McMansion, passive income, remote working, Vanguard fund

His simple path to wealth is just this: Spend less than you earn, and invest the balance in index funds. If you’re anything like me, when someone mentions something like “index fund investing,” you nod your head knowingly and let the conversation move on to something you understand, too embarrassed to ask the obvious question: “What’s index fund investing?” As I researched FIRE, at least four people separately recommended index funds to me, including Mad Fientist’s Brandon Ganch during Chautauqua, and each time, I kept quiet, reluctant to admit how little I actually knew. JL fixed that. Here is what I learned: the basics of fire-approved investing An index fund allows you to invest in the stock market without buying individual stocks and without trying to understand, play, or “beat” the stock market. An index fund uses computer algorithms to buy up whole baskets of stocks that mimic and represent the entirety of the stock market.

Throughout history, on average and over the long term, the stock market overall has gone up approximately 10 percent per year; thus an index fund that reflects the market will most likely experience a similarly positive, predictable result. Stock index funds are low cost, and they are a central component of the FIRE playbook. They are the universally accepted and most popular investment choice in the mainstream FIRE blogosphere. That said, the number-one fan of index funds is arguably Warren Buffett, the chairman and CEO of one of the world’s largest companies, Berkshire Hathaway. Buffett is usually found in the top three of the wealthiest people in the world, and he is considered by many to be the world’s WHAT THE HECK IS AN INDEX FUND? 1. Index Funds Are Awesome 111 PLAYING WITH FIRE best investor. He’s jolly, folksy, down-to-earth, and generally beloved.

Most FIRE bloggers recommend VTSAX, which is an index fund that represents the entire US stock market. VTSAX has a $10,000 minimum investment, but they have a similar fund called VTSMX that has a $3,000 minimum investment. There are also great index fund options without any minimum investment. 2. Avoid Money Managers (or Be Prepared to Pay) As it turns out, trying to beat the performance of the stock market statistically doesn’t work. Only 15 percent of professionals manage to beat it, and what’s the likelihood that the person you’ve hired is one of those 15 percent? Not very high. Because an index fund doesn’t require a building full of portfolio managers, analysts, and traders to work diligently day in and day out to try to beat the stock market, indexing is dirt cheap: the expense ratio of the Vanguard index fund VTSAX, a FIRE favorite, was 0.04% when this book went to press.


Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, price anchoring, price stability, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

The narrative of how Wells Fargo Investment Advisors became today’s powerhouse of investment management dates back to July 1971, when the group—then known as the Wells Fargo Trust Department— confidently launched the world’s first index fund. This step was just the T 127 bern_c10.qxd 3/23/07 128 9:07 AM Page 128 THE PRACTITIONERS beginning (see Chapter 12 of Capital Ideas, “The Constellation”).* In 1977, the trust department went on to develop the first computerdriven methodology for tactical asset allocation. Two years later it offered a variation on the index fund theme that blended the index fund structure with a risk-controlled active management strategy. Soon after, the trust department was promoting a full-f ledged active strategy based on expected returns derived from the dividend discount model. In 1979, Wells Fargo launched the “Yield-Tilt Fund,” a quasi-index fund favoring stocks with higher yields. In 1981, it started the first international equity index fund and then the first bond index fund in 1983.

The foundation would be the Active Investor, and Hord assures the committee he would have no trouble finding a suitable Index Investor with a current $200 million investment in BGI’s international index fund. BGI would liquidate that international index fund investment and transfer the proceeds to the active international manager. Hord explains that the Index Investor would still be guaranteed the return on the international index fund, and that guarantee would be collateralized by $200 million transferred to the Asset Trust from the foundation’s fixed-income assets. For safety’s sake, the fixed-income allocation would be converted from BGI’s active management to the BGI fixed-income index fund, but the fixed-income return would continue to accrue to the foundation. All earnings on all assets involved would be reinvested. Let us review what has happened.

Meanwhile, the Index Investor continues to earn the return on the international index fund, at no cost and zero tracking error, plus the promised spread over that return to compensate it for contributing assets to the Trust. The foundation’s actively managed fixed-income portfolio has been converted into an index fund and is now held in the Trust as collateral against the Index Investor’s advance of its international equity assets. How do matters appear at the end of the first year? Let us assume that the active international manager will have provided an annual total return of 12 percent as against the 9 percent annual return on the international index fund. The original $200 million will have grown to $224 million under the active manager’s skilled care, while the international index fund would have grown only to $218 million. The active bern_c13.qxd 3/23/07 194 9:11 AM Page 194 THE PRACTITIONERS manager will have produced an alpha of 3 percent, or $6 million, for the foundation without using a penny of the foundation’s money.


pages: 332 words: 81,289

Smarter Investing by Tim Hale

Albert Einstein, asset allocation, buy and hold, buy low sell high, capital asset pricing model, collapse of Lehman Brothers, corporate governance, credit crunch, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, fiat currency, financial independence, financial innovation, fixed income, full employment, implied volatility, index fund, information asymmetry, Isaac Newton, John Meriwether, Long Term Capital Management, Northern Rock, passive investing, Ponzi scheme, purchasing power parity, quantitative easing, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, technology bubble, the rule of 72, time value of money, transaction costs, Vanguard fund, women in the workforce, zero-sum game

Warren Buffett (the Sage of Omaha), widely regarded as one of the greatest active investors of our time, has been described by John Bogle (Targett, 2001) as follows: ‘He thinks like an index investor: he buys a few large stocks, holds them for a good holding period – forever – and it’s worked quite brilliantly.’ In further support of index funds, Warren Buffett himself stated in one of the annual letters to shareholders (1998) of the investment firm Berkshire Hathaway that he and Charlie Munger run: ‘Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.’ Peter Lynch, one-time manager of Fidelity Investment’s Magellan Fund, the world’s largest actively managed fund, and highly respected active manager states of most investors that (Anon, 1990): ‘They’d be better off in an index fund.’ Charles Schwab, the pioneer of online brokerage in the USA, actively supports indexing as the core of an optimal long-term portfolio and states (Schwab, 1999): ‘Most of the mutual fund investments I have are in index funds, approximately 75 per cent.’

Charles Schwab, the pioneer of online brokerage in the USA, actively supports indexing as the core of an optimal long-term portfolio and states (Schwab, 1999): ‘Most of the mutual fund investments I have are in index funds, approximately 75 per cent.’ David Swensen, CIO of the Yale Endowment and one of the most respected institutional investors, agrees: ‘You should invest only in things that you understand. That should be the starting point and the finishing point. For most investors the practical application of this axiom is to invest in index funds (low-fee investments that aim to mirror the performance of a particular stock market index). The overwhelming number of investors, individual and institutional, should be completely in low-cost index funds because that’s easy to understand.’ What better testimonials could you ask for than those? So, without any hesitation I suggest to you that you choose, as your default, index-replicating products to create your long-term investment policy portfolio.

You should always check to see what type of process is used and ask why it makes sense for this kind of index. Take a look and see what other providers are doing. Fees and costs contribute to tracking error Fees always go a long way towards explaining tracking error, as not all index funds are made equal. Some charge very low fees of a few basis points (100ths of 1%) and others as high as 1% for domestic retail products. Better still, find out what the total expense ratio (TER) or Ongoing Charge of the fund is – you can get this from the fund fact sheet or the Key Investor Information Document (KIID) which they are obliged to provide. Never pay an initial fee for an index fund. Some index funds are taking the ‘mickey’ with high upfront fees and high ongoing charges. Vote with your wallet and avoid them. I just want to reiterate the quote that I used earlier in the book from Morningstar, the world’s pre-eminent fund research tool and database: ‘If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision.


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Work Optional: Retire Early the Non-Penny-Pinching Way by Tanja Hester

"side hustle", Affordable Care Act / Obamacare, Airbnb, anti-work, asset allocation, barriers to entry, buy and hold, crowdsourcing, diversification, estate planning, financial independence, full employment, gig economy, hedonic treadmill, high net worth, index fund, labor-force participation, longitudinal study, medical bankruptcy, mortgage debt, obamacare, passive income, post-work, remote working, rent control, ride hailing / ride sharing, risk tolerance, stocks for the long run, Vanguard fund

If you want the simplest, easiest investing approach possible, go with index funds. Ideally, you’ll invest automatically and regularly in your chosen vehicles, either monthly or twice each month. Your goal is to invest for the long term, investing on schedule no matter what the markets are doing, and then keeping your hands off of it until you begin living off your magic money sources. As to where you invest it, that’s up to you, but choosing one or two diversified stock funds and one or two diversified bond funds will keep you well covered. Some favorites of financial experts and early retirees are the Vanguard Total Stock Market Index Fund (VTSMX or VTSAX) and Total Bond Market Index Fund (VBMFX or VBTLX), S&P 500 index funds like the Fidelity Spartan 500 fund, and other index funds with extremely low fees. Because these funds already invest in a broad swath of the stock and bond markets, you don’t have to worry about choosing the right mix of assets to insulate you from risk and expose you to growth opportunities.

Some mutual funds known as target date funds manage risk by moving toward more conservative investments as the target date approaches, but these funds have management fees averaging 0.84% according to Morningstar, which is still high enough to erode your gains over the long term. Index Funds Stock and bond index funds are a subcategory of mutual funds and ETFs that mirror key stock or bond indices like the S&P 500, the Dow Jones Industrial Average, the total US stock market, or the total US bond market. With index funds, the singular goal is to match the markets, never to beat them. Therefore, index funds are passively managed, and instead of being constantly tweaked to maximize gains, fund managers simply buy shares of the stocks and bonds included in the index they are seeking to mirror, in proportion to the shares in the index, and then sit back and let the magic of compounding happen.

That passive management means that investors pay minuscule management fees in relation to actively managed funds, often under 0.25% per year. Some of the broad market index funds with the lowest fees are the Schwab US Broad Market Fund, iShares Core S&P Total US Stock Market Fund, Vanguard Total Stock Market Fund, Fidelity Spartan 500 Index Fund, and a range of other funds with Vanguard, Fidelity, USAA, and T. Rowe Price, all of which have total expense ratios under 0.4%. But even those small percentage differences affect how much magic money you generate from your invested assets, so pay attention to fees even with index funds. Index funds have other benefits as well, namely in terms of taxes and health care premium calculation. Whenever you or a fund manager sells a share of stock, you trigger what’s called a taxable event.


pages: 621 words: 123,678

Financial Freedom: A Proven Path to All the Money You Will Ever Need by Grant Sabatier

"side hustle", 8-hour work day, Airbnb, anti-work, asset allocation, bitcoin, buy and hold, cryptocurrency, diversified portfolio, Donald Trump, financial independence, fixed income, follow your passion, full employment, Home mortgage interest deduction, index fund, loss aversion, Lyft, money market fund, mortgage debt, mortgage tax deduction, passive income, remote working, ride hailing / ride sharing, risk tolerance, Skype, stocks for the long run, stocks for the long term, TaskRabbit, the rule of 72, time value of money, uber lyft, Vanguard fund

Many companies offer an index fund that tracks the U.S. stock market, and many companies actually offer two levels (investor and admiral/premium), where you pay a higher or lower fee based on how much you invest. Some of the most popular index funds with the lowest fees are the Vanguard Total Stock Market Index Fund (VTSAX) and the Vanguard Total Stock Market Index ETF (VTI), both of which hold the top 2,800 stocks in the United States; the Schwab Total Stock Market Index ETF (SWTSX); BlackRock’s iShares Edge MSCI Min Vol USA ETF (USMV); and the Fidelity Total Market Index Fund Premium Class (FSTVX). There are also many companies that have an S&P 500 fund, like the Vanguard 500 Index Fund Investor Shares (VFINX); the Vanguard 500 Index Fund Admiral Shares (VFIAX); the Schwab S&P 500 Index Fund (SWPPX); and the Fidelity Spartan 500 Index Shares (FUSEX).

Adding an international stock index fund to your portfolio might give you greater growth potential over the long term, but I recommend you invest no more than 5 percent of your portfolio in an international stock index fund, which is far below the 30 percent that many investment advisors currently recommend. To keep your investments as efficient and effective as possible you should invest in index funds whenever possible across all of your accounts. You should also set up all of your index fund dividends (the cash issued by the companies who have a dividend in the index fund) to automatically reinvest within the index fund. This means that whenever a company issues a dividend, you will automatically be using the dividend to buy new shares of the index fund to keep your money growing and compounding. If you withdraw your dividends, then the money will either sit in cash within your tax-advantaged account or your will be responsible for paying taxes on the withdrawals from a taxable account. If you do decide to withdraw your dividends for some reason, likely to spend the cash or invest it in something else, some dividends get taxed at a lower qualified dividend tax rate equal to the capital gains tax rates—so you can take the dividends as income and pay less tax than your income tax bracket.

If you want to be a little more aggressive you can invest most of your money in a total U.S. stock market index fund and then a small percentage in an international stock market fund. My investment accounts have always been invested in a few simple index funds—a total stock market index fund and an international index fund. If you don’t have a total stock market index fund, then the next best selection is an S&P 500 index fund. BUILDING YOUR TOTAL STOCK MARKET FUND IF YOU DON’T HAVE ACCESS TO ONE If you don’t have access to a total stock market fund, then you can invest in funds to mirror the holdings of those types of funds. In other words, you can create your own diverse portfolio based on a mixture of stocks for different-sized companies that will approximate what you would get in a total market fund. While it will take you a little bit of time to design your own diverse portfolio, it’s actually pretty easy and well worth your time to achieve optimal diversification.


pages: 519 words: 118,095

Your Money: The Missing Manual by J.D. Roth

Airbnb, asset allocation, bank run, buy and hold, buy low sell high, car-free, Community Supported Agriculture, delayed gratification, diversification, diversified portfolio, estate planning, Firefox, fixed income, full employment, hedonic treadmill, Home mortgage interest deduction, index card, index fund, late fees, mortgage tax deduction, Own Your Own Home, passive investing, Paul Graham, random walk, Richard Bolles, risk tolerance, Robert Shiller, Robert Shiller, speech recognition, stocks for the long run, traveling salesman, Vanguard fund, web application, Zipcar

Although this 1.75% difference in costs between actively and passively managed mutual funds may not seem like much, there's a growing body of research that says it makes a huge difference in long-term investment results. Other advantages of index funds include diversification (see Mutual Funds) and tax efficiency. And because index funds have a low turnover rate—as described on Mutual Funds—they don't generate as much tax liability. Note Exchange-traded funds (or ETFs) are basically index funds that you can buy and sell like stocks (instead of going through a mutual fund company). To learn more about the subtle differences between index funds and ETFs, head to http://tinyurl.com/YH-etfs. In Unconventional Success: A Fundamental Approach to Personal Investment (Free Press, 2005), David Swensen writes, "Fully 95% of active investors lose to the passive alternative, dropping 3.8% per annum to the Vanguard 500 Index Fund results." In other words, people who own index funds have typically earned almost 4% more each year than those who own actively managed funds.

Stick with the basics you learned in this chapter: Start with an index-fund portfolio. Do your research (you can find a list of recommended reading on this book's Missing CD page at www.missingmanuals.com). As you have the time and education, make adjustments that fit your style and view of the market. Move slowly. Ignore the Wall Street hype machine. Use common sense and don't take unnecessary risks. For 99% of folks reading this book, systematic investments in index funds are the way to go. Though I've pitched index funds as a great place to start, they're also a great place to finish. Many smart investors make index funds the core of their portfolios and never worry about anything else. In other words, they're not a dumbed-down investment that you have to abandon for something more complicated—you can stick with index funds for the rest of your life and still get great returns.

Some succeed and some don't, but as a whole, all actively managed funds earn the market average. Passively managed funds (called index funds), on the other hand, try to match the performance of a specific benchmark, like the Dow Jones Industrial Average or S&P 500 stock-market indexes. As you'll learn in the next section, this makes them a great long-term investment. Index funds Because index funds try to match an index and not beat it, they don't require much intervention from the fund manager, which makes their costs much lower than those of actively managed funds. In The Little Book of Common Sense Investing (Wiley, 2007), John Bogle writes that the average actively managed fund has a total of about 2% in annual costs, whereas a typical passive index fund's costs are only about 0.25%. Although this 1.75% difference in costs between actively and passively managed mutual funds may not seem like much, there's a growing body of research that says it makes a huge difference in long-term investment results.


pages: 300 words: 77,787

Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, Kenneth Rogoff, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

That said, from my perspective the decision between physical and synthetic ETFs is less important than selecting the right ETF on the basis of tax considerations, liquidity or cost. Index-tracking funds The index funds work like a regular mutual fund or unit trust, even the terminology and exact fund structure vary slightly between jurisdictions (in the UK, for example, they are often called unit trusts or OEICs – open-ended investment companies). In the case of the index funds, the simplest way to think about these is that you give them £1,000 to invest and they then take that £1,000 and buy the underlying securities that make up the index exposure. If you want to redeem or sell your index investment that same index fund will then sell shares in proportion to your index investment and give you back the proceeds from those sales. The index fund sector is more local. Unlike the ETFs that you can buy from any location in the world, like you would a stock, index-tracking funds are typically local financial institutions and the major player in the US is thus not the same as that in Germany, the UK or elsewhere.

As new products come to market there is a risk that the information outlined here grows stale quickly and I would strongly encourage the reader to survey the market for new and better products before making investments. With the large growth of index funds and exchange traded funds (ETF) investing over the past decades, the abundance of different product offerings leave even professional investors confused; it’s no wonder that many investors say ‘forget it’ and revert to doing what they have always done. The two main ways to gain index-type exposure is through ETFs and index funds (this term covers a few different structures). The main difference between the two is that an ETF is traded like any stock while index funds are more akin to mutual funds or unit trusts in their structures. If you can find a product provided by Vanguard, iShares, State Street or one of their major competitors that meets your needs from an exposure and tax perspective, this is probably a very good way to gain your exposure.

Have patience and keep trying – it’s worth your while. Failing that you can always revert to browsing through the ETF or index fund providers listed earlier. While many other product providers try to compete with them there is a reason that those listed are among the market leaders. Some index fund providers charge a small trading fee to get into the fund, just like they do if you redeem from the fund. This charge just reflects the cost to the fund of investing your money in the underlying securities. If there were no charges and you were a long-term holder of the fund (like you hopefully will be) you would instead indirectly be paying the trading fees as other investors come in and out of the fund. While entry/exit fees are explicit in index funds, in ETFs those charges are implicit in the bid/offer spread, or in some cases if the ETFs trade at a premium or discount to the net asset value.


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MONEY Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins

3D printing, active measures, activist fund / activist shareholder / activist investor, addicted to oil, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, backtesting, bitcoin, buy and hold, clean water, cloud computing, corporate governance, corporate raider, correlation does not imply causation, Credit Default Swap, Dean Kamen, declining real wages, diversification, diversified portfolio, Donald Trump, estate planning, fear of failure, fiat currency, financial independence, fixed income, forensic accounting, high net worth, index fund, Internet of things, invention of the wheel, Jeff Bezos, Kenneth Rogoff, lake wobegon effect, Lao Tzu, London Interbank Offered Rate, market bubble, money market fund, mortgage debt, new economy, obamacare, offshore financial centre, oil shock, optical character recognition, Own Your Own Home, passive investing, profit motive, Ralph Waldo Emerson, random walk, Ray Kurzweil, Richard Thaler, risk tolerance, riskless arbitrage, Robert Shiller, Robert Shiller, self-driving car, shareholder value, Silicon Valley, Skype, Snapchat, sovereign wealth fund, stem cell, Steve Jobs, survivorship bias, telerobotics, the rule of 72, thinkpad, transaction costs, Upton Sinclair, Vanguard fund, World Values Survey, X Prize, Yogi Berra, young professional, zero-sum game

Said another way, this could get you to your goal that much quicker and save you 5 to 15 years of accumulation time so that you can retire sooner if you so choose. By simply removing expensive mutual funds from your life and replacing them with low-cost index funds you will have made a major step in recouping up to 70% of your potential future nest egg! How exciting! What will that mean for you and your family? Vanguard has an entire suite of low-cost index funds (across multiple different types of asset classes) that range between 0.05% and 0.25% per year in total “all-in” costs. Dimensional Funds is another great low-cost index fund provider. If you don’t have access to these low-cost providers in your 401(k), we will show you how to make that happen. And while low-cost index funds are crucial, determining how much of each index fund to buy, and how to manage the entire portfolio over time, are the keys to success. We will cover that in the pages ahead.

I’m enjoying myself, and thriving on my mission to give investors a fair shake. Jack Bogle Portfolio Core Principles 1. Asset allocation in accordance with your risk tolerance and your objectives. 2. Diversify through low-cost index funds. 3. Have as much in bond funds as your age. A “crude” benchmark, he says. Jack is in his 80s and has 40% of his total portfolio invested in bonds. But a very young person could be 100% equities. So in my total portfolio, including both my personal and retirement accounts, about 60% of my assets are in stocks, mostly in Vanguard’s stock index funds. The rest is split between Vanguard’s Total Bond Market Index Fund and tax-exempt [municipal bond] funds. My municipal bond holdings are split about two-thirds in Vanguard’s Intermediate-Term Tax-Exempt Fund and about one-third in Vanguard’s Limited-Term Tax-Exempt Fund [limited being somewhere between short and intermediate; a little bit longer for the extra yield].

The opposite of active management is called passive management, better known as ‘indexing.’ ” CHAPTER 2.1 MYTH 1: THE $13T LIE: “INVEST WITH US. WE’LL BEAT THE MARKET!” * * * The goal of the nonprofessional should not be to pick winners—neither he nor his “helpers” can do that—but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal. —WARREN BUFFETT, 2013 letter to shareholders When you look at the results on an after-fee, after-tax basis, over reasonably long periods of time, there’s almost no chance that you end up beating the index fund. —DAVID SWENSEN, author of Unconventional Success and manager of Yale University’s more than $23.9 billion endowment FINANCIAL ENTERTAINMENT When you turn on the financial news today, you can see that it is less “news” and more sensationalism. Talking heads debate with zeal.


pages: 44 words: 13,346

Extreme Early Retirement: An Introduction and Guide to Financial Independence (Retirement Books) by Clayton Geoffreys

asset allocation, dividend-yielding stocks, financial independence, index fund, passive income, risk tolerance

Be sure to keep an eye out for index funds that are too high in cost because they do not give any meaningful return and should be avoided. Instead, keep your focus on low cost index funds as they make it easier to replicate a market rather than trying to shoot past the charts and fail in the long run. One might argue that you cannot really get high returns by simply investing on an index fund, and while that may be true for the most part, you are still getting a significant amount of return nevertheless. Whatever works will continue to work, and if it is not broken, there is no need to fix it; this can serve as a secondary concept for index funds. Of course there are still risks involved, but these risks are easily calculated and allow you to invest on index funds with minimal effort. Index fund investing is so cost-efficient that it leaves more room for your funds to grow and if you are looking for a strategy for your extreme early retirement endeavors, you are already bringing your foot one step further by investing.

Another thing is to keep your costs at a low level because there is absolutely no reason for you to be investing at a high cost when you can comparatively invest elsewhere at a much lower cost. At this point, one might ask why he or she should try out index fund investing or why is it such a good strategy. Well, there are different reasons as to why you should begin investing, but one of the key designs of an index fund is that it replicates the market trend, and if the market is at an all-time high, what better way to earn returns than with index funds? With index funds, you also know exactly what it is you are investing into, unlike actively-managed funds where the portfolio manager might begin investing into certain stocks and at some point engage in another type of investment, hence, affecting your asset allocation.

Just remember, if you are engaged with actively-managed funds and you decide to invest in other things or sell a few of your investments due to your asset allocation being thrown off course, you will incur taxes and trading fees. On the other hand, index funds provide great consistency and you save more money, allowing room for further investments. Diversification is another reason why you should get started in index investing because the concept is relatively easy to grasp. Think about your stocks, if you own an index fund in that type of investment, then you have already diversified as that index fund replicates the entire stock market. The same thing can be said with your bonds and real estate. Additionally, if you are engaged in these three types of investments (stocks bonds and real estate), you have already created diversity across the markets. Be sure to keep an eye out for index funds that are too high in cost because they do not give any meaningful return and should be avoided.


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Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

activist fund / activist shareholder / activist investor, Airbnb, Albert Einstein, asset allocation, bitcoin, Bretton Woods, buy and hold, buy low sell high, cognitive bias, cognitive dissonance, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, endowment effect, financial innovation, fixed income, hindsight bias, index fund, invention of the wheel, Isaac Newton, John Meriwether, Kickstarter, Long Term Capital Management, loss aversion, mega-rich, merger arbitrage, Myron Scholes, Paul Samuelson, quantitative easing, Renaissance Technologies, Richard Thaler, Robert Shiller, Robert Shiller, Snapchat, Stephen Hawking, Steve Jobs, Steve Wozniak, stocks for the long run, transcontinental railway, value at risk, Vanguard fund, Y Combinator

CHAPTER 5 Jack Bogle Find What Works for You Sometimes in life, we make the greatest forward progress by going backward. —Jack Bogle The Vanguard 500 Index fund is the world's largest mutual fund, with $292 billion in assets. That's 292 followed by nine zeros. How do you get to be so gigantic? Start with $11 million and grow 29% per year for the past 40 years. To give you an idea of how much money $292 billion is, if you were to stack it in hundred dollar bills, it would stretch 198 miles, which is just about the round‐trip distance from New York City to Vanguard's headquarters in Valley Forge, Pennsylvania. Index funds have picked up incredible momentum in the past few years. Since the end of 2006, active investors have pulled $1.2 trillion from active mutual funds and plowed $1.4 trillion into index funds.1 Vanguard has been the biggest beneficiary of the tidal wave of change of investor preference.

On September 24, 1974, Vanguard was born.”19 After 16 months of trying to convince the board to create an index fund, the First Index Investment Trust was born. Bogle had shown them the evidence, that over the previous three decades, the S&P 500 index averaged 11.3% growth per year, while the funds trying to beat it earned just 9.7%. The rest is history. Well, sort of. Wall Street wasn't ready to embrace the index fund or stocks for that matter. When they launched in August 1976, stocks were just wrapping up a lost decade. They were trading at the same levels as they had 10 years ago and just experienced the worst bear market since the Great Depression. But determined and sure that he was onto something, Bogle pressed on. He knew that the index fund would give investors their best chance at capturing their fair share of market returns over the long‐term.

In fact, the second index fund wasn't created until 1984, by Wells Fargo. The Stagecoach Corporate Stock Fund came with a 4.5% sales load and an annual expense ratio of 1%.20 Today, the fund has just $2 billion. I guess there is something to Bogle's saying “ideas are a dime a dozen, but implementation is everything.” Success found its way to index funds in the second decade after their creation, when they went from $600 million to $91 billion. In the end, Bogle was vindicated, and then some. From 1976 to 2012, the Vanguard 500 returned 10.4%, compared to the 9.2% return of the average large‐cap blend funds. The 1.2% difference is nearly identical to the one Bogle presented to his board 40 years earlier. That decades‐long track record illustrates the consistent returns that index funds can offer – their primary benefit over other types of investments.


Early Retirement Guide: 40 is the new 65 by Manish Thakur

"side hustle", Airbnb, diversified portfolio, financial independence, hedonic treadmill, index fund, Lyft, passive income, passive investing, risk tolerance, Robert Shiller, Robert Shiller, time value of money, uber lyft, Vanguard fund, Zipcar

It can be overpowering picking funds with all the technical finance industry jargon, discussions of futures and options, or how foreign markets are performing. Enter the magic of index funds. Index funds buy stocks that represent a whole market or industry, and get rebalanced to keep it representative of the market each year. As the market grows, so does the value of your investments. Instead of having to beat the market, you'll become one with it and benefit from all the hard work of the fund's companies' employees. Index funds also have the benefit of low expenses ratios. An expense ratio is the cut of money that a broker gets for letting you invest money with them, regardless of how well the fund performs. A typical actively managed fund expense ratio is around .71%, which doesn't seem like much, but when you have $600,000 in a fund, this equals $4,440 a year! This is compared to index fund ratios of .25% to as low as .06%. Numerous studies found over a period from 1997 to 2014 index funds outperformed actively managed funds 82-90% of the time!

Numerous studies found over a period from 1997 to 2014 index funds outperformed actively managed funds 82-90% of the time! What's worse is that these managers charge you for their underperformance through a higher expense ratio! It makes little sense to pay someone for doing a worse job that someone that could do it for pennies on the dollar. This might fly in the face of the popular trends in investing or be missing the excitement of having a portfolio manager decide where your money goes. It's definitely exciting to say you have a stock manager giving you advice on money, but what's even more exciting is making plenty of money without the help of someone else. Studies examined how effective different investing techniques are, ranging from day trading to index funds. In most cases, index funds outperformed a majority of actively managed funds, but there are some benefits to actively managed funds.

In most cases, index funds outperformed a majority of actively managed funds, but there are some benefits to actively managed funds. Ultimately, the best choice for the average investor, who already works a full time job and has other responsibilities, is a passively managed, broadly invested index funds. While looking for the ideal index fund, most people want to go about it with a "set it and forget it" mindset. Total market index funds give us this by buying stocks of 500 to 5000 companies, depending on the fund you choose. By buying so many companies, a fund is essentially mirroring how the economy does and the market has historically grown about 9.6% a year. Keep in mind that this is only what the market has done in the past, not what it will be doing in the future. Keep in mind, these are only investing best practices, not financial recommendations backed up by any professional certification.


pages: 572 words: 94,002

Reset: How to Restart Your Life and Get F.U. Money: The Unconventional Early Retirement Plan for Midlife Careerists Who Want to Be Happy by David Sawyer

Airbnb, Albert Einstein, asset allocation, beat the dealer, bitcoin, Cal Newport, cloud computing, cognitive dissonance, crowdsourcing, cryptocurrency, David Attenborough, David Heinemeier Hansson, Desert Island Discs, diversification, diversified portfolio, Edward Thorp, Elon Musk, financial independence, follow your passion, gig economy, hiring and firing, index card, index fund, invention of the wheel, knowledge worker, loadsamoney, low skilled workers, Mahatma Gandhi, Mark Zuckerberg, meta analysis, meta-analysis, mortgage debt, passive income, passive investing, Paul Samuelson, pension reform, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, Skype, smart meter, Snapchat, stakhanovite, Steve Jobs, Tim Cook: Apple, Vanguard fund, Y Combinator

Monevator’s slow and steady portfolio Set up in 2011 with £3,000, an extra £900 has been invested every quarter, complete with quarterly blog post and the numbers tracking progress. It’s an all-index-funds, no-transaction-charges portfolio aimed at the UK investor. This passive portfolio uses threshold rebalancing[398]. In April 2018[399], it comprised: Vanguard FTSE UK All Share Index Trust: 5.79%. Vanguard FTSE Developed World Ex-UK Equity Index Fund: 35.45%. Vanguard Global Small-Cap Index Fund: 6.91%. iShares Emerging Markets Equity Index Fund D: 10.03%. iShares Global Property Securities Equity Index Fund D: 6.64%. Vanguard UK Government Bond Index: 29.02%. Vanguard UK Inflation-Linked Gilt Index Fund: 6.16%. RESET View Monevator is the UK FI index investing guru, who I first discovered through a recommendation on the Mr.

Fidelity Index UK Fund P Accumulation. Fidelity Index Europe Ex-UK P Accumulation. Fidelity Index Emerging Markets P Accumulation. Fidelity Index Japan P Accumulation. Fidelity Index Pacific Ex-Japan Fund P Accumulation Shares. Vanguard US Equity Index Fund – Accumulation. FTSE UK All Share Index Unit Trust – Accumulation. FTSE Developed Europe Ex-UK Equity Index Fund – Accumulation. Emerging Markets Stock Index Fund – Accumulation. Japan Stock Index Fund – Accumulation. Pacific Ex-Japan Stock Index Fund – Accumulation. Overall charges Here’s how the overall charges stack up under the suggested RESET portfolio. The calculations[383] assume your stash is under £250k, meaning a wrapper charge from Fidelity of 0.35% and Vanguard of 0.15%. The overall charge for investing with Fidelity, choosing all Fidelity funds is 0.43% (0.35% + 0.08%).

[359] “A Challenge to Judgment”: “The inspiration for John Bogle’s great invention – MarketWatch.” 5 Mar. 2014, toreset.me/359. [360] $403bn: “VFINX - Vanguard 500 Index Fund Investor Shares | Vanguard.” toreset.me/360. [361] 29% of the entire US market: “Index funds to surpass active fund assets in U.S. by 2024: Moody’s.” 2 Feb. 2017, toreset.me/361. [362] “Something new under the sun”: “The inspiration for John Bogle’s great invention – MarketWatch.” 5 Mar. 2014, toreset.me/362. [363] but it’s a lot more rational than us: “Is the Market Rational? – Kiplinger.” toreset.me/363. [364] “who employ high-fee managers”: “Warren Buffett to heirs: Put my estate in index funds – MarketWatch.” 13 Mar. 2014, toreset.me/364. [365] Peter Lynch: “Peter Lynch – Wikipedia.” toreset.me/365a. Lynch is an amazing investor, a once-in-a-lifetime who, statistical analysis shows, consistently beat the market in the long-term.


pages: 89 words: 29,198

The Big Secret for the Small Investor: A New Route to Long-Term Investment Success by Joel Greenblatt

backtesting, discounted cash flows, diversified portfolio, hiring and firing, index fund, Sharpe ratio, time value of money, Vanguard fund

They also achieve the tax benefits of an ETF. A reasonable expectation for outperformance over market-cap-weighted indexes is approximately 2 percent per year over the very long term. iShares Russell 1000 Value Index Fund (symbol: IWD)—larger stocks iShares Russell 2000 Value Index Fund (symbol: IWN)—smaller stocks iShares Russell Midcap Value Index Fund (symbol: IWS) iShares Russell Small Cap Value Index Fund (symbol: IJS) Vanguard Value ETF (symbol: VTV) Vanguard Mid-Cap Value Index Fund (symbol: VOE) Vanguard Small-Cap Value ETF: (symbol: VBR) INTERNATIONAL VALUE INDEX ETF iShares MSCI EAFE Value Index Fund (symbol: EFV)—based on EAFE International Value Index MUTUAL FUNDS (“VALUE-WEIGHTED”) We have created a free website, valueweightedindex.com, to keep readers updated on what I believe will be a growing area in the investment field.

But ideally, our plan should also leave us with enough rope to beat the market and almost all other investors! How are we going to do all that? Well, we already have part of the solution. Clearly, we should start with a strategy that should outperform most others over time. As we’ve already learned, a market-cap-weighted index fund will likely outperform most active managers. Of course, over time, an equally weighted index fund or a fundamentally weighted index fund should do even better. But as we saw in the last chapter, a value-weighted index should do better still—and possibly by a lot! And if we choose the value-weighted index fund, we’ll actually be taking advantage of the systematic mistakes that most of us humans make, rather than suffering from them! Remember, the only reason the value strategy works is that we are systematically setting ourselves up to buy companies that most people don’t want.

Remember, a market-cap-weighted index ends up having a larger weighting in stocks that increase in value and a smaller weighting in companies whose prices decrease. As Mr. Market gets overly excited about certain companies and overpays, their weighting in a market-cap-weighted index rises. Consequently, an index fund that owns these same stocks ends up being more heavily weighted in these overpriced stocks. If Mr. Market is overly pessimistic about particular companies or industries, the opposite happens. The stock prices of these companies fall below fair value, and the index and the accompanying index fund effectively own less of these bargain-priced stocks. In fact, the effect of owning too much of the overpriced stocks and too little of the bargain-priced stocks is actually built into the market-cap-weighting system. Again, as stocks move up in price, we own more of them through the index.


Work Less, Live More: The Way to Semi-Retirement by Robert Clyatt

asset allocation, backtesting, buy and hold, delayed gratification, diversification, diversified portfolio, employer provided health coverage, estate planning, Eugene Fama: efficient market hypothesis, financial independence, fixed income, future of work, index arbitrage, index fund, lateral thinking, Mahatma Gandhi, McMansion, merger arbitrage, money market fund, mortgage tax deduction, passive income, rising living standards, risk/return, Silicon Valley, Thorstein Veblen, transaction costs, unpaid internship, upwardly mobile, Vanguard fund, working poor, zero-sum game

Mutual funds or Exchange Traded Funds (ETFs) are pooled invest­ ments that allow owning a piece of many different securities, far more than you would likely be able to buy on your own. Actively managed funds are led by a manager who uses expertise to try to beat the index— that is, the average of the securities in the asset class. Index funds, however, own nearly every security in an index and thereby match the returns of the asset class. Because they do not try to decide what will go up and down but simply buy the securities in the index, index funds run with fewer people and lower expenses. The average mutual fund charges its investors 1.3% per year to manage its assets, whereas many index funds or ETFs run at around 1/10th of that amount, or under 0.2%. ETFs, which tend to be index funds, are bought in a brokerage account and trade during the day on the stock exchanges; mutual funds are bought at the end of the trading day from the mutual fund company.

All this detail is simply to impress on you that an index, while certainly a useful creation, is only an approximation of the actual returns for the asset class and tilt in which you are interested. Whenever the match is close, you are in luck. In those cases, your best choice for the portfolio will almost always be the low-fee, tax-efficient index fund or index ETF. But there’s not always an index fund available that matches your needs. You are then left with little choice but to find a low-fee actively managed fund to do the job. Likewise, a tilt or subindex may not have an index or traditional index fund that properly tracks it—for example, international small stocks or international large value stocks. You may occasionally find actively managed funds that, through some credible difference in trading strategy, develop a consistent deviation from their index or benchmark.

Later in the chapter, you will find a list of good choices of index and other funds for each asset class. Choose from among these and compare them to other favorite or new funds as you set about implementing the Rational Investing Method for yourself. chapter 3 | Put Your Investing on Autopilot | 185 TiP Not all index funds are created equal. After years of experience in reducing trading costs while still matching the underlying index, Vanguard has learned how to often produce marginally better returns than the index, even after its fees. And Dimensional Fund Advisors (DFA) offers a variety of funds called enhanced index funds that track asset classes and tilts rather than an index per se. These will give you, for instance, funds tracking the International Small or International Large Value asset classes, making them a good fit for investors following the Rational Investing Method.


pages: 369 words: 128,349

Beyond the Random Walk: A Guide to Stock Market Anomalies and Low Risk Investing by Vijay Singal

3Com Palm IPO, Andrei Shleifer, asset allocation, buy and hold, capital asset pricing model, correlation coefficient, cross-subsidies, Daniel Kahneman / Amos Tversky, diversified portfolio, endowment effect, fixed income, index arbitrage, index fund, information asymmetry, liberal capitalism, locking in a profit, Long Term Capital Management, loss aversion, margin call, market friction, market microstructure, mental accounting, merger arbitrage, Myron Scholes, new economy, prediction markets, price stability, profit motive, random walk, Richard Thaler, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, survivorship bias, transaction costs, Vanguard fund

The primary reason for persistence is the focus on tracking error by index fund managers. Index fund managers are evaluated strictly on the size and volatility of the tracking error (difference between the fund’s return and the S&P 500 return) and not on the direction of the tracking error. A manager of a large index fund (more than $1 billion) is not expected to have a tracking error of more than 0.03 percent in a year. If it is more than 0.10 percent, the manager is 173 174 Beyond the Random Walk likely to be fired. Therefore, it is easy to see that the managers are constrained, and must buy (sell) the firm added to (deleted from) the index on the effective date at the close. Arbitrageurs know this. So they buy the stock added to the index before the effective date knowing that they will be able to unload the stock to the index fund managers at a higher price.

If the change in the index takes place immediately, the arbitrageurs will not be able to time their trades to the detriment of index fund managers. The second reason is the way owners of index funds evaluate the index fund managers. The performance of an index fund manager is measured by the tracking error, which forces the managers to trade exactly at the time that changes to the index are implemented. If the managers were free to trade the stocks deleted from or added to the index within a reasonable period around the effective date, they will not be forced to play into the hands of the arbitrageurs, and the investors will actually gain from this limited freedom given to the managers. Trading Around the Effective Date This section expands on the evidence presented above suggesting that a temporary price effect around the effective date is available for trading.

The consensus is that arbitrageurs have started playing the “S&P game” with the preannouncements, as explained in the section titled “Persistence.” With additions, arbitrageurs or market participants know that the index fund managers must buy the stock at the close of the effective date. Therefore, the arbitrageurs buy the stock be- Changes to the S&P 500 Index fore the effective date in the hope of unloading it to the index fund managers at a higher price on the effective date. For deletions, it is exactly the opposite. A question that arises is why index fund managers don’t buy immediately upon announcement instead of waiting till the effective date. The index fund managers must wait because their objective is not to beat the index but to minimize tracking error. To minimize tracking error, they must buy the added stock at the time and at the price that Standard and Poor’s adds it to the index, neither before nor after.


Investment: A History by Norton Reamer, Jesse Downing

activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, business cycle, buttonwood tree, buy and hold, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, dogs of the Dow, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

Over the period from 1994 to 1996, some 91 percent of managed funds underperformed their index fund counterparts within US equities—a victory for the vehicle that was once derided as a recipe for mediocrity.58 Today there exist nearly 300 distinct stock and bond index mutual funds in the United States and over 1,000 American passive ETFs, and the world of investment has come a very long way toward not only accepting index funds as a fixture of investing but also fully embracing the power of indexing as one component of a strategy to outperform the market in terms of risk-adjusted return.59 The first index funds were meant for passive investors who simply wanted a small piece of the larger pie of the equity markets. Modern index funds, however, cater not only to passive investors who are looking for a broadly diversified portfolio of securities but also to active investors who want to enhance their portfolio returns by investing in particular asset classes through indexing. For instance, there are index funds that specialize in timberland investment, leveraged index funds that attempt to double or triple the return of a common stock index such as the S&P 500 on a daily basis, and index funds that specialize in commodities.

The benefit of the latter approach is lower transaction costs, but it comes at the expense of the possibility of additional tracking error.60 The differences between ETFs and index funds are subtle. First, ETFs can be bought and sold throughout the trading day, whereas index funds are purchased or redeemed once per day. Second, index funds are intended to trade at the net asset value of the portfolio’s underlying holdings, whereas ETFs can actually trade at a discount or premium to net asset value. Many ETFs do have mechanisms to prevent very large deviations in price from net asset value, but there is no structural reason that they have to trade at net asset value (as is the case for index funds). Index funds also reinvest dividends immediately whereas ETFs capture cash for distribution at a regular interval (often quarterly). There tend to be some tax advantages for ETFs over index funds because of how the shares trade and are redeemed, but the need to pay the broker and the bid-ask spread tends to result in higher transaction costs for ETFs.

This fund lasted only 7 years, closing in 1993.57 It was not until the early 1990s that Vanguard started to see any meaningful competition. Vanguard had eleven different index funds by the end of 1992. That same year, thirty-five new index funds were formed by competitors, bringing the total number of index mutual funds in the investment market to just under eighty. The universe of product offerings also expanded. In 1993, Vanguard and some of its competitors offered the first bond index funds. With these, investors could get exposure to a wider array of investments than just equities. The bull market of the 1990s spurred continued growth in the industry, and many of the US equity index funds dramatically outperformed actively managed accounts during this time. Over the period from 1994 to 1996, some 91 percent of managed funds underperformed their index fund counterparts within US equities—a victory for the vehicle that was once derided as a recipe for mediocrity.58 Today there exist nearly 300 distinct stock and bond index mutual funds in the United States and over 1,000 American passive ETFs, and the world of investment has come a very long way toward not only accepting index funds as a fixture of investing but also fully embracing the power of indexing as one component of a strategy to outperform the market in terms of risk-adjusted return.59 The first index funds were meant for passive investors who simply wanted a small piece of the larger pie of the equity markets.


pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, business cycle, butter production in bangladesh, butterfly effect, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, fixed income, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, intangible asset, Internet Archive, John Nash: game theory, Kenneth Arrow, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, Metcalfe’s law, moral hazard, mutually assured destruction, Myron Scholes, natural language processing, negative equity, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Robert Metcalfe, Ronald Reagan, Rubik’s Cube, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra, your tax dollars at work

Even so, there are economies of scale to be had in managing large index funds. This is reflected by the current business situation in which there are a small number of large index fund providers around the world, such as State Street and Barclays Global Investments. Estimates of total assets managed using this sort of passive approach, in a variety of markets, now exceed $4 trillion. 112 Nerds on Wall Str eet Imagine 500 stocks in this box, one for each company in the S&P 500 index. Figure 5.1 Full Replication Index Fund. All the stocks, all the time. Setting aside considerations of trading costs for now, the idea of an index fund is a very simple one. Nevertheless, it is a quantitative concept, and running an index fund requires the use of a computer. The most straightforward way to manage an index fund is simply to hold all of the stocks in the index: every single one of them, each in its index weight.

For the most common S&P 500 there are 500 stocks to deal with. For a total market index like the Russell 3000, there are 3,000. For the Wilshire 5000, there are about 6,700. The measure of how well you are doing in an index fund is clearly not alpha; that should be zero. It is tracking error, a measure of the difference between the calculated index and the actual portfolio. An ideal index fund has a tracking error of zero. Real-world index funds have tracking errors around 0.1 percent. If it gets much larger than that, someone is confused. Index Funds: The Godfather of Quantitative Investing Index funds have an interesting history. Prior to the 1960s, most institutional equity portfolios were managed by bank trust departments, and performance reporting was not the refined art that it has become today. A Gentle Intr oduction to Computerized Investing 111 Bill Fouse, one of the founders of the world’s first indexing group at Wells Fargo in the 1970s, tells stories of when performance reporting by a bank trust department consisted of a table listing all stocks held, the acquisition price of each, the current price, and the size of the position.

The idea, the desire, and the means to achieve it all came together in the early 1970s for index funds. But this is a chapter about alpha strategies, the anti-index funds—so why are we talking about them at all? Because they are a starting point for all active quantitative computerized equity strategies. Indexing 101 Calculating an index is fairly simple. Multiply the prices of the stocks in the index by their weights (usually their share of the total capitalization of the index constituents), add them up, and there’s your index. Charles Dow, a journalist, started doing it with a pencil and paper in 1896. You need to make adjustments for mergers, splits, and the like, and can get fancy, including dividends for total return. Running an index fund is less simple. You have to figure out how many of hundreds or thousands of different stocks to buy (or sell) each time cash moves in or out of the portfolio in the form of investments, withdrawals, and dividends.


pages: 670 words: 194,502

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

3Com Palm IPO, accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, George Santayana, hiring and firing, index fund, intangible asset, Isaac Newton, Long Term Capital Management, market bubble, merger arbitrage, money market fund, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, stocks for the long run, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

First of all, recognize that an index fund—which owns all the stocks in the market, all the time, without any pretense of being able to select the “best” and avoid the “worst”—will beat most funds over the long run. (If your company doesn’t offer a low-cost index fund in your 401(k), organize your coworkers and petition to have one added.) Its rock-bottom overhead—operating expenses of 0.2% annually, and yearly trading costs of just 0.1%—give the index fund an insurmountable advantage. If stocks generate, say, a 7% annualized return over the next 20 years, a low-cost index fund like Vanguard Total Stock Market will return just under 6.7%. (That would turn a $10,000 investment into more than $36,000.) But the average stock fund, with its 1.5% in operating expenses and roughly 2% in trading costs, will be lucky to gain 3.5% annually. (That would turn $10,000 into just under $20,000—or nearly 50% less than the result from the index fund.) Index funds have only one significant flaw: They are boring.

You’ll never be able to boast that you beat the market, because the job of an index fund is to match the market’s return, not to exceed it. Your index-fund manager is not likely to “roll the dice” and gamble that the next great industry will be teleportation, or scratch-’n’-sniff websites, or telepathic weight-loss clinics; the fund will always own every stock, not just one manager’s best guess at the next new thing. But, as the years pass, the cost advantage of indexing will keep accruing relentlessly. Hold an index fund for 20 years or more, adding new money every month, and you are all but certain to outper-forms the vast majority of professional and individual investors alike. Late in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffett.6 Tilting the Tables When you add up all their handicaps, the wonder is not that so few funds beat the index, but that any do.

Today’s defensive investor can do even better—by buying a total stock-market index fund that holds essentially every stock worth having. A low-cost index fund is the best tool ever created for low-maintenance stock investing—and any effort to improve on it takes more work (and incurs more risk and higher costs) than a truly defensive investor can justify. Researching and selecting your own stocks is not necessary; for most people, it is not even advisable. However, some defensive investors do enjoy the diversion and intellectual challenge of picking individual stocks—and, if you have survived a bear market and still enjoy stock picking, then nothing that Graham or I could say will dissuade you. In that case, instead of making a total stock market index fund your complete portfolio, make it the foundation of your portfolio.


Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

addicted to oil, asset allocation, backtesting, Black-Scholes formula, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

Indexing became so popular that in the first six months of 1999 nearly 70 percent of the money that was invested went into index funds.13 By 2007, all Vanguard 500 Index funds had attracted over $200 billion in assets, but the largest single equity mutual fund is the American Growth Fund with assets of $185 billion.14 One of the attractions of index funds is their extremely low cost. The total annual cost in the Vanguard 500 Index Fund is only 0.18 percent of market value (and as low as 2 basis points for large institutional investors). Because of proprietary trading techniques and interest income from loaning securities, Vanguard S&P 500 Index funds for individual investors have fallen only 9 basis points behind the index over the last 10 years, and its institutional index funds have actually outperformed the index.15 THE PITFALLS OF CAPITALIZATION-WEIGHTED INDEXING Despite their past success, the popularity of indexing, especially those funds linked to the S&P 500 Index, may cause problems for index 12 Five years before the Vanguard 500 Index Fund, Wells Fargo created an equally weighted index fund called “Samsonite,” but its assets remained relatively small. 13 Heather Bell, “Vanguard 500 Turns 25, Legacy in Passive Investing,” Journal of Index Issues, Fourth Quarter 2001, pp. 8–10. 14 Vanguard’s number includes assets of its 500 Index Fund open to both individuals and institutions. 15 The Vanguard Institutional Index Fund Plus shares, with a minimum investment of $200 million, have outperformed the S&P 500 Index by 7 basis points in the 10 years following the fund’s inception on July 7, 1997. 352 PART 5 Building Wealth through Stocks investors in the future.

Thus, the 1990s witnessed an enormous increase in passive investing, the placement of funds whose sole purpose was to match the performance of an index. The oldest and most popular of the index funds is the Vanguard 500 Index Fund.12 The fund, started by visionary John Bogle, raised only $11.4 million when it debuted in 1976, and few thought the concept would survive. But slowly and surely indexing gathered momentum, and the fund’s assets reached $17 billion at the end of 1995. In the latter stages of the 1990s bull market, the popularity of indexing soared. By March 2000, when the S&P 500 Index reached its alltime high, the fund claimed the title of the world’s largest equity fund with assets over $100 billion. Indexing became so popular that in the first six months of 1999 nearly 70 percent of the money that was invested went into index funds.13 By 2007, all Vanguard 500 Index funds had attracted over $200 billion in assets, but the largest single equity mutual fund is the American Growth Fund with assets of $185 billion.14 One of the attractions of index funds is their extremely low cost.

Steel Group, 49 Utilities sector: in GICS, 53 global shares in, 175i, 177 Utility, 322 Valuation, 144–145 value versus growth stocks and, 144–145 Value Line Index, 47n, 256 Value stocks, 362–363 growth stocks versus, 144–145 nature of, 157 Value-weighted indexes, 42–45 (See also Center for Research in Security Prices [CRSP] index; Nasdaq Index; Standard & Poor’s [S&P] index) Valuing Wall Street (Smithers and Wright), 117 Vanguard 500 Index Fund, 263n Vanguard Institutional Index Fund Plus, 351n Vanguard S&P 500 Index funds, 351 Van Strum, Kenneth S., 80n Verizon, 177 Vesting, 106 Viceira, Luis M., 35n Vietnam War, 233 bear market and, 85 Virginia Carolina Chemicals, 60i, 63 Vishny, R., 326n VIX Index, 281–282, 282i, 334 Vodafone, 177 Volatility (see Market volatility) 380 Volcker, Paul, 9, 195 Vuolteenaho, Tuomo, 158n Wachovia Bank, 21n Wages, Nixon’s freezing of, 194 Wall Street Journal, 38, 290 Wal-Mart, 155, 176i, 177 Wang, Jiang, 304n War: market movements and, 225, 231–235 (See also specific wars) War on terrorism, 234 Weber, Steven, 218n Wein, Byron, 86 Index Welch, Ivo, 325n Wells Fargo, 351n Werner, Walter, 12n, 21n Western Co., 63 White, Weld & Co., 97 Williams, Frank J., 319q Williams, John Burr, 101 Wilshire 5000 index, 342 Wisdom Tree Investments, 356 Withers, Hartley, 81 Wm.


pages: 733 words: 179,391

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

"Robert Solow", Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, Sam Peltzman, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, survivorship bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

But the transition from equal weighting to market-cap weighting occurred through trial and error, not because the market for new financial products was particularly efficient. The emergence of the multitrillion-dollar index fund industry was an evolutionary process driven by competition, innovation, and natural selection. This is the Adaptive Markets Hypothesis at work. NEW SPECIES OF INDEX FUNDS The success of the index mutual fund, beginning with the Vanguard Index Trust, led to an evolutionary explosion of financial innovation. Three different stock market index futures debuted in 1982, based on the New York Stock Exchange (NYSE) Composite, the S&P 500, and the Value Line index, respectively. Indexes for each asset class emerged, and additional index funds to track them: the first bond index fund for retail investors in 1986, the first international share index funds in 1990, and the first exchange-traded fund in 1993. Exchange traded funds were similar to index mutual funds in that they closely tracked an index, but could be bought and sold throughout the day on exchanges. 266 • Chapter 8 If the previous financial generation saw “markets in everything,” we currently see “indexes in everything,” as well as funds and derivatives based on those indexes.

Instead, he advised readers to put their money in broadly 6 • Introduction diversified, passive mutual funds that charged minimal fees—and millions of his readers did. In a curious twist of fate, a former Princeton undergraduate launched a mutual fund company for this exact purpose a year after Malkiel’s book debuted. You may have heard of this individual, the index fund pioneer John C. Bogle. His little startup, the Vanguard Group, manages over $3 trillion and employs more than fourteen thousand people as of December 31, 2014.5 Vanguard’s main message, and the advice most often dispensed to millions of consumers, is “don’t try this at home.” Don’t try to beat the market. Instead, stick to passive buy-and-hold investments in broadly diversified stock index funds, and hold these investments until you retire. Still, there’s no shortage of examples of investors who did and do beat the market. A few well-known portfolio managers have routed it decisively, like Warren Buffett, Peter Lynch, and George Soros.

On the other side were the behavioral Introduction • 7 economists, who believe that we are all irrational animals, driven by fear and greed like so many other species of mammals. Some debates are merely academic. This one isn’t. If you believe that people are rational and markets are efficient, this will largely determine your views on gun control (unnecessary), consumer protection laws (caveat emptor), welfare programs (too many unintended consequences), derivatives regulation (let a thousand flowers bloom), whether you should invest in passive index funds or hyperactive hedge funds (index funds only), the causes of financial crises (too much government intervention in housing and mortgage markets), and how the government should or shouldn’t respond to them (the primary financial role for government should be producing and verifying information so that it can be incorporated into market prices). The financial crisis became a battleground in a greater ideological war.


pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, statistical model, stocks for the long run, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

More directly on topic (and on Bogle’s reading list at the time) was a 1974 essay by Paul Samuelson in the Journal of Portfolio Management, a wonky new publication for quantitatively inclined money managers, pension executives, and such.36 Samuelson declared that “most portfolio decision makers should go out of business” and pleaded for someone, anyone, to launch an index fund for small investors.37 A year later came a Financial Analysts Journal article by pension consultant Charley Ellis, titled “The Losers’ Game,” which reiterated a point that Ben Graham had made a decade before—professional investors now were the market, which meant that their performance must on average, after fees, trail the market.38 Bogle got SEC approval for the fund in 1976 but struggled to find a Wall Street firm willing to underwrite its launch. Then the magazine that had gotten him into the mutual fund business, Fortune, came through for him with a lengthy article by a recent graduate of the University of Rochester’s Business School, headlined “Index Funds—An Idea Whose Time Is Coming.”39 After that, the money flowed.40 Now it’s possible that the index fund would have been created even in the absence of these writings and of the efficient market hypothesis that helped inspire them.

The work of ivory tower scholars had launched a new school of investing, one that would survive and flourish in the decades to come. It was one of the great practical triumphs in the history of the social sciences. AFTER THE LAUNCH OF THE Vanguard index fund, Paul Samuelson announced in his Newsweek column that he had celebrated the birth of his first grandson by buying the boy a few shares.41 Ben Graham, just before he died in 1976, offered his own endorsement. In a Q&A with Charley Ellis in the Financial Analysts Journal, Graham defended index funds against their detractors on Wall Street and said that, in some matters, he now considered himself “on the side of the ‘efficient market’ school of thought now generally accepted by the professors.” This utterance has since been portrayed as an admission of defeat on the part of a tired old man, but it wasn’t that at all.42 Graham had been saying similar things for years.

He used mathematical tools that presaged Albert Einstein’s work to describe this randomness. Fischer Black Computer scientist who was introduced to finance working alongside Jack Treynor at the consulting firm Arthur D. Little in the 1960s. Coauthor with Myron Scholes of the Black-Scholes option pricing model, later a partner at Goldman Sachs and an early supporter of behavioral finance research. John Bogle After arguing against unmanaged index funds in 1960, the veteran mutual fund executive launched the first retail index fund at Vanguard in 1976. Warren Buffett Student of value-investing legend Benjamin Graham at Columbia Business School who went on to great success as an investor. Outspoken critic of the efficient market hypothesis and the academic approach to finance. Alfred Cowles III Chicago Tribune heir who, while convalescing from tuberculosis in Colorado in the 1920s, decided to research the effectiveness of various stock market forecasters.


pages: 517 words: 139,477

Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Asian financial crisis, asset allocation, backtesting, banking crisis, Black-Scholes formula, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen: Great Stagnation, Vanguard fund

Indexing became so popular that in the first six months of 1999 nearly 70 percent of the money that was invested went into index funds.14 By 2013, all Vanguard 500 Index funds had attracted over $275 billion in assets, and Vanguard’s Total Stock Market Funds, which include smaller stocks, attracted $250 billion. One of the attractions of index funds is their extremely low cost. The total annual cost in the Vanguard 500 Index Fund is only 0.15 percent of market value (and as low as 2 basis points for large institutional investors). Because of proprietary trading techniques and interest income from loaning securities, Vanguard S&P 500 Index funds for individual investors have fallen only 9 basis points behind the index over the last 10 years, and its S&P 500 Index fund for institutional investors has actually outperformed the benchmark index.15 THE PITFALLS OF CAPITALIZATION-WEIGHTED INDEXING Despite the past success of index funds, their popularity, especially those funds linked to the S&P 500 Index, may cause problems for index investors in the future.

Thus, the 1990s witnessed an enormous increase in passive investing, the placement of funds whose sole purpose was to match the performance of an index. The oldest and most popular of the index funds is the Vanguard 500 Index Fund.13 The fund, started by visionary John Bogle, raised only $11.4 million when it debuted in 1976, and few thought the concept would survive. But slowly and surely, indexing gathered momentum, and the fund’s assets reached $17 billion at the end of 1995. In the latter stages of the 1990s bull market, the popularity of indexing soared. By March 2000, when the S&P 500 Index reached its all-time high, the fund claimed the title of the world’s largest equity fund, with assets over $100 billion. Indexing became so popular that in the first six months of 1999 nearly 70 percent of the money that was invested went into index funds.14 By 2013, all Vanguard 500 Index funds had attracted over $275 billion in assets, and Vanguard’s Total Stock Market Funds, which include smaller stocks, attracted $250 billion.

Because of proprietary trading techniques and interest income from loaning securities, Vanguard S&P 500 Index funds for individual investors have fallen only 9 basis points behind the index over the last 10 years, and its S&P 500 Index fund for institutional investors has actually outperformed the benchmark index.15 THE PITFALLS OF CAPITALIZATION-WEIGHTED INDEXING Despite the past success of index funds, their popularity, especially those funds linked to the S&P 500 Index, may cause problems for index investors in the future. The reason is simple. If a firm’s mere entry into the S&P 500 causes the price of its stock to rise, due to the anticipated buying by index funds, index funds will hold a number of overpriced stocks that will depress future returns. An extreme example of overpricing occurred when Yahoo!, the well-known Internet firm, was added to the S&P 500 Index in December 1999. Standard & Poor’s announced after the close of trading on November 30 that Yahoo! would be added to the index on December 8. The next morning, Yahoo! opened at $115—up almost $9 per share from its close the day before—and continued upward to close at $174 a share on December 7, when index funds had to buy the shares in order to match the index. In just 5 trading days between the announcement of Yahoo!’s inclusion in the index until it formally became a member, the stock surged 64 percent.


pages: 389 words: 81,596

Quit Like a Millionaire: No Gimmicks, Luck, or Trust Fund Required by Kristy Shen, Bryce Leung

"side hustle", Affordable Care Act / Obamacare, Airbnb, asset allocation, barriers to entry, buy low sell high, call centre, car-free, Columbine, cuban missile crisis, Deng Xiaoping, Elon Musk, fear of failure, financial independence, fixed income, follow your passion, hedonic treadmill, income inequality, index fund, longitudinal study, low cost airline, Mark Zuckerberg, mortgage debt, obamacare, offshore financial centre, passive income, Ponzi scheme, risk tolerance, risk/return, Silicon Valley, single-payer health, Snapchat, Steve Jobs, supply-chain management, the rule of 72, working poor, Y2K, Zipcar

How to Steal from Wall Street If you ever want to see a banker sweat, try this: walk into your bank, ask to see a salesperson, and ask to put your savings into index funds. It’s the funniest thing ever. Armed with the knowledge of why index funds outperform actively managed funds, I did exactly that. I had done my homework. I knew the literature and research cold; I knew the statistics. I had looked up the commission the salesperson would earn on an index fund: precisely $0. So, I was expecting an amusing spectacle. And boy did I get it. That salesperson spun story after story about why I was making a huge mistake, and I slammed down chart after chart onto his desk proving him wrong. Eventually, he resorted to outright lying. This account, he claimed, couldn’t purchase those types of investments. But after I asked to speak to his supervisor, he relented. I got my account set up, and I invested in my index funds. Here’s the deal: Wall Street hates index funds.

They’ll throw around terms like “proprietary algorithm” or “high alpha and low beta,” but at the end of the day the fund manager’s not going to tell you because if they did they’d be out of a job. The power of indexing is how simple it is. You could probably run an index fund yourself: just throw all the companies in the stock market into a spreadsheet, sort by market cap, and pick the top five hundred. Done. You’ve just created an index fund. And because it’s so simple, there’s no fund manager to pay. In the United States, actively managed mutual funds charge MERs (Management Expense Ratio fees) north of 1 percent annually. In Canada, it’s even worse, with a typical mutual fund charging around 2 percent. But a typical index fund tracking the American stock market (NYSE: VTI) charges only 0.04 percent! That’s twenty-five times lower than the fee for an actively managed one. The sneaky thing about management fees is that you don’t get a bill at the end of the year.

I left my bank that day with this strange sense of satisfaction. When I sat down in that salesperson’s office, he had every intention of screwing me. He was the robber. But when I left, I was. CHAPTER 10 SUMMARY Index investing allows you to invest in all companies at once rather than trying to pick out the winners. Indexes can’t crash to zero. Index funds have lower fees. Index funds beat 85 percent of all actively managed mutual funds after fees. — 11 — HOW TO SURVIVE A STOCK MARKET CRASH I’ve been talking a lot about my life, and it might seem that I learned everything myself, but the truth is that my husband, Bryce, was with me through it all. We met in university as lab partners (nerd love!) and since then we’ve been navigating the big scary world of finance and adulting together.


pages: 1,164 words: 309,327

Trading and Exchanges: Market Microstructure for Practitioners by Larry Harris

active measures, Andrei Shleifer, asset allocation, automated trading system, barriers to entry, Bernie Madoff, business cycle, buttonwood tree, buy and hold, compound rate of return, computerized trading, corporate governance, correlation coefficient, data acquisition, diversified portfolio, fault tolerance, financial innovation, financial intermediation, fixed income, floating exchange rates, High speed trading, index arbitrage, index fund, information asymmetry, information retrieval, interest rate swap, invention of the telegraph, job automation, law of one price, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market clearing, market design, market fragmentation, market friction, market microstructure, money market fund, Myron Scholes, Nick Leeson, open economy, passive investing, pattern recognition, Ponzi scheme, post-materialism, price discovery process, price discrimination, principal–agent problem, profit motive, race to the bottom, random walk, rent-seeking, risk tolerance, risk-adjusted returns, selection bias, shareholder value, short selling, Small Order Execution System, speech recognition, statistical arbitrage, statistical model, survivorship bias, the market place, transaction costs, two-sided market, winner-take-all economy, yield curve, zero-coupon bond, zero-sum game

The DJIA and the S&P 500 Index are not dividend-adjusted indexes. Corresponding total return indexes for these two indexes, however, are widely available. 23.2 INDEX FUNDS An index fund is a portfolio that index managers design to replicate the performance of an index. Tracking error is the difference between the portfolio return and the corresponding dividend-adjusted index return. Index fund managers try to minimize their tracking errors. Most U.S. index funds try to replicate the S&P 500 Index, although other indexes are becoming increasingly popular. Replicating a value-weighted equity index is quite simple. If the value of the index fund is 0.01 percent of the total capitalization of all the index components, the index fund manager simply buys 0.01 percent of the outstanding shares of each index component. The value of the fund therefore is exactly proportional to the total value of all index components, which is proportional to the value of the value-weighted index.

The maximized expected return from using the t-test—expressed relative to the expected index fund return—is the value of the option to decide whether to invest with an active manager when the alternative is to invest in an index fund. It is always positive because you can always choose to invest in an index fund. For sample sizes of ten or fewer years, the value of this option is extremely low. With ten years of data, it is only 8.6 basis points. Not surprisingly, many investors choose to ignore these options. They invest in index funds because they do not believe that they can add significant value to their wealth by choosing managers. 22.4.5 Choosing Among Many Managers In practice, investors rarely decide only between just one active manager and an index fund when choosing whether to invest with an active manager.

Buy and hold investors avoid trading losses by not trading. They also avoid high management fees. Since index funds implement buy and hold strategies, they are very attractive to investors who want exposure to index risk without the risk of substantially underperforming the market. The minor frictions associated with index fund management ensure that index funds will slightly underperform their indexes. Although index funds slightly underperform their indexes, they regularly beat three-quarters of all active managers. Once again, note that this regularity is not simply an empirical fact. It is an implication of the zero-sum game. Although investors can save transaction costs by pursuing any buy and hold strategy, they generally choose to invest in broad-based market index funds because they offer well-diversified portfolios that replicate the market.


pages: 425 words: 122,223

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

"Robert Solow", Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate raider, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, Kenneth Arrow, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, money market fund, Myron Scholes, new economy, New Journalism, Paul Samuelson, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, stochastic process, Thales and the olive presses, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond, zero-sum game

To perform as well as the index was to perform well above average, and at lower levels of risk. The index funds have had the last laugh. There is nothing like solid quantitative proof to make people sit up and take notice. Once started, the indexing business grew steadily, from $6 million in 1971 to $10 billion in 1980. It is now a huge and varied business, with about 30 percent of total institutional equity assets currently indexed. According to one authoritative count, as of mid-1990 a total of $270 billion of financial assets was in index funds, one-third of it at Wells Fargo. Not all of it was in stock funds, and not all of what was in stock funds was in the S&P 500. According to another survey, as of late 1990 112 out of the top 200 pension funds were invested in equity index funds and 56 in bond index funds. Indexes that reflect the non-S&P part of the domestic stock market have become increasingly popular.

They also helped with his experiments on the use of beta, industry breakdowns, company size, and other sophisticated variations on the security selection problem. Treynor was so impressed that he predicted that Mellon would be the first institution to go into the business of putting the new ideas into practice. Fouse now felt the wind in his sails. In 1969, he recommended that Mellon launch an index fund that would replicate one of the popular market indexes, like the Standard & Poor’s 500-Stock Composite. An index fund requires no one to select stocks, no security analysts, and no portfolio manager. It is a passively managed rather than an actively managed portfolio. Fouse felt that the index fund would give him an opportunity to put Sharpe’s idea about the super-efficient portfolio on a real-time basis. For his efforts, Fouse recalls, he was “figuratively thrown out of the policy meeting.”b But Fouse was irrepressible. His had encountered John Burr Williams’s Dividend Discount Model in business school, and he set out to apply that model to security analysis.

The first two contributions to the fund were Wells Fargo’s own pension fund, with $5 million, and the pension fund of Illinois Bell, with a like amount. Those contributions fell short of the $25 million required to buy 1,000 shares of each of the 500 components of the index. So a sampling strategy had to be followed—with unfortunate errors in tracking the index—until the total reached $25 million. From that point forward, the S&P 500 index fund has held the 500 stocks in proportion to their relative market values. In 1976, Samsonite folded its equal-weighted New York Stock Exchange fund into the S&P 500 index fund. That fund has been the model for index funds ever since, even though, as McQuown describes it, “It’s a weird damn thing.” The Composite includes most of the large companies in the United States, so it accounts for a major share of the market. But its composition, as determined by the Standard & Poor’s Corporation that publishes it, is forever changing.


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, money market fund, moral hazard, Myron Scholes, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

In 1999, you had just over one million dollars in the index fund. It’s almost 10 years later and you’ve only gained about $200,000, or 13.72 percent. Looking at your statements, you earned 15.61 percent last year! Your head starts to hurt. Has the market gone nowhere since the beginning of the decade? Little did you know that next year, in 2008, the S&P 500 would plunge 36.58 percent. Out of frustration, you sell all of your shares at the end of the year for just more than $750,000. Looking at your statements from 1997 and 1998, you realize that you had about the same amount of money back then. Where did it all go? Aren’t index funds supposed to be a good investment? index fund A mutual fund that seeks to track the performance of a market index (e.g., S&P 500). Developed in 1973, index funds provide investors a way to trade broad indexes.

Developed in 1973, index funds provide investors a way to trade broad indexes. Professional investors use index funds to capture the performance of a broad market without the cost of buying hundreds of stocks. Charlatans have been known to create mutual funds that try to beat the index, but are in fact simply “closet index funds.” The most popular index funds are Exchange Traded Funds. See Chapter 8. My Dinner with Burton It was November of 2008 and I was invited to a due diligence conference in Boston. For those outside the Wall Street system, this is an event where a company flies you someplace nice and warm to hear them pitch a story under the cover of education. It was winter in Boston—you had to want to go to this one. My main reason for leaving the relatively decent weather in New Mexico was to hear Dr. Burton Malkiel speak. You may not know the name, but this guy is a legend in the business.

If you would have bought the index and held it for the same time period, reinvesting all of the dividends, you only would have earned 1,211.57 percent. Not bad for 13.12 times your original $100 investment. But you only would have ended up with $1,311.57! Table 1.2 Performance 1970–2010 Stock portfolio S&P 500a Average monthly total return 1.13% 0.54% Total return 1970-2010 21,628.91% 1,211.57% Value in 1970 $100.00 $100.00 Value in 2010 $21,728.91 $1,311.57 a S&P 500 is treated as an imaginary no-load index fund priced at the index value. But Wait There’s More! It’s 1990 and your kids are older and grown up. They’re all broke except for your son Cornelius, who wants to start investing like you did back in the day. Disneyland is certainly still around. Coca-Cola is still the preferred drink of the Magic Kingdom. Digital photography has not yet overtaken film. IBM miraculously has survived the death of mainframes and the birth of PCs.


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, fixed income, implied volatility, index fund, intangible asset, interest rate swap, inventory management, London Interbank Offered Rate, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

Technically, one cannot buy an index, but one can purchase index mutual funds and exchange-traded funds that allow investors to invest in securities representing broad market indexes. Related Terms: • Benchmark • Dow Jones Industrial Average—DJIA • Index Fund • Index Futures • Standard & Poor’s 500 Index—S&P 500 Index Fund What Does Index Fund Mean? A type of mutual fund with a portfolio constructed to match or track the components of a market index such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses, and low portfolio turnover. Investopedia explains Index Fund Indexing is a passive form of fund management that some argue outperforms most actively managed mutual funds. The most popular index funds track the S&P 500, but a number of other indexes, including the Russell 2000 (small companies), the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, and the Far East), and the Lehman Aggregate Bond Index (total bond market), are followed widely by investors.

Related Terms: • Debt • Interest Rate • Money Market • London Interbank Offer Rate—LIBOR • Singapore Interbank Offered Rate—SIBOR Exchange-Traded Fund (ETF) What Does Exchange-Traded Fund (ETF) Mean? A type of closed-end mutual fund that trades like a stock on an exchange; ETFs usually are constructed to track an index, a commodity, or a basket of assets like an index fund. ETFs fluctuate in price during the trading day as they are bought and sold on an exchange just like a stock. Investopedia explains Exchange-Traded Fund (ETF) Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated every day the way an open-end mutual fund does. By owning an ETF, an investor gets the diversification of an index fund as well as the ability to sell short, buy on margin, and purchase as little as one share (like a stock). Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund.

Investopedia explains Lehman Aggregate Bond Index The index, which is constructed by Lehman Brothers, is considered by investors to be the best total market bond tracking index. Along with the aggregate index, Lehman has bond indexes tailored to European and Asian investors. This index cannot be purchased, but it is tracked by bond index funds; there are also exchange-traded funds (ETFs) that track the index. The Lehman Aggregate Bond Index trades on an exchange just like a stock. Related Terms: • Bond • Corporate Bond • Index • Index Fund • Mortgage-Backed Securities—MBS Letter of Credit What Does Letter of Credit Mean? A letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. If the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.


file:///C:/Documents%20and%... by vpavan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, asset allocation, Berlin Wall, business cycle, buttonwood tree, buy and hold, corporate governance, corporate raider, disintermediation, diversification, diversified portfolio, Donald Trump, estate planning, fixed income, index fund, intangible asset, interest rate swap, margin call, money market fund, Myron Scholes, new economy, price discovery process, profit motive, risk tolerance, shareholder value, short selling, Silicon Valley, Small Order Execution System, Steve Jobs, stocks for the long run, stocks for the long term, technology bubble, transaction costs, Vanguard fund, women in the workforce, zero-coupon bond, éminence grise

For the year ended December 30, 2001, 47 percent of domestic stock funds did not perform as well as the S&P 500, according to Morningstar, even though the S&P lost 13.4 percent. And 2001 was one of the better years for managed funds. For years, experts have debated whether index funds are superior to managed funds. Index-fund proponents argue that actively managed funds waste money by paying higher salaries for top-flight analysts and stock pickers to put together a winning portfolio. They also incur higher transaction costs because they engage in frequent trading. But after all that, most managed funds still can't beat the passive index funds. On the other hand, managed-fund backers say that index funds don't always perform better, such as in the twelve months following the March 2000 technology bust. And managed-fund aficionados say index funds are, well, boring. When the market is booming, they mimic but never outshine the indices. And when the market slides, they tamely follow it over the precipice.

If your head is spinning from all of this, take the easiest and safest route and pick a low-cost index fund. Many Vanguard, Fidelity, and TIAA-CREF funds fit the criteria I outlined above. Vanguard, for example, has twenty-one no-load index funds to choose from. Start off with the boring but predictable returns of a broad-based index fund— one that tracks the S&P 500 or, to get exposure to the entire market, the Wilshire 5000— over the more alluring, but volatile, managed funds. Index funds generate less capital gains taxes and also charge lower fees and expenses. They make the most sense when you want to be invested in large-cap stocks, since it's harder for portfolio managers to beat those indices. If you want to diversify beyond a broad-based index fund— assuming your budget allows it— you could start off with a fund that invests in small-cap companies and that tracks the Russell 2000 index.

If you buy and sell stocks through an online trading firm, you're still accessing the market through a broker, albeit an electronic one. Fire Your Broker If you have less than $50,000 to invest, you don't need a broker. The strategy that makes the most sense is investing in low-cost mutual funds, especially index funds that match the performance of a stock index. You could start off with a fund that follows the Wilshire 5000, which includes virtually all U.S. stocks, or the Standard & Poor's 500, which mimics the shares of 500 large U.S. companies. As you become more comfortable investing in mutual funds, and as your assets grow, you can move into index funds that track small, medium, and large companies. Or you can buy funds that track fast-growing companies or undervalued ones. As most experts suggest, put a small amount of your assets into an international fund. And for diversification, consider a corporate or government bond fund.


pages: 426 words: 115,150

Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford

asset allocation, Buckminster Fuller, buy low sell high, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fixed income, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, job satisfaction, Menlo Park, money market fund, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, Thorstein Veblen, Vanguard fund, zero-coupon bond

Mutual fund managers are constrained by regulations imposed by the Security and Exchange Commission (SEC), a federal agency. Index Funds Index Funds are mutual funds designed to mimic the performance of stock market indices such as the Dow Industrials, the NASDAQ Composite and the S&P 500. As an FI investor you have learned when enough is enough, particularly in terms of your money. In using index funds to invest your capital you are not attempting to beat the market. Instead you are looking for enough of a return to meet your short-term as well as long-term goals while taking as little risk as possible. That is why index funds, with their low fees and ability for diversification, can work well for the FI investment program. At its core, index fund investing means you are using an approach and strategy that seeks to track the investment returns of a specified stock or bond market benchmark or index.

At its core, index fund investing means you are using an approach and strategy that seeks to track the investment returns of a specified stock or bond market benchmark or index. One of the most popular index funds today is the S&P 500 Index Fund, which attempts to replicate the investment results of this specific target index. There is no attempt to use traditional “active” money management or to make “bets” on individual stocks. Indexing is a passive investment approach emphasizing broad diversification and low portfolio trading activity. Low cost is a key advantage of index funds, leaving a larger share of the pie for investors, which is why this choice aligns well for your FI investment plan. Low Fees Are Key Fees, by far, are one of the most overlooked areas in terms of investment decisions. Index funds boast some of the lowest portfolio-management fees in the industry, which is why they are the vehicle of choice for investors looking for value as well as performance.

Post-FI3 you can carefully rearrange your investments, avoiding as much as possible fees for early withdrawal. When you have a choice about where to invest your money, though, choose firms that offer no-load funds, carry no sales fees (loads) and don’t charge 12b-1 fees to cover marketing expenses. Actively Managed Funds or Index Funds? If you can’t figure out which to choose—an actively managed mutual fund or an index fund—no worries. The sharpest minds in the industry seem to favor index funds for people like us. A few examples: Legendary investor Warren Buffett: “Most investors are better off putting their money in low-cost index funds. A very low-cost index is going to beat a majority of the professionally managed money.” Best-selling author Larry Swedroe from his book, What Wall Street Doesn’t Want You to Know: “Regardless of the asset class [see below], use only index or passive asset class funds.


Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager

Asian financial crisis, banking crisis, barriers to entry, beat the dealer, Black-Scholes formula, commodity trading advisor, computer vision, East Village, Edward Thorp, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John Meriwether, John von Neumann, locking in a profit, Long Term Capital Management, margin call, money market fund, Myron Scholes, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K

It can even be WIZARD LESSONS argued that the mere knowledge of the existence of large portfolio insurance sell orders below the market was one of the reasons for the enormous magnitude of the October 19, 1987, decline. Index funds may well provide a current example of this principle. As Lauer explained, index funds originally made a lot of sense for the investor, providing the opportunity to own a representative piece of the market, with presumably lower risk due to the index's diversification, and a low cost structure and favorable tax treatment (due to low turnover). As index funds outperformed the majority of actively managed funds, however, they attracted steadily expanding investment flows. This investment shift, in turn, created more buying for the stocks in the index at the expense of the rest of the market, which helped the index funds outperform the vast majority of individual stocks, attracting still more assets, and so on.

It allows the investor to own a representative piece of the market, with presumably lower risk due to the index's diversification. In addition, because of their low turnover of stock holdings, index funds also offer the benefits of lower management fees and more favorable tax treatment. Frankly, there is nothing wrong with this argument. Indexation, as it was intended, is a reasonable investment strategy. As index funds outperformed the majority of other funds at lower costs, however, they attracted a steadily expanding portion of investment flows. This shift, in turn, created more buying for the stocks in the index at the expense of much of the rest of the market, which helped the index funds outperform the vast majority of individual stocks, and so on. As a result, what started out as a strategy for investors to link their fortunes to the market via an index has been turned on its head, with the index responding to the ever-increasing share of index-linked investment capital.

Thus, we now have a phenomenon of the top fifty stocks in the S&P 500 trading at an average of over fifty times estimated earnings, compared with an average of only about twenty for the remaining 450 stocks in the index, and the high teens for a broaderbased index, such as the Russell 2000. The bottom line is that in the present perverse incentive structure of benchmark-guided portfolios, there is more risk for fund managers in not owning certain grossly overvalued mega-capitalization stocks than in abstaining from them. Including enhanced index funds, such as Fidelity Magellan, the S&P 500 index funds now account for over two-thirds of new equity investments. What happens when the enhanced index funds want to MICHAEL LAUER lighten or liquidate their current positions, which are overwhelmingly concentrated in severely overpriced stocks? Who are they going to sell to? This is an amazingly small community. Only about 25 mutual fund institutions control almost one-third of total equity assets in this country, and every one of those guys knows what the others are doing.


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

activist fund / activist shareholder / activist investor, Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, buy and hold, centralized clearinghouse, clean water, computerized trading, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, fixed income, Flash crash, income inequality, index fund, information asymmetry, invisible hand, Kenneth Arrow, Kickstarter, light touch regulation, London Whale, Long Term Capital Management, moral hazard, Myron Scholes, Northern Rock, passive investing, performance metric, Ponzi scheme, post-work, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

These funds attempt to track the returns and risks of an asset class (as represented by a benchmark such as the S&P 500 or FTSE 100) and make no effort to outperform it. The great advantage of index funds is that they generally charge very low fees.57 Nearly a quarter of all mutual fund assets in the United States are now in index funds, as are about 17 percent in Europe.58 Even in the United Kingdom, a redoubt of active management, the market share of “trackers” recently reached a market record 8.7 percent in 2012, up from 7.4 percent in 2011.59 Many professionals create a “core and satellite” structure, using index funds as the core allocation to any asset class (say, bonds and stocks) and active managers for specialty allocations. USING COLLECTIVE ACTION The popularity of index funds has its own consequences. When large numbers of investors are locked into a list of stocks, portfolio companies receive less robust signals of confidence or discontent through the marketplace.

The amount of each stock within that index will vary with its market capitalization. As of this writing, for example, the largest company, Apple Computer, comprises about 3 percent of the S&P 500 index, while the tenth largest, AT&T, comprises about 1.5 percent. The companies that rank 499th and 500th in the index account for only a few hundredths of a percent. To track accurately, an index fund comprises its portfolio by owning stocks in the same percentages as the index. Index funds are constituted that way because modern portfolio theory says that the market overall is the result of thousands or millions of Warren Buffetts making active, considered decisions. The result, according to the theory, is a market that efficiently prices risk and reward. The market weights of the various stocks are therefore rational and can form the basis of a relatively efficient index.

See International Finance Corporation (IFC) IMF (International Monetary Fund), 163–64 Impartiality, fiduciary duty and, 139 Incentives: executive compensation and, 72–73, 175–76, 245n29 for dishonesty, 144–45 for fiduciaries, 137 for finance industry, 30–31, 33–35, 60, 61, 188 fund management company, 77–78 institutional investors and performance, 112–13 interaction with social and institutional factors, 179–80 regulation and, 133 Income Data Services, 71 Indentures, 18 Index fund managers, stock selection and, 46 Index funds (tracker funds), 57 determination of, 45–46 Individual savings, collective pensions vs., 263n1 Indulgences, 23, 237n8 Information, access to relevant and unbiased, 141, 149–50 Institute for New Economic Thinking, 180, 189 Institutional design, regulation and, 146 Institutional investors: civil society organizations and behavior of, 119–20 corporate governance and, 98 fiduciary duty and, 11, 111–12 financial crisis and, 8 governance and oversight of, 228 improving accountability and, 109–14 ownership and, 3–4, 249n3 reducing number of agents, 58–59 Institutions, 262n51 economic, 183–86 market, 170 political, 183–84 systemic regulation, 141–42.


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, zero-sum game

15 Another fund management firm papered Wall Street with posters showing an angry Uncle Sam putting a rubber stamp across index funds. “Index funds are un-American!” the ad screamed. “Help stamp out index funds.” Even the prudent Bostonians got into the game. My husband’s father, Robert Minturn Sedgwick, happened to be one of those stewards who worked in the Boston asset management industry before and after World War II. During his time as an associate with Scudder, Stevens & Clark, he came to believe (like Bogle and a growing number of others of that generation) that the whole actively managed fund business was basically a scam. The average investor was far better off putting his or her money into what Sedgwick called the “20 largest,” a group of big-cap US stocks that he came up with, which essentially mimicked a modern index fund. He published an article about his idea in the Harvard Business Review and began raising it within his firm.

(Morningstar, the respected purveyor of mutual fund analysis services, basically conceded this point in 2010.)13 A particularly telling recent piece of research done by law academics at Yale and the University of Virginia found that after considering costs, not only did index funds outperform actively managed portfolios by a significant amount, but 16 percent of the time the impact of high fees would actually offset the entire tax benefit of investing in a 401(k) plan for young workers over the course of their careers.14 Investors then and now were better off simply linking their investments to the market via an index fund, an industry that Bogle and others had begun to develop. But active fund management was much more profitable, and the industry worked hard to convince average Joe investors that they needed to pay for professional guidance through this wild world of investing. “You wouldn’t settle for an ‘average’ brain surgeon,” said one index fund critic. “So why would you settle for an ‘average’ mutual fund?”

It’s likely that CSC will use behavioral nudges to get as many eligible people as possible to participate, for instance by making enrollment automatic unless a worker opts out, rather than requiring a sign-up to opt in.45 Participants in CSC would sock away at least 3 percent of their income, most likely in a conservative index fund like an S&P 500 fund, where the pooled money is invested in all 500 stocks in that index. Index funds are considered a simple way to ensure that investors see the same return as the overall stock market—and they’re cheaper, too, since index funds don’t employ stock-picking wizards and charge the related fees. Advocates say that the government role will be to help recruit more people to save, and that costs of such plans will be kept low through efficiencies of scale derived from all those participants, much as happens at some big public employee plans.


pages: 505 words: 142,118

A Man for All Markets by Edward O. Thorp

3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy and hold, buy low sell high, carried interest, Chuck Templeton: OpenTable:, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, Stanford marshmallow experiment, statistical arbitrage, stem cell, stocks for the long run, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

This means if the oil giant Exxon has a market value, computed as share price times number of shares outstanding, of $400 billion and the total market value of all stocks is $10 trillion, then the index fund puts 4 percent of its net worth in Exxon, and so on for all the other stocks. A mutual fund like this that replicates the composition and investment results of a specified pool of securities is called an index fund, and investors who buy such funds are known as indexers. Call any investment that mimics the whole market of listed US securities “passive” and notice that since each of these passive investments acts just like the market, so does a pool of all of them. If these passive investors together own, say, 15 percent of every stock, then “everybody else” owns 85 percent and, taken as a group, their investments also are like one giant index fund. But “everybody else” means all the active investors, each of whom has his own recipe for how much to own of each stock and none of whom has indexed.

To see what might be done, imagine you’re an eighteen-year-old blue-collar worker with no savings and no prospects. What if, somehow, you could save $6 a day and buy shares in the Vanguard S&P 500 Index Fund at the end of each month? If that investment grows in a tax-deferred retirement plan at the long-term average for large stocks of about 10 percent, then after forty-seven years you can retire at age sixty-five with $2.4 million. But where do you find an extra $6 a day? The pack-and-a-half-a-day smoker who kicks his drug habit saves $6 each day. If the construction worker who drinks two $5 six-packs of beer or Coke each day switches to tap water he can save $10 a day, $6 of which he puts in an index fund and $4 of which he spends on healthy food to replace the junk calories from the beer or Coke. Most of us, with greater opportunities to redirect our expenditures, can expect to do better than our poor, young, blue-collar worker.

A calculation shows that in 1.2 million years we would be a solid sphere of flesh with a radius almost as large as that of our galaxy, expanding at the speed of light! How fast do ordinary investments grow? The best simple long-term choice has been a broad common-stock index fund. At the average past growth rate of about 10 percent a year, such an investment has doubled in about 7.3 years. Historically, inflation offset about 3 percent of this, stretching to a little over a decade the average time required to double real buying power. Taxable investors in an index fund, which generates dividends and some realized capital gains, pay government another percent or so annually, delaying the doubling time to about twelve years. To get quick approximate answers to compound interest problems like these, accountants have a handy trick called “the rule of 72.”


Concentrated Investing by Allen C. Benello

activist fund / activist shareholder / activist investor, asset allocation, barriers to entry, beat the dealer, Benoit Mandelbrot, Bob Noyce, business cycle, buy and hold, carried interest, Claude Shannon: information theory, corporate governance, corporate raider, delta neutral, discounted cash flows, diversification, diversified portfolio, Edward Thorp, family office, fixed income, high net worth, index fund, John von Neumann, Louis Bachelier, margin call, merger arbitrage, Paul Samuelson, performance metric, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, survivorship bias, technology bubble, transaction costs, zero-sum game

If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed. It was this “form of self‐deception” as Buffett described it, that nearly destroyed GEICO in the early 1970s.158 Simpson believes that, when considering active management, the base case for an investor must be a passive index fund, for example an S&P 500 index fund, a total market index fund, or a worldwide market index fund. That base case index fund allows an investor to obtain a market return very cheaply, so unless an active manager can add value over and above that index, the investor is better off in the index fund. For active managers as a whole, investing is a zero sum game, less fees and transaction costs, so most active managers won’t do as well as the market because they are the market. Academic studies tend to flatter the active managers due to survivorship bias, which means that because the worst drop out, they aren’t counted.

Illustrating his tendency toward understating his own achievements, Simpson says, “Concentration may be the only way I can add value to the process.”160 Simpson is also skeptical that any investor can add value over a longer period of time by trading vigorously. He doesn’t believe, for example, that the ease of buying and selling exchange traded funds (ETFs) will help most investors because most investors will trade them, and tend to buy when they are high and sell when they are low. He agrees with John Bogle, who prefers index funds to ETFs, not because they’re cheaper—the fees on index funds might be a few basis points more—but because investors are more likely to buy them and put them away. They’re not likely to trade them. The ETF’s big advantage— that they can be traded throughout the entire day—will turn out to be a negative for most investors, including professional investors, because it will make them more likely to trade the ETF for a few percentage points, which won’t work over a long period of time.

As Glenn Greenberg said, Peter Lynch (manager of the Fidelity Magellan Fund during its most successful period, earning truly amazing average annual returns during his tenure) was anything but a concentrated investor, owning a large number of securities in the fund. Furthermore, concentrated investing should only be undertaken by people who are prepared to do intensive research and analysis on their investments. People outside of the investment profession usually don’t have the time to do this, and are far better off with an index fund or finding a competent investment manager— preferably one who employs a focused approach. xi Preface The second caveat is more important, and applies to investment professionals and non-professionals alike (perhaps even more to professionals). It is summed up in an insightful and humbling quote from legendary martial artist Bruce Lee, which is as follows: A goal is not always meant to be reached, it often serves simply as something to aim at.


pages: 120 words: 39,637

The Little Book That Still Beats the Market by Joel Greenblatt

backtesting, index fund, intangible asset, random walk, survivorship bias, transaction costs

There just aren’t that many great managers, and your chances of finding one are quite slim. So that’s why many people just choose to invest in an index fund.27 An index fund is a mutual fund that just tries to equal the overall market’s return, less a very small fee. These funds pick a market index (perhaps the S&P 500 index of 500 large stocks or the Russell 2000 index, an index that consists of 2,000 somewhat smaller stocks) and buy all of the stocks in that particular index. Although this strategy won’t help you beat the market, it will help you achieve returns that are at least close to the market averages.28 Since, after taking into account fees and other costs, most other investment choices leave you with much lower returns than index funds, many people who have carefully studied the issue have concluded that settling for average returns is actually a pretty good alternative.

Let me tell you this much: In the beginning, there were mutual funds, and that was good. But their sales fees and expenses were way too high. Then came no-load funds, which were better. They eliminated the sales fee, but were still burdened with management fees and with the tax and transactional burden that comes from active management. Then came “index funds,” which cut fees, taxes, and transaction costs to the bone. Very, very good. What Joel would have you consider, in effect, is an index-fund-plus, where the “plus” comes from including in your basket of stocks only good businesses selling at low valuations. And he has an easy way for you to find them. Not everyone can beat the averages, of course—by definition. But my guess is that patient people who follow Joel’s advice will beat them over time. And that if millions of people should adopt this strategy (Vanguard: please hurry up and offer a low-priced fund like this), two things will happen.

Market can do anything in the short term, money that you require over the next few years for necessities is best left in the bank. Otherwise, you may be forced to sell to Mr. Market at just the wrong time (for instance, when you need money to cover expenses and a depressed Mr. Market is offering low prices for your shares). 27 Or an exchange-traded fund (ETF), an index fund that trades similar to the way a stock trades. 28 Also, if you are not investing using a tax-free retirement account and taxes are a concern for you, this strategy will minimize the amount of taxes you must pay because index funds typically do not sell their stock holdings unless a particular security is dropped from the index. This is usually less than 10 percent of the securities in the index in any one year. 29 Either a traditional investment retirement account or a Roth IRA. 30 Thereafter making no further contributions of any kind. 31 From investing the maximum allowable $4,000 per year in an IRA over two years and then the increased maximum of $5,000 per year for the following four years equaling $28,000 over the six years. 32 It’s fascinating to note that if you had decided to contribute $5,000 per year for the remaining 24 years of this 30-year period, rather than stopping contributions after just six years as we did in this example, your IRA account would have grown to approximately $16.5 million after 30 years versus the $13.4 million from just those six contributions.


pages: 179 words: 59,704

Meet the Frugalwoods: Achieving Financial Independence Through Simple Living by Elizabeth Willard Thames

"side hustle", Airbnb, asset allocation, barriers to entry, basic income, buy and hold, carbon footprint, delayed gratification, dumpster diving, East Village, financial independence, hedonic treadmill, IKEA effect, index fund, indoor plumbing, loss aversion, McMansion, mortgage debt, passive income, payday loans, risk tolerance, Stanford marshmallow experiment, universal basic income, working poor

Many employers offer the ability to contribute to your 401(k) directly from your paycheck, so you never even see the money or have the chance to consider spending it. It’s a great way to force/motivate yourself to save. Investments in the form of low-fee index funds. This is where the bulk of my cash hangs out. Index funds are, in my opinion, the best way to invest because the fees are low, you can manage them yourself, and they often outperform actively managed funds. Index funds are also ideal because they’re a heavily diversified way to invest, since you’re invested across the entire market. But the real win with index funds is their absence of high fees, which are what you’ll encounter with a portfolio manager and what will cripple your net worth in the long run. The reason to invest in the market, as opposed to keeping all of your money in a checking or savings account, is that investing is how you build wealth.

This is an oversimplification of investing, and there are other variables such a rebalancing and asset allocation, as well as decreasing your exposure to risk as you near traditional retirement age, but this is the basic gist. If you want to grow your wealth, you need to avail yourself of the stock market. Investing in low-fee index funds is as straightforward as any other facet of online banking, and you can set up an account online by yourself in minutes. You will need to select a brokerage that offers low-fee index funds, and then you will need to set up an account and transfer over some money to get started. In order to remove human error and the very human temptation to time the market, I simply invest money every month. Our account is set up to automatically invest a specified amount of money every month, so that we’re constantly adding to our investments without concerning ourselves over what the market happens to be doing at a particular moment in time.

Plus, when you’re paying off a car loan or other debt with interest, your money is compounding in your creditor’s favor. When you instead invest that money in low-fee index funds, for example, your money is working for you and compounds in your favor. And it doesn’t take all that much money to yield substantial dividends in the future. Since I’ve already gone there, let’s do another example with real numbers. For this exercise, I’m going to use cable television, which has to be my all-time favorite budget scapegoat. Here’s the premise: Would you rather watch TV or have $91,000? Permit me to explain. Let’s say you spend $75 a month on cable. I’ll grant you that doesn’t sound like a huge amount of money on its own. But multiplied by twelve months, that’s $900 a year on television. Now, let’s say you instead invested that $900 in low-fee index funds and realized a 7 percent return, which is considered an average annual market return over the long term.


pages: 244 words: 79,044

Money Mavericks: Confessions of a Hedge Fund Manager by Lars Kroijer

activist fund / activist shareholder / activist investor, Bernie Madoff, capital asset pricing model, corporate raider, diversification, diversified portfolio, family office, fixed income, forensic accounting, Gordon Gekko, hiring and firing, implied volatility, index fund, intangible asset, Jeff Bezos, Just-in-time delivery, Long Term Capital Management, merger arbitrage, NetJets, new economy, Ponzi scheme, post-work, risk-adjusted returns, risk/return, shareholder value, Silicon Valley, six sigma, statistical arbitrage, Vanguard fund, zero-coupon bond

Instead of enriching the many layers of financial advisers and principals, Mr Straw should simply have put his money in Treasury bonds, and slept easily at night (particularly as his retirement date was fast approaching) or a stock-market index fund if he wanted market exposure. But wouldn’t Mr Straw be quite upset with the company canteen folks if they forced him to pay this kind of price premium for a slightly more exotic-sounding and tasting fruit as part of his standard company lunch? The example described needs one further explanation. Namely, how did the hedge fund generate its 10 per cent return? If the hedge fund was just long the Standard & Poor’s 500 index and that index was up 10 per cent for the year, Mr Straw would have paid large fees for very little additional value. He could just have bought a Vanguard index fund and paid 0.2 per cent in total fees, not 7 per cent (although he might not be able to avoid some pension-fund costs to gain tax advantages).

As far as I have been able to find out, there are few money-management firms that do the kind of investing described above. When I asked a former professor of mine at HBS, he said that for whatever reason the world does not seem to value this kind of investing very highly. Increasing amounts of money are invested in index funds like Vanguard, but taking that a step further and picking broad arrays of indices has, for whatever reason, not been something a lot of people do or are willing to pay a lot for. This is probably because anyone who can convince people to let them manage their money would prefer to claim higher fees for doing so, and would not want clients to allocate money to an index-fund product that might charge a mere 0.2 per cent per year or less. There is more money to be made from active management or convincing people to invest in more fancy products like hedge funds or private equity.

Although the portfolio would not be static, there would be fairly little trading and the costs and fees could be kept very low as a result – besides, it is fairly cheap to buy whole markets through ETFs, index funds or futures. The arguments in this section are based on the premise of what an investor that does not have edge in the markets should do. This does not mean that edge does not exist – I’m on the board of a few hedge funds that I certainly believe have edge in the market, and they are well worth their fees as a result. After making my own scepticism about the high levels of fees floating around the financial system clear to anyone who cares to listen (and many that don’t), I often get asked how I think people should be investing their money. The above may sound like financial mumbo-jumbo, but it is eminently practicable in the real world – sort of a real and practical adapted version of a capital asset pricing model (CAPM). You buy a portfolio of world stock-index funds, corporate and government debts, and do so in the cheapest way, while trying to tax-optimise and adjust your gearing level.


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, business cycle, butter production in bangladesh, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, stocks for the long run, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

Chapter 8 - Connectedness and Chaotic Price Movements Insider Trading and Subterranean Information Processing Trading Strategies, Whim, and Ant Behavior Chaos and Unpredictability Extreme Price Movements, Power Laws, and the Web Economic Disparities and Media Disproportions Chapter 9 - From Paradox to Complexity The Paradoxical Efficient Market Hypothesis The Prisoner’s Dilemma and the Market Pushing the Complexity Horizon Game Theory and Supernatural Investor/Psychologists Absurd Emails and the WorldCom Denouement Bibliography Index Copyright Page Also by John Allen Paulos Mathematics and Humor (1980) I Think Therefore I Laugh (1985) Innumeracy: Mathematical Illiteracy and its Consequences (1988) Beyond Numeracy: Ruminations of a Numbers Man (1991) A Mathematician Reads the Newspaper (1995) Once Upon a Number: The Hidden Mathematical Logic of Stories (1998) To my father, who never played the market and knew little about probability, yet understood one of the prime lessons of both. “Uncertainty,” he would say, “is the only certainty there is, and knowing how to live with insecurity is the only security.” 1 Anticipating Others’ Anticipations It was early 2000, the market was booming, and my investments in various index funds were doing well but not generating much excitement. Why investments should generate excitement is another issue, but it seemed that many people were genuinely enjoying the active management of their portfolios. So when I received a small and totally unexpected chunk of money, I placed it into what Richard Thaler, a behavioral economist I’ll return to later, calls a separate mental account. I considered it, in effect, “mad money.”

Studying the market wasn’t nearly as engaging as doing mathematics or philosophy or watching the Comedy Network. Thus, taking Keynes literally and not having much confidence in my judgment of popular taste, I refrained from investing in individual stocks. In addition, I believed that stock movements were entirely random and that trying to outsmart dice was a fool’s errand. The bulk of my money therefore went into broad-gauge stock index funds. AWC, however, I deviated from this generally wise course. Fathoming the market, to the extent possible, and predicting it, if at all possible, suddenly became live issues. Instead of snidely dismissing the business talk shows’ vapid talk, sports-caster-ish attitudes, and empty prognostication, I began to search for what of substance might underlie all the commentary about the market and slowly changed my mind about some matters.

Is the “double-dip” recession discussed in early 2002 simply a double bottom? Predictability and Trends I often hear people swear that they make money using the rules of technical analysis. Do they really? The answer, of course, is that they do. People make money using all sorts of strategies, including some involving tea leaves and sun-spots. The real question is: Do they make more money than they would investing in a blind index fund that mimics the performance of the market as a whole? Do they achieve excess returns? Most financial theorists doubt this, but there is some tantalizing evidence for the effectiveness of momentum strategies or short-term trend-following. Economists Narasimhan Jegadeesh and Sheridan Titman, for example, have written several papers arguing that momentum strategies result in moderate excess returns and that, having done so over the years, their success is not the result of data mining.


pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low cost airline, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, stocks for the long run, survivorship bias, the market place, transaction costs, Y2K, yield curve, zero-sum game

I’m not talking about a traditional tactical asset allocation (TAA). Rather, I am talking about a somewhat intermediate step between SAA and TAA. Call it cyclical asset allocation (CAA). Such a strategy emphasizes different asset classes as well as activeversus-passive management, as cycles dictate. When markets do not provide much in terms of selection opportunities for securities, the index fund is a cost-efficient tool with which to access broad market moves. But, market efficiency has cycles, too. Correspondingly, reallocating index funds is another source of value that can be added through the asset-allocation process. There is a time for everything. There is a time for active management and a time for passive management; a time for value stocks and a time for growth stocks; a time for large-caps and a time for small-caps. Constructing major stock indices provides an excellent illustration of this.

Given our portfolio’s 40 percent allocation to fixed income, it follows we allocate 4 percent to short-term instruments and 36 percent to longer-maturity instruments. (We could further disaggregate the longer-term fixed-income instruments into a global allocation, but for this exercise, we stay domestic.) Figure 6.3 illustrates the SAA produced by my interpretation of the various asset classes’ market weights. Either exchange-traded funds (ETFs), or passively managed low-cost index funds, could fill most buckets in question. ETFs and the low cost-managed index funds are diversified baskets of securities designed to track the performance of well-known indices, proprietary indices or basket of securities. The major differences between the two is that the ETF are traded as individual stocks on major exchanges while the passive funds are subject to the traditional mutual funds-pricing mechanism (that is, at the close of market).

If taxes and governmental regulations rise, what does that mean for bonds? A forward-looking view one can tie together such important variables is critical to the asset-allocation process. But, the process needs to differentiate itself in two additional ways: The first way has to do with the versatility of the framework. The second way has to do with actively using passive vehicles (also known as index funds). xix When I talk about the framework’s versatility, I mean the assetallocation model can be changed to find opportunity. For example, I do not view the nontraditional sector as the hedge fund’s exclusive domain. To me, it is a place for any investment decision that does not correlate with traditional capital-market indices but does have value. This sector can include hedge funds, but it can also include investments in discounted closed-end funds and industry-sector funds, or specific securities representing good long-term value.


pages: 463 words: 105,197

Radical Markets: Uprooting Capitalism and Democracy for a Just Society by Eric Posner, E. Weyl

3D printing, activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Airbnb, Amazon Mechanical Turk, anti-communist, augmented reality, basic income, Berlin Wall, Bernie Sanders, Branko Milanovic, business process, buy and hold, carbon footprint, Cass Sunstein, Clayton Christensen, cloud computing, collective bargaining, commoditize, Corn Laws, corporate governance, crowdsourcing, cryptocurrency, Donald Trump, Elon Musk, endowment effect, Erik Brynjolfsson, Ethereum, feminist movement, financial deregulation, Francis Fukuyama: the end of history, full employment, George Akerlof, global supply chain, guest worker program, hydraulic fracturing, Hyperloop, illegal immigration, immigration reform, income inequality, income per capita, index fund, informal economy, information asymmetry, invisible hand, Jane Jacobs, Jaron Lanier, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, labor-force participation, laissez-faire capitalism, Landlord’s Game, liberal capitalism, low skilled workers, Lyft, market bubble, market design, market friction, market fundamentalism, mass immigration, negative equity, Network effects, obamacare, offshore financial centre, open borders, Pareto efficiency, passive investing, patent troll, Paul Samuelson, performance metric, plutocrats, Plutocrats, pre–internet, random walk, randomized controlled trial, Ray Kurzweil, recommendation engine, rent-seeking, Richard Thaler, ride hailing / ride sharing, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Rory Sutherland, Second Machine Age, second-price auction, self-driving car, shareholder value, sharing economy, Silicon Valley, Skype, special economic zone, spectrum auction, speech recognition, statistical model, stem cell, telepresence, Thales and the olive presses, Thales of Miletus, The Death and Life of Great American Cities, The Future of Employment, The Market for Lemons, The Nature of the Firm, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade route, transaction costs, trickle-down economics, Uber and Lyft, uber lyft, universal basic income, urban planning, Vanguard fund, women in the workforce, Zipcar

This means that there is little point in stock-picking in the first place, certainly for amateur investors.14 “Behavioral finance” holds that ordinary investors often act irrationally.15 All this theory exhorted investors to simply diversify while paying as little as possible to dishonest money managers who claim to be able to “beat the market.” The cheapest way to do this is via low-cost mutual funds (especially index funds) that track broad market indices. A mutual fund is a portfolio of stocks that may have an industry focus (e.g., energy) or a strategy (e.g., growth). An index fund (which is a type of mutual fund) holds a portfolio of stocks designed to exactly mimic the index of interest (e.g., S&P 500). Beginning in the 1970s, a huge demand developed for such funds, in part because of the shift of pension savings into the stock market spurred by various government reforms and in part because governments, persuaded by financial theory, encouraged investors to park their savings in such low-cost, diversified funds.

Beginning in the 1970s, a huge demand developed for such funds, in part because of the shift of pension savings into the stock market spurred by various government reforms and in part because governments, persuaded by financial theory, encouraged investors to park their savings in such low-cost, diversified funds. The overall effect was that institutional investors, which controlled these funds, became the largest owners, and thus the largest controllers (at least in principle), of the major corporations. Who are the institutional investors, anyway? They include companies that manage mutual funds and index funds, asset managers, and other firms that buy and hold equities on behalf of their customers. The largest names are those we mentioned above: Vanguard, BlackRock, State Street, and Fidelity. Index fund operations are relatively mechanical, so their costs are low; today they comprise probably less than a quarter of the offerings of institutional investors.16 Figure 4.2 displays the growth of the fraction of the US public stock market controlled by institutional investors. The control of institutional investors has risen dramatically, starting roughly in 1980 at about 4% control and leveling out around the Great Recession at 26%.

The key features of these investors, which keep them “boring,” is that they are diversified and many of their investments are held somewhat passively. Diversification means that they own stock in a wide range of companies rather than in any one company or group of similar companies. Passivity means that they do not frequently buy and sell stocks, but instead mostly hold onto them. They also often manage the assets that are technically owned by workers and other ordinary people. Vanguard has been rightly praised for pioneering low-cost index funds, which enable workers to diversify their retirement savings and avoid the hazards of stock-picking. These features give the impression that these institutions play no active role in guiding the economy. Yet economic research suggests that diversified institutional investors have harmed a wide range of industries, raising prices for consumers, reducing investment and innovation, and potentially lowering wages.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, business cycle, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

Or at least they felt safer than they would have navigating among tens of thousands of small investment managers with complicated strategies. However, I think the biggest perceived problem in the IGT world would have been a lack of basic fairness. There are problems in index funds, but people like that any individual can get the average return of the market, without much expense or effort. All the slick people trying to do better, do worse as a group. If some make money, others lose it, and neither the winners nor the losers hurt the index fund investor (but both pay more fees, expenses, and taxes than the index fund investor). This fairness helps generate the social support for the financial system. In the IGT world, people would have hated Wall Street for the reasons they used to—that it was a bunch of sharpies playing with other people’s money and doing no social good—rather than the current reasons—that it wrecked the economy and used huge bailout funds to pay obscene bonuses.

Belief in MPT CAPM helped make the markets more efficient cross-sectionally; that is, returns on different asset classes over the same time periods aligned pretty well with their respective risk levels. But, at least arguably, MPT CAPM contributed toward prices diverging from fundamental value. Index fund investors don’t ask what something is worth; they want to hold it in proportion to its price. Among other things, it guarantees that they are overinvested in anything overpriced, and underinvested in anything underpriced. It may be impossible to tell overpriced assets from underpriced ones, but that doesn’t matter; it’s a mathematical certainty the index fund investor has the worst of both worlds. (Of course, as Ken French and John Bogle independently pointed out to me, half the nonindex investors must be even more overweighted in the overpriced assets, and all the nonindex investors pay higher costs.)

What if IGT had been the dominant theory instead, and had encouraged the growth of hedge funds while discouraging index funds and other highly diversified investments? We can imagine the Securities and Exchange Commission insisting that investment managers know a lot about the securities they buy, not just buy everything available at the asking price. Other regulators might insist that professional managers provide rigorous oversight and demonstrate that their strategies didn’t exacerbate bubbles and crashes. In fact, things like these have happened over the years, but not due to IGT or any other comprehensive theory. They were reactions to market events caused in part by MPT-based investment techniques. We had bubbles and crashes long before we had MPT or index funds, so they cannot be the main cause. It is undoubtedly active investors who trigger these events.


pages: 202 words: 62,901

The People's Republic of Walmart: How the World's Biggest Corporations Are Laying the Foundation for Socialism by Leigh Phillips, Michal Rozworski

Berlin Wall, Bernie Sanders, call centre, carbon footprint, central bank independence, Colonization of Mars, combinatorial explosion, complexity theory, computer age, corporate raider, decarbonisation, discovery of penicillin, Elon Musk, G4S, Georg Cantor, germ theory of disease, Gordon Gekko, greed is good, hiring and firing, index fund, Intergovernmental Panel on Climate Change (IPCC), Internet of things, inventory management, invisible hand, Jeff Bezos, Joseph Schumpeter, linear programming, liquidity trap, mass immigration, Mont Pelerin Society, new economy, Norbert Wiener, oil shock, passive investing, Paul Samuelson, post scarcity, profit maximization, profit motive, purchasing power parity, recommendation engine, Ronald Coase, Ronald Reagan, sharing economy, Silicon Valley, Skype, sovereign wealth fund, strikebreaker, supply-chain management, technoutopianism, The Nature of the Firm, The Wealth of Nations by Adam Smith, theory of mind, transaction costs, Turing machine, union organizing

And so, as capitalism heaves from boom to bust, its managers switch from plans for prosperity to plans for surviving a crisis, all of them contested and imperfectly implemented. Communism by Index Fund? Contemporary capitalism is ever more tightly integrated through the financial system. What do we mean by integration? Well, for instance, the chance that any two firms in the broad S&P 1500 index of the US stock market have a common owner that holds at least 5 percent of shares in both is today a stunning 90 percent. Just twenty years ago, the chance of finding this kind of common ownership was around 20 percent. And index funds (which invest money passively), pension funds, sovereign wealth funds, and other gargantuan pools of capital all bind economic actors still closer together via their enormous pools of money.

Big institutional investors and passive investment funds, on the other hand, move entire sectors toward concentration that looks much more like monopoly—with handy profits, as firms have less reason to undercut one another. The result is a very capitalist sort of planning. This unseemly situation led Bloomberg business columnist Matt Levine to ask, in the title of a remarkable 2016 article, “Are Index Funds Communist?” Levine imagines a slow transition from today’s index funds, which use simple investing strategies, through a future where investing algorithms become better and better, until “in the long run, financial markets will tend toward perfect knowledge, a sort of central planning—by the Best Capital Allocating Robot.” For him, capitalism may end up creating its own gravediggers—except they will be algorithms, not workers.

Other titles in this series available from Verso Books: Utopia or Bust by Benjamin Kunkel Playing the Whore by Melissa Gira Grant Strike for America by Micah Uetricht The New Prophets of Capital by Nicole Aschoff Four Futures by Peter Frase Class War by Megan Erickson Building the Commune by George Ciccariello-Maher Capital City by Samuel Stein The People’s Republic of Walmart How the World’s Biggest Corporations Are Laying the Foundation for Socialism LEIGH PHILLIPS AND MICHAL ROZWORSKI First published by Verso 2019 © Leigh Phillips and Michal Rozworski 2019 All rights reserved The moral rights of the authors have been asserted 1 3 5 7 9 10 8 6 4 2 Verso UK: 6 Meard Street, London W1F 0EG US: 20 Jay Street, Suite 1010, Brooklyn, NY 11201 versobooks.com Verso is the imprint of New Left Books ISBN-13: 978-1-78663-516-7 ISBN-13: 978-1-78663-517-4 (UK EBK) ISBN-13: 978-1-78663-518-1 (US EBK) British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record for this book is available from the Library of Congress Typeset in Monotype Fournier Printed in the US by Maple Press CONTENTS Acknowledgements 1.Introduction 2.Could Walmart Be a Secret Socialist Plot? 3.Islands of Tyranny 4.Mapping the Amazon 5.Index Funds as Sleeper Agents of Planning 6.Nationalization Is Not Enough 7.Did They Even Plan the Soviet Union? 8.Hardly Automated Space Communism 9.Allende’s Socialist Internet 10.Planning the Good Anthropocene 11.Conclusion: Planning Works ACKNOWLEDGEMENTS The idea for this book was born of a beer or three at a scruffy Gastown pub early on in our friendship. Sharing our frustrations about the absence of democratic planning from political debate, we quickly realized that we were both thinking of writing the very same book.


pages: 222 words: 70,559

The Oil Factor: Protect Yourself-and Profit-from the Coming Energy Crisis by Stephen Leeb, Donna Leeb

Buckminster Fuller, buy and hold, diversified portfolio, fixed income, hydrogen economy, income per capita, index fund, mortgage debt, North Sea oil, oil shale / tar sands, oil shock, peak oil, profit motive, reserve currency, rising living standards, Ronald Reagan, shareholder value, Silicon Valley, Vanguard fund, Yom Kippur War, zero-coupon bond

In the discussion a few paragraphs above, where we contrasted a buy-and-hold strategy with an oil indicator strategy and saw our return double, the results were based on buying and selling “the market.” And this was not in any way a mere theoretical exercise: it is entirely possible to buy and sell “the market” by investing in index funds that include all the stocks in particular market indices. In our comparisons, we assumed you were buying and selling the Vanguard 500 Index Fund, which is a no-load fund that can be purchased through the Vanguard Group. But while index funds are a convenient way to showcase our oil indicator’s performance, they won’t be good investments in the years ahead, and when oil flashes a positive signal, we don’t suggest that you buy “the market.” That’s because, as we explain later, we believe that oil prices have embarked upon a long-term uptrend.

As energy prices rise, the industry’s woes will multiply. A few airlines will survive, and there may be some new entrants and some consolidations, but we think the industry is doomed to struggle fiercely to very little avail. One final category of things to avoid should be obvious given our projections of rough sledding ahead for the general run of stocks. In the 1990s some of the most popular investments were the index funds, such as the enormously successful Vanguard 500 Index Fund. It was the perfect choice for scads of investors, who no doubt felt they had discovered the Holy Grail—a one-shot investment in a highly diversified group of safe big-cap stocks that seemed capable of returning annual gains of 20 percent or more year after year. But the fund began to turn sour in 2000 and will continue to produce unsatisfactory returns for a while to come.

As noted above, though, it quickly became clear that Saddam lacked the ability to cripple oil production. And as oil prices collapsed back to the high teens, the recession ended. Stocks once again embarked upon a bull run—and this one was to be a bull run for the ages. Between 1991 and 2000, with oil prices remaining well under control, stocks staged one of the greatest rallies any financial market has ever seen. If you had invested in the S&P 500, say, by buying the Vanguard 500 Index Fund, in January 1991, you would have gained on average 20 percent a year for the next nine years. To put it differently, a $10,000 investment would have turned into more than $50,000. And because those nine years were ones of low inflation, your gains were mostly real gains in terms of their actual purchasing power. Moreover, as everyone knows, while the market as a whole was thriving, the tech sector, especially as the decade drew to a close, was on a real tear.


pages: 209 words: 53,236

The Scandal of Money by George Gilder

Affordable Care Act / Obamacare, bank run, Bernie Sanders, bitcoin, blockchain, borderless world, Bretton Woods, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, Claude Shannon: information theory, Clayton Christensen, cloud computing, corporate governance, cryptocurrency, currency manipulation / currency intervention, Daniel Kahneman / Amos Tversky, Deng Xiaoping, disintermediation, Donald Trump, fiat currency, financial innovation, Fractional reserve banking, full employment, George Gilder, glass ceiling, Home mortgage interest deduction, index fund, indoor plumbing, industrial robot, inflation targeting, informal economy, Innovator's Dilemma, Internet of things, invisible hand, Isaac Newton, Jeff Bezos, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, Law of Accelerating Returns, Marc Andreessen, Mark Zuckerberg, Menlo Park, Metcalfe’s law, money: store of value / unit of account / medium of exchange, mortgage tax deduction, obamacare, Paul Samuelson, Peter Thiel, Ponzi scheme, price stability, Productivity paradox, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, Ray Kurzweil, reserve currency, road to serfdom, Robert Gordon, Robert Metcalfe, Ronald Reagan, Sand Hill Road, Satoshi Nakamoto, Search for Extraterrestrial Intelligence, secular stagnation, seigniorage, Silicon Valley, smart grid, South China Sea, special drawing rights, The Great Moderation, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Tim Cook: Apple, time value of money, too big to fail, transaction costs, trickle-down economics, Turing machine, winner-take-all economy, yield curve, zero-sum game

They are a net positive force in the economy, but most of them contribute comparatively little of the innovation that yields real economic growth, jobs, and learning. With little access to the venture capital or private equity game, the public at large is counseled to invest its money in “index funds.” These yield no more knowledge and learning than the state lotteries do. Purchasing a sampling of all the stocks in the market without any research on specific companies, indexers give the public some exposure to the gains of the inside-trading conglomerateurs. But they provide less than no benefit to the learning processes that create growth and wealth. Index funds are parasites on the research done by actual investors. Index funds are even worse than they look because they base allocation not on the expected yield of the investment but on market capitalization. As companies grow overvalued, they become an ever-larger share of the holdings of the funds.

Momentum prevails until it stops. But as the economist Charles Gave of Gavekal puts it, “In a true capitalist system, the rule is the higher the price the lower the demand. With indexation, the higher the price, the higher the demand. This is insane.”3 Yet as pioneered by the laureled John Bogle at Vanguard and encouraged by the SEC’s insider-trading phobias, these parasitical and distortionary index funds directly extinguish knowledge and learning in the economy.4 Vanguard now passively “manages” some $2.9 trillion of assets while contributing nothing to the investment process. Rather than investing in the market, they parasitically infest and congest it. Rather than creating wealth and jobs, they destroy them. Dwarfing all positive investment by “inside traders” and knowledge brokers are the financial power brokers in the major banks.

Through Wall Street, Silicon Valley provides Main Street with opportunities for sharing in the equity of the ascendant sectors of the world economy. In recent years, Silicon Valley has suffered from the HYPERTROPHY OF FINANCE, become bloated with MONOPOLY MONEY, and been bent by controls from the Wall Street–Washington axis. Like Wall Street, Silicon Valley has bypassed Main Street, which has remained trapped in its pedestrian time-based compensation and mindless index fund investments. Sand Hill Road: The arboreal abode of California venture capitalists and their “unicorns,” stretching from the Camino Real near Stanford to Route 280 and into the clouds and wealth of Woodside and SILICON VALLEY. Expansionary fiscal and monetary policy: The attempt by central banks to stimulate economic activity by selling government securities to pay for a governmental deficit.


pages: 209 words: 53,175

The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel

"side hustle", airport security, Amazon Web Services, Bernie Madoff, business cycle, computer age, coronavirus, discounted cash flows, diversification, diversified portfolio, Donald Trump, financial independence, Hans Rosling, Hyman Minsky, income inequality, index fund, invisible hand, Isaac Newton, Jeff Bezos, Joseph Schumpeter, knowledge worker, labor-force participation, Long Term Capital Management, margin call, Mark Zuckerberg, new economy, Paul Graham, payday loans, Ponzi scheme, quantitative easing, Renaissance Technologies, Richard Feynman, risk tolerance, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Stephen Hawking, Steven Levy, stocks for the long run, the scientific method, traffic fines, Vanguard fund, working-age population

Did I beat the market? I’m not sure. Like most who try, I didn’t keep a good score. Either way, I’ve shifted my views and now every stock we own is a low-cost index fund. I don’t have anything against actively picking stocks, either on your own or through giving your money to an active fund manager. I think some people can outperform the market averages—it’s just very hard, and harder than most people think. If I had to summarize my views on investing, it’s this: Every investor should pick a strategy that has the highest odds of successfully meeting their goals. And I think for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success. That doesn’t mean index investing will always work. It doesn’t mean it’s for everyone. And it doesn’t mean active stock picking is doomed to fail.

Over the years I came around to the view that we’ll have a high chance of meeting all of our family’s financial goals if we consistently invest money into a low-cost index fund for decades on end, leaving the money alone to compound. A lot of this view comes from our lifestyle of frugal spending. If you can meet all your goals without having to take the added risk that comes from trying to outperform the market, then what’s the point of even trying? I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one. When I think of it that way, the choice to buy the index and hold on is a no-brainer for us. I know not everyone will agree with that logic, especially my friends whose job it is to beat the market. I respect what they do. But this is what works for us. We invest money from every paycheck into these index funds—a combination of U.S. and international stocks. There’s no set goal—it’s just whatever is leftover after we spend.

The share of Americans over age 25 with a bachelor’s degree has gone from less than 1 in 20 in 1940 to 1 in 4 by 2015.⁷ The average college tuition over that time rose more than fourfold adjusted for inflation.⁸ Something so big and so important hitting society so fast explains why, for example, so many people have made poor decisions with student loans over the last 20 years. There is not decades of accumulated experience to even attempt to learn from. We’re winging it. Same for index funds, which are less than 50 years old. And hedge funds, which didn’t take off until the last 25 years. Even widespread use of consumer debt—mortgages, credit cards, and car loans—did not take off until after World War II, when the GI Bill made it easier for millions of Americans to borrow. Dogs were domesticated 10,000 years ago and still retain some behaviors of their wild ancestors. Yet here we are, with between 20 and 50 years of experience in the modern financial system, hoping to be perfectly acclimated.


pages: 117 words: 31,221

Fred Schwed's Where Are the Customers' Yachts?: A Modern-Day Interpretation of an Investment Classic by Leo Gough

Albert Einstein, banking crisis, Bernie Madoff, corporate governance, discounted cash flows, diversification, fixed income, index fund, Long Term Capital Management, Northern Rock, passive investing, Ralph Waldo Emerson, random walk, short selling, South Sea Bubble, The Nature of the Firm, the rule of 72, The Wealth of Nations by Adam Smith, transaction costs, young professional

For example, between 2000 and 2003 US shares lost an inflation-adjusted 6.8% a year, even though they gained 6.5% a year between 1900 and 2007. HERE’S AN IDEA FOR YOU… Although the idea of index investing makes a lot of sense, there are some potential problems. Some indices might be driven up to artificially high prices, followed by a crash, so you need to keep your eye on what is happening in the index fund market. And if the Western economies are going to go downhill in the course of a ‘hegemonic shift’ towards Asia, as some people like to predict, then the big US and UK indices may not perform very well in the future. Lastly, there are already some daft index funds that try to do a bit of active management at the same time – that’s not the point, so avoid them. 28 DON’T INVEST ON A HIGH ‘The habit of buying popular shares works for bad results … It must tend to get the buyer in nearer the top than the middle.’ What could be stupider than buying high and selling low?

People who live much longer than expected make a profit, but it’s probably better to keep control of your wealth and manage it on your own – the upside potential is better. 27 INDEX INVESTING ‘Admittedly, it is preposterous to suggest that stock speculation is like coin flipping. I know that there is more skill in stock speculation. What I have never been able to determine is – how much more?’ DEFINING IDEA… Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. ~ WARREN BUFFETT, 1996 In chapter 13 the idea of index investing was mentioned. In the US this approach has become very widely used, with hundreds of billions of dollars going into special funds, known as tracker funds, which mimic one of the major indices, such as the NYSE or the S&P 500. It is quite telling that some 40% of institutional funds in the US, and slightly less in the UK, now goes into tracker funds.

Let’s divide them into four: young adulthood, building a family, middle age and retirement. Young adulthood: people in their twenties naturally have a big appetite for life but usually are earning less than they will later on. Many people at this stage tend to spend too easily. There is a danger of getting into debt. On the other hand, any sound long term investment is likely to grow substantially. Try contributing a small sum each month to an index fund. Building a family: if you are starting a family, your expenditure is likely to have increased dramatically. Purchasing a home is an important form of long term saving. You also need to start planning for retirement. Middle age: by this time many people have got some equity in their homes and are at the top of their career and earning power. Now is the time to put as much money as possible into your investments and pension scheme, if you have one.


Triumph of the Optimists: 101 Years of Global Investment Returns by Elroy Dimson, Paul Marsh, Mike Staunton

asset allocation, banking crisis, Berlin Wall, Bretton Woods, British Empire, buy and hold, capital asset pricing model, capital controls, central bank independence, colonial rule, corporate governance, correlation coefficient, cuban missile crisis, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, European colonialism, fixed income, floating exchange rates, German hyperinflation, index fund, information asymmetry, joint-stock company, negative equity, new economy, oil shock, passive investing, purchasing power parity, random walk, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, stocks for the long run, survivorship bias, technology bubble, transaction costs, yield curve

Institutions have a research edge that is denied to most people. When investors are concerned that they do not have the skill to beat the market, there is an obvious response— buy index funds. The incremental risk of running an active strategy adds relatively little to equity portfolio volatility, however. So institutions that wish to play the investment game to win need not follow our focus on index investment, and may apply our findings to actively managed portfolios as well. Treynor and Black (1973) approach investment management as a task in which a high-risk overlay (the “active portfolio”) is blended with a low cost, highly diversified index fund (the “passive portfolio”). The active portfolio comprises a decision to hold more-than-index weightings in securities that are perceived to be undervalued, plus a decision to hold lessthan-index weightings (or even have a short position) in securities that are perceived to be overvalued.

For equity investors to have beaten bond investors, it would often have been necessary to have an investment horizon of forty years or more. We discuss some of the investment implications of our findings. We emphasize how we should alter our judgments in the light of a reduced estimate for the future equity risk premium. There are strong inferences that can be drawn about the role for active management, the case for index funds, levels of management fees, tax management, asset allocation, international diversification, and strategies for exploiting anomalies and regularities. Chapter 14 summarizes the implications of our research for investors and investment institutions. In chapter 15 we extend this discussion to the cost of capital and the impact of an attenuated equity premium on real investment decisions. We express a concern that companies may themselves be seeking too high a rate of return, and if so, that they run the risk of underinvesting.

In the United Kingdom, it has been noted that the stock market has become more concentrated recently, and that the biggest companies have grown so large that they dominate the index. This has raised a regulatory concern, since UK mutual funds are not permitted to hold more than 10 percent in a single stock. At start-2001, at least one company, Vodafone, had a weighting of 11 percent in the FTSE 100 Index of the largest 100 UK stocks, while its weighting exceeded 9 percent even in the FTSE All-Share Index. This raised an intriguing issue, namely, that an index fund in one of the world’s largest equity markets could be prohibited by the regulators from holding the index portfolio. Figure 2-4 shows how the United Kingdom compares with other countries. This chart shows the weighting at start-2001 of the largest, and the three largest, stocks, in each of the sixteen countries covered by our database, plus Finland. Countries are ranked from the least concentrated on the left to the most concentrated on the right.


pages: 267 words: 71,941

How to Predict the Unpredictable by William Poundstone

accounting loophole / creative accounting, Albert Einstein, Bernie Madoff, Brownian motion, business cycle, butter production in bangladesh, buy and hold, buy low sell high, call centre, centre right, Claude Shannon: information theory, computer age, crowdsourcing, Daniel Kahneman / Amos Tversky, Edward Thorp, Firefox, fixed income, forensic accounting, high net worth, index card, index fund, John von Neumann, market bubble, money market fund, pattern recognition, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, Rubik’s Cube, statistical model, Steven Pinker, transaction costs

A line on the company’s website once ran, “Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark.” Another rule of thumb is never invest in anything you don’t understand. Though the sentiment is laudable, it’s unrealistic in today’s complex financial universe. Some people don’t truly “understand” money market accounts or index funds. Should they keep their money in a mattress? In any case, someone investing with a miracle-working manager should not expect a complete explanation of how he makes the money. That’s the secret sauce. Madoff’s investors believed he had achieved annual returns of something like 10 percent a year with low volatility, and had done so over an otherwise volatile decade. Despite what you may have heard, this wasn’t too good to be true.

When a company’s earnings are growing rapidly, its PE is usually high, and this might make sense. When a company is in a declining industry or has financial problems, its PE may be low, and this also could be reasonable. You can compute PE ratios for an entire market index like the FTSE 100 (of the hundred most valuable companies on the London Stock Exchange) or the S&P 500 (the S&P 500 index covers the broad American stock market, and there are scores of index funds tracking it). The FTSE 100 dates back to 1984. Its median PE has been about 19. It has varied wildly, though. It has topped 30; other times it’s been in the single digits. The American indices show similar variation. This doesn’t make sense. The FTSE 100 is all of Britain’s big companies averaged together. Even in boom times, the whole index can hardly merit the valuation of a growth stock. In the worst of times, it doesn’t deserve the low PEs of a doomed company.

Someone who wants to get the most value from the PE’s predictive power needs to be willing to sell as well as buy. Let’s look at ways to do that. Warren Buffett said that the first rule of making money is to not lose money. A realistic goal is to use PEs to exit the stock market during most of the biggest plunges. These generally happen when PEs are high. I’ll focus on the S&P 500 as it has the longest track records. Here’s the simplest PE-based system of all. You invest in a low-cost S&P 500 index fund, buying low and selling high (in PE terms). When the ten-year PE hits a specified high value (the sell trigger), you sell and put the proceeds in a low-cost fixed-income fund (offering the return of ten-year US Treasury bonds, let’s say). You stay in the bond fund until the PE hits a particular low value, the buy trigger. Then you buy back into the stock fund, and the cycle repeats. To make things as easy as possible, I’ll assume that you’re very busy and can check the PE — and trade when indicated — only once a month.


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

3Com Palm IPO, asset allocation, Bernie Madoff, Brownian motion, buy and hold, collateralized debt obligation, commodity trading advisor, computerized trading, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index arbitrage, index fund, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, survivorship bias, transaction costs, two-sided market, value at risk, yield curve

Long-Only Funds (Mutual Funds) If a fund is highly correlated to the market (or a sector)—as is true for virtually all long-only funds—its performance will be far more a reflective of the market than the fund’s investment process and skill. For example, a so-called closet index fund—a fund that is managed so that its performance does not deviate much from the selected index—would by design be highly correlated to the market. For a closet index fund, high returns would simply mean that the market had witnessed similar high returns and would provide no additional information about the fund’s relative merits. Although closet index funds may represent an extreme case, most long-only mutual funds are still highly correlated to whichever index most closely resembles the types of stocks in their portfolios (an index representing similar capitalization companies, sector, and country or region) and could be described as quasi-closet index funds. In contrast, a market neutral fund—a fund in which long and short positions are equally balanced—would likely have a low correlation to the market.

Although this limited sample does not rise to the level of a persuasive proof, the results are entirely consistent with the available academic research on the subject. The general conclusion appears to be that the advice of the financial experts may sometimes trigger an immediate price move as the public responds to their recommendations (a price move that is impossible to capture), but no longer-term net benefit. My advice to equity investors is either buy an index fund (but not after a period of extreme gains—see Chapter 3) or, if you have sufficient interest and motivation, devote the time and energy to develop your own investment or trading methodology. Neither of these approaches involves listening to the recommendations of the experts. Michael Marcus, a phenomenally successful trader, offered some sage advice on the matter: “You have to follow your own light. . . .

Investment Insights Most of key assumptions related to the efficient market hypothesis, which underlies much of investment theory, are simply inconsistent with the way markets actually behave. Although markets are often efficiently priced (or approximately so), there are many exceptions, and it is the exceptions that provide skilled market participants the opportunity for outperformance. Markets are indeed difficult to beat, and recognition of this fact means that for many investors, the best choice might well be traditional academic advice: Invest in index funds so that you can at least match the market. But there is a big difference between hard to beat and impossible to beat. Investors with an interest in markets who are willing to put in the hard work to develop an investment or trading methodology and who have the discipline to follow a plan should not be dissuaded from that endeavor by the efficient market hypothesis. The model of market prices being determined strictly by fundamentals is overly simplistic.


pages: 417 words: 97,577

The Myth of Capitalism: Monopolies and the Death of Competition by Jonathan Tepper

Affordable Care Act / Obamacare, air freight, Airbnb, airline deregulation, bank run, barriers to entry, Berlin Wall, Bernie Sanders, big-box store, Bob Noyce, business cycle, Capital in the Twenty-First Century by Thomas Piketty, citizen journalism, Clayton Christensen, collapse of Lehman Brothers, collective bargaining, computer age, corporate raider, creative destruction, Credit Default Swap, crony capitalism, diversification, don't be evil, Donald Trump, Double Irish / Dutch Sandwich, Edward Snowden, Elon Musk, en.wikipedia.org, eurozone crisis, Fall of the Berlin Wall, family office, financial innovation, full employment, German hyperinflation, gig economy, Gini coefficient, Goldman Sachs: Vampire Squid, Google bus, Google Chrome, Gordon Gekko, income inequality, index fund, Innovator's Dilemma, intangible asset, invisible hand, Jeff Bezos, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, late capitalism, London Interbank Offered Rate, low skilled workers, Mark Zuckerberg, Martin Wolf, means of production, merger arbitrage, Metcalfe's law, multi-sided market, mutually assured destruction, Nash equilibrium, Network effects, new economy, Northern Rock, offshore financial centre, passive investing, patent troll, Peter Thiel, plutocrats, Plutocrats, prediction markets, prisoner's dilemma, race to the bottom, rent-seeking, road to serfdom, Robert Bork, Ronald Reagan, Sam Peltzman, secular stagnation, shareholder value, Silicon Valley, Skype, Snapchat, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, undersea cable, Vanguard fund, very high income, wikimedia commons, William Shockley: the traitorous eight, zero-sum game

Small investors who had been paying absurdly high fees to Wall Street investment managers suddenly got access to a low-cost product that democratized investing. For the last decade, passive investing has outperformed active management, and it has involved a lot less effort or skill. The index does all the work. The highest paid investment managers in the world lost out to a simple index in which anyone could invest. Jack Bogle is the godfather of index funds. He created the world's first retail index fund at Vanguard in 1974. Buffett has called him a hero for helping the average investor. Jack humbly responded, “I'm not a hero, I'm an ordinary guy … who gave a damn about the people investing and wanted to make sure they got a fair shake.” Bogle never could have anticipated the incredible inflows into this asset class. The appetite has been insatiable, and money has steadily flowed out of active funds and into passive over the last few years.

José Azar, Martin Schmalz, and Isabel Tecu, “Why Common Ownership Creates Antitrust Risks,” CPI Antitrust Chronicle (June 2017). 13. Ibid. 14. https://www.forbes.com/sites/laurengensler/2017/02/25/warren-buffett-annual-letter-2016-passive-active-investing/#1bae82286bbd. 15. https://www.theatlas.com/charts/S1lPjxkM-. 16. https://www.nytimes.com/2017/04/14/business/mutfund/vanguard-mutual-index-funds-growth.html. 17. https://www.theatlantic.com/magazine/archive/2017/09/are-index-funds-evil/534183/?utm_source=twb. 18. National Bureau of Economic Research, “Explaining Low Investment Spending,” http://www.nber.org/digest/feb17/w22897.html. 19. https://www.theatlantic.com/business/archive/2017/06/how-companies-decide-ceo-pay/530127/. 20. https://www.mercurynews.com/2018/05/07/butler-who-do-stock-buy-backs-leave-behind/. 21. https://www.bloomberg.com/gadfly/articles/2018-03-05/five-charts-that-show-where-those-corporate-tax-savings-are-going. 22. https://www.brookings.edu/wp-content/uploads/2016/06/lazonick.pdf. 23.

They felt that they could beat the market by researching, employing smart mathematicians and economists, and by spending a lot of time noodling about market trends. This is known as active investing – and in recent years it has come under fire for being ineffective and expensive. Warren Buffett claims that investors have “wasted” upwards of $100 billion paying useless wealth managers high management fees.14 He is a proponent of what's known as passive investing, or investing in index funds. These funds do not try to beat the market, but mimic a performance of a particular index like the S&P, Russell 500, and so forth. They do not have to be managed, so they are much less expensive than active funds, and they help investors lessen risk through diversification. Passive investing has brought great benefits for average, middle-class investors. It has been somewhat of a Robin Hood story in finance.


pages: 348 words: 83,490

More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) by Michael J. Mauboussin

Albert Einstein, Andrei Shleifer, Atul Gawande, availability heuristic, beat the dealer, Benoit Mandelbrot, Black Swan, Brownian motion, butter production in bangladesh, buy and hold, capital asset pricing model, Clayton Christensen, clockwork universe, complexity theory, corporate governance, creative destruction, Daniel Kahneman / Amos Tversky, deliberate practice, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, dogs of the Dow, Drosophila, Edward Thorp, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, fixed income, framing effect, functional fixedness, hindsight bias, hiring and firing, Howard Rheingold, index fund, information asymmetry, intangible asset, invisible hand, Isaac Newton, Jeff Bezos, Kenneth Arrow, Laplace demon, Long Term Capital Management, loss aversion, mandelbrot fractal, margin call, market bubble, Menlo Park, mental accounting, Milgram experiment, Murray Gell-Mann, Nash equilibrium, new economy, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative finance, random walk, Richard Florida, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, statistical model, Steven Pinker, stocks for the long run, survivorship bias, The Wisdom of Crowds, transaction costs, traveling salesman, value at risk, wealth creators, women in the workforce, zero-sum game

The objective is to create a game plan that exploits the competition’s weaknesses and neutralizes its strengths. Teams generally consider intelligent scouting vital to their long-term success. So what’s the competition for a money manager? Investors with particular objectives can typically invest either with active managers or with index funds. For example, an investor seeking exposure to large-capitalization stocks can place money with a large-cap active manager or with an index fund that mirrors the S&P 500. Accordingly, we can consider an appropriate index’s return to be a measure of an investor’s opportunity cost—the cost of capital—and that beating the benchmark over time should be an active manager’s measure of success. So how do active managers fare against the competition? Not well. Over a recent five-year period, the indexes outperformed over forty percent of all active managers, and more than half of active funds underperformed the benchmark over ten years.

Also critical is that index funds closely track the S&P 500 at a very low cost. Evaluating the Winners Some actively managed funds clearly do beat the benchmark, even over longer time periods. To see if we could come to some stylized conclusions about how these successful investors did it, we created a screen of the general equity funds that beat the S&P 500 over the decade that ended with 2006 where the fund had one manager and assets in excess of $1 billion (see exhibit 2.1).2 Four attributes generally set this group apart from the majority of active equity mutual fund managers:• Portfolio turnover. As a whole, this group of investors had about 35 percent turnover in 2006, which stands in stark contrast to turnover for all equity funds of 89 percent. The S&P 500 index fund turnover was 7 percent.

Financial Analysts Journal (January-February 2005). 7 Kathryn Kranhold, “Florida Might Sue Alliance Capital Over Pension Fund’s Enron Losses,” The Wall Street Journal, April 23, 2002. 8 This is not to say that the stock market is short-term oriented. The research consistently shows that stocks reflect expectations for ten to twenty years of value-creating cash flow. Increasingly, though, investors are making short-term bets on long-term outcomes. 9 Ernst Fehr, “The Economics of Impatience,” Nature, January 17, 2002, 269-70. 10 John Spence, “Bogle Calls for a Federation of Long-Term Investors,” Index Funds, Inc., http://www.indexfunds.com/articles/20020221_boglespeech_com_gen_JS.htm. By my calculations, the weighted average return in 2001 was-4.8 percent for the funds with 20 percent turnover or less, -7.8 percent for the funds with turnover over 100 percent, and -10.5 percent for the funds that had over 200 percent turnover. See http://www.indexfunds.com/articles/20020221_boglespeech_com_gen_JS.htm. 11 Alice Lowenstein, “The Low Turnover Advantage,” Morningstar Research, September 7, 1997, http://news.morningstar.com/news/ms/FundFocus/lowturnover1.html. 12 Russ Wermers, “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transaction Costs, and Expenses,” Journal of Finance 55 (August 2000): 1655-1703. 13 Yahoo provides the risk classifications (above average, average, and below average) based on the standard deviation of portfolio performance.


pages: 386 words: 122,595

Naked Economics: Undressing the Dismal Science (Fully Revised and Updated) by Charles Wheelan

"Robert Solow", affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, business cycle, buy and hold, capital controls, Cass Sunstein, central bank independence, clean water, collapse of Lehman Brothers, congestion charging, creative destruction, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, Daniel Kahneman / Amos Tversky, David Brooks, demographic transition, diversified portfolio, Doha Development Round, Exxon Valdez, financial innovation, fixed income, floating exchange rates, George Akerlof, Gini coefficient, Gordon Gekko, greed is good, happiness index / gross national happiness, Hernando de Soto, income inequality, index fund, interest rate swap, invisible hand, job automation, John Markoff, Joseph Schumpeter, Kenneth Rogoff, libertarian paternalism, low skilled workers, Malacca Straits, market bubble, microcredit, money market fund, money: store of value / unit of account / medium of exchange, Network effects, new economy, open economy, presumed consent, price discrimination, price stability, principal–agent problem, profit maximization, profit motive, purchasing power parity, race to the bottom, RAND corporation, random walk, rent control, Richard Thaler, rising living standards, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Sam Peltzman, school vouchers, Silicon Valley, Silicon Valley startup, South China Sea, Steve Jobs, The Market for Lemons, the rule of 72, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, transaction costs, transcontinental railway, trickle-down economics, urban sprawl, Washington Consensus, Yogi Berra, young professional, zero-sum game

(Burton Malkiel has pointed out that since diversification is important, the monkey should actually throw a wet towel at the stock pages.) Indeed, investors now have access to their own monkey with a towel: index funds. Index funds are mutual funds that do not purport to pick winners. Instead, they buy and hold a predetermined basket of stocks, such as the S&P 500, the index that comprises America’s largest five hundred companies. Since the S&P 500 is a broad market average, we would expect half of America’s actively managed mutual funds to perform better, and half to perform worse. But that is before expenses. Fund managers charge fees for all the tire-kicking they do; they also incur costs as they trade aggressively. Index funds, like towel-throwing monkeys, are far cheaper to manage. But that’s all theory. What do the data show? It turns out that the monkey with a towel can be an investor’s best friend.

But look what happens as the time frame gets longer: Only 45 percent of actively managed funds beat the S&P over a twenty-year stretch, which is the most relevant time frame for people saving for retirement or college. In other words, 55 percent of the mutual funds that claim to have some special stock-picking ability did worse over two decades than a simple index fund, our modern equivalent of a monkey throwing a towel at the stock pages. If you had invested $10,000 in the average actively managed equity fund in 1973, when Malkiel’s heretical book A Random Walk Down Wall Street first came out, it would be worth $355,091 today (many editions later). If you had invested the same amount of money in an S&P 500 index fund, it would now be worth $364,066. Data notwithstanding, the efficient markets theory is obviously not the most popular idea on Wall Street. There is an old joke about two economists walking down the street. One of them sees a $100 bill lying in the street and points it out to his friend.

Craig MacKinlay of the Wharton School are the authors of a book entitled A Non-Random Walk Down Wall Street in which they assert that financial experts with extraordinary resources, such as supercomputers, can beat the market by finding and exploiting pricing anomalies. A BusinessWeek review of the book noted, “Surprisingly, perhaps, Lo and MacKinlay actually agree with Malkiel’s advice to the average investor. If you don’t have any special expertise or the time and money to find expert help, they say, go ahead and purchase index funds.”8 Warren Buffett, arguably the best stock picker of all time, says the same thing.9 Even Richard Thaler, the guy beating the market with his behavioral growth fund, told the Wall Street Journal that he puts most of his retirement savings in index funds.10 Indexing is to investing what regular exercise and a low-fat diet are to losing weight: a very good starting point. The burden of proof should fall on anyone who claims to have a better way. As I’ve already noted, this chapter is not an investment guide. I’ll leave it to others to explain the pros and cons of college savings plans, municipal bonds, variable annuities, and all the other modern investment options.


pages: 232 words: 71,965

Dead Companies Walking by Scott Fearon

bank run, Bernie Madoff, business cycle, corporate raider, creative destruction, crony capitalism, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, Golden Gate Park, hiring and firing, housing crisis, index fund, Jeff Bezos, Joseph Schumpeter, late fees, McMansion, moral hazard, new economy, pets.com, Ponzi scheme, Ronald Reagan, short selling, Silicon Valley, Snapchat, South of Market, San Francisco, Steve Jobs, survivorship bias, Upton Sinclair, Vanguard fund, young professional

Can you think of another business in the world that would continue to exist as a going concern even after it had been proven definitively—as John Bogle of Vanguard proved about the financial industry—that most of its products are vastly inferior to other, cheaper alternatives like index funds? I can’t. How about a business whose most prestigious firms have been caught defrauding their own customers not once, but over and over again? In the normal corporate world, would such a business not only continue to operate, but actually make more and more money every year? Of course not. It would be long dead by now. And yet deceiving its clients and foisting inferior and even fraudulent products on them is exactly how Wall Street stays in business! Hedged After all my talk of Wall Street types making poor investors, you might think I would keep my money strictly in index funds. But that’s not case. I’m proud to say that, unlike some of my peers in the business, I keep almost all of my money in my own hedge fund.

It also creates an even more destructive mind-set—once they themselves rise to positions of power, they see themselves as infallible and worthy of worship. Add it all up and there’s only one conclusion you can reach: these are the last people you want safeguarding your money. And it’s not just me saying this. The numbers back me up. The great author and investor John Bogle—who invented the passive index fund back in the 1970s—examined the average returns of equity mutual funds from 1983 to 2003. A dollar invested in those kinds of funds in the early 1980s netted just $7.10 in profits twenty years later. Over the same period, a dollar invested in the S&P 500 index, which Bogle’s Vanguard 500 Fund tracks, would have brought in over $11.50.§ Think about those numbers for a second. The overseers of the Vanguard 500 merely invest in all the stocks of the S&P 500.

Compare that to your average mutual fund, where you’ve got highly paid professional investors buying and selling individual stocks all day, every day. (And when I say highly paid, I mean it. Bogle has calculated the total fees and commissions reaped by the financial industry at more than $500 billion a year.) For all that extra effort, and all that extra expense, all of those well-compensated experts earned considerably less than an index fund whose managers did next to nothing. Not all money managers are doomed to eternal underperformance, just most of them. A handful beat the market consistently, even after all taxes and fees. Warren Buffet comes to mind. Peter Lynch, too. Not to brag or put myself in those guys’ class, but I think my twenty-three-year record as a hedge fund manager is also proof that the indexes are beatable.


pages: 147 words: 39,910

The Great Mental Models: General Thinking Concepts by Shane Parrish

Albert Einstein, Atul Gawande, Barry Marshall: ulcers, bitcoin, Black Swan, colonial rule, correlation coefficient, correlation does not imply causation, cuban missile crisis, Daniel Kahneman / Amos Tversky, dark matter, delayed gratification, feminist movement, index fund, Isaac Newton, Jane Jacobs, mandelbrot fractal, Pierre-Simon Laplace, Ponzi scheme, Richard Feynman, statistical model, stem cell, The Death and Life of Great American Cities, the map is not the territory, the scientific method, Thomas Bayes, Torches of Freedom

Instead of thinking through the achievement of a positive outcome, we could ask ourselves how we might achieve a terrible outcome, and let that guide our decision-making. Index funds are a great example of stock market inversion promoted and brought to bear by Vanguard’s John Bogle.9 Instead of asking how to beat the market, as so many before him, Bogle recognized the difficulty of the task. Everyone is trying to beat the market. No one is doing it with any consistency, and in the process real people are losing actual money. So he inverted the approach. The question then became, how can we help investors minimize losses to fees and poor money manager selection? The results were one of the greatest ideas—index funds—and one of the greatest powerhouse firms in the history of finance. The index fund operates on the idea that accruing wealth has a lot to do with minimizing loss. Think about your personal finances.

The Problem of Incentives The problem of incentives can really skew how much you can rely on someone else’s circle of competence. This is particularly acute in the financial realm. Until recently, nearly all financial products we might be pushed into had commissions attached to them—in other words, our advisor made more money by giving us one set of advice than another, regardless of its wisdom. Fortunately, the rise of things like index funds of the stock and bond markets has mostly alleviated the issue. In cases like financial advisory, we’re not on solid ground until we know, in some detail, the compensation arrangement our advisor is under. The same goes for buying furniture, buying a house, or buying a washing machine at a retail store. What does the knowledgeable advisor stand to gain from our purchase? It goes beyond sales, of course.


pages: 304 words: 22,886

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler, Cass R. Sunstein

Al Roth, Albert Einstein, asset allocation, availability heuristic, call centre, Cass Sunstein, choice architecture, continuous integration, Daniel Kahneman / Amos Tversky, desegregation, diversification, diversified portfolio, endowment effect, equity premium, feminist movement, fixed income, framing effect, full employment, George Akerlof, index fund, invisible hand, late fees, libertarian paternalism, loss aversion, Mahatma Gandhi, Mason jar, medical malpractice, medical residency, mental accounting, meta analysis, meta-analysis, Milgram experiment, money market fund, pension reform, presumed consent, price discrimination, profit maximization, rent-seeking, Richard Thaler, Right to Buy, risk tolerance, Robert Shiller, Robert Shiller, Saturday Night Live, school choice, school vouchers, transaction costs, Vanguard fund, Zipcar

The asset allocation is 65 percent foreign (that is, non-Swedish) stocks, 17 percent Swedish stocks, 10 percent fixed-income securities (bonds), 4 percent hedge funds, and 4 percent private equity. Across all asset classes, 60 percent of the funds are managed passively, meaning that the portfolio managers are simply buying an index of stocks and not trying to beat the market. One good thing about index funds is that they are cheap. The fees they charge investors are much lower than those charged by funds that try to beat the market. These low fees for the index funds helped keep the costs in the default fund very low, 0.17 percent. (This means that for every $100 invested, the investor is charged 17 cents per year.) Overall, most experts would consider this fund to be very well designed. Table 9.1 Comparison of the default fund and the mean actively chosen portfolio Note: The table compares the default fund and the mean actively chosen portfolio.

Louis Germany, organ donations in Gilovich, Tom Give More Tomorrow Goldstein, Dan Goolsbee, Austan Gore, Al Gould, Stephen Jay government: distrust of, libertarian paternalism of, neutrality in, paternalism of, and RECAP, and retirement plans, and slippery slope, starting points provided by, transparency in government bonds greenhouse gas emissions Greenhouse Gas Inventory (GGI), proposed Green Lights, EPA program, Gross, David, group norms, gut feelings Hackman, Gene Halloween night experiment H&R Block, and FAFSA software Harvard School of Public Health Hazard Communication Standard (HCS) health care, birth control pills, choosing, costs of, defensive medicine, Destiny Health Plan, deterrent effect of tort liability in, drug compliance, framing in, freedom of contract in, incentive conflicts in, ineffective lawsuits in, libertarian paternalists on, medical malpractice liability, negligence defined in, “no-fault” system in some countries, organ donations, prescription drug plan, right to sue for negligence, social influences in, treatment options “heuristics and biases” approach Hoffman, Dustin home-building industry home equity loans Home Ownership and Equity Protection Act homo economicus (economic man) “hot-cold empathy gap,” hot-hand theory hot states Houston Natural Gas Howell, William Hoxby, Carolyn Humans: Automatic Systems used by, conformity of, difficult choices for, influenced by a nudge, loss aversion of, and money, social pressures on, use of term Hurricane Katrina Illinois First Person Consent registry imitation incentives, conflicts of, in free markets, in investments, and salience income tax: Automatic Tax Return, compliance in, refunds from index funds inertia: and default option, and loss aversion, and organ donations, power of, and status quo bias, “yeah, whatever,” information, spread of Informed Decisions inheritance INSEAD School of Business, France insurance: costs of, fraught choices in, health Internal Revenue Service (IRS) intuitive thinking, test of investment goods investments, asset allocation in, in company stock, default options, and ERISA, error expected in, feedback in, incentives in, index funds, “lifestyle” funds, mappings in, and market timing, mental accounting in, mutual funds, past performance of, portfolio management, portfolio theory, rates of return, risk in, rules of thumb for, stocks and bonds, structuring complex choices, “target maturity funds,” iPhone and iPod IRAs Johnson, Eric Johnson, Samuel Jones, Rev.

Treasury bills (short-term, completely safe, bonds issued by the government), you would have turned your dollar into $18, a 3.7 percent rate of return per year. That does not seem bad until you realize that just to keep up with inflation you had to earn 3.0 percent per year. If you had invested your money in longer-term bonds, your dollar would have become $71, a 5.5 percent rate of return, which is quite a bit better. But if you had invested in mutual funds that held shares in the largest American companies (such as an S&P 500 index fund), your dollar would have grown into $2,658, a 10.4 percent rate of return, and if you had invested in a broad portfolio of the stocks of smaller companies, you could have earned even more. In economics jargon, in which stocks are referred to as equities, the difference in the returns between Treasury bills and equities is called the “equity premium.” This premium is considered to be compensation for the greater risk associated with investing in stocks.


pages: 321

Finding Alphas: A Quantitative Approach to Building Trading Strategies by Igor Tulchinsky

algorithmic trading, asset allocation, automated trading system, backtesting, barriers to entry, business cycle, buy and hold, capital asset pricing model, constrained optimization, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial intermediation, Flash crash, implied volatility, index arbitrage, index fund, intangible asset, iterative process, Long Term Capital Management, loss aversion, market design, market microstructure, merger arbitrage, natural language processing, passive investing, pattern recognition, performance metric, popular capitalism, prediction markets, price discovery process, profit motive, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, selection bias, sentiment analysis, shareholder value, Sharpe ratio, short selling, Silicon Valley, speech recognition, statistical arbitrage, statistical model, stochastic process, survivorship bias, systematic trading, text mining, transaction costs, Vanguard fund, yield curve

Total Market Index, which is tracked by Vanguard Group’s largest index funds, encompasses the entire US market, from large caps to microcaps, and accordingly does not trigger any trading Finding an Index Alpha227 requirements when cap-size migrations occur. (However, funds benchmarked to the individual capitalization ranges would still need to trade and thus potentially would impact market prices for some illiquid stocks.) OTHER INDEX ANOMALIES Captive Capital-Raising by Newly Indexed Companies Index changes can lead to other market anomalies. For example, when stocks are added to major blue-chip indices, such as the S&P 500, a few of the added companies occasionally engage in opportunistic capital-­ raising without the usual offering discount, as index funds are forced buyers of stock around that time. Real estate companies are the most notable offenders: more than a quarter of real estate investment trusts (REITs) added to the S&P 500 since 2005 have engaged in this behavior.

. •• Low costs: In general, ETFs incur lower costs (expense ratio < 1%) compared with traditional mutual funds (1–3%), benefiting all investors. For instance, SPY’s expense ratio is 0.09%, and those of some others, such as Schwab US Broad Market ETF (SCHB), are as low as 0.03%. One reason for such low expense ratios is that many ETFs are index funds that are not actively managed – hence they are relatively simple to run. Also, ETFs do not need to maintain a cash reserve for redemptions. ETFs and Alpha Research233 •• Tax efficiency: Taxable capital gains are created when a mutual fund or ETF sells securities that have appreciated in value. However, as most ETFs are passive index funds with very low turnover of the portfolio securities (most trading happens only for index rebalancing), they are highly tax efficient. More notably, ETFs have a unique creation and redemption mechanism: only authorized participants (APs) – large, specialized financial institutions – can create or redeem ETF shares.

Reducing Intrinsic Risks Intrinsic risks, as well as the extrinsic risks that remain after soft neutralization or hedging, should be controlled by dynamic position sizing. Most alphas benefit from broad caps on volatility, value at risk, expected tail loss, and position concentrations. When the risk goes up, the book size should scale down so that the alpha does not risk all of its long-term PnL on only a few high-risk days. Alphas with broad beta or risk-on/risk-off behavior can also use other relevant proxies, such as the CBOE Volatility Index, fund flows into risk-on/risk-off assets, or spikes in the correlation eigenvalues, as signals to scale their risk appetite to fit current market conditions. No single risk measure captures the full complexity of the risk profile, so it is useful to combine several relevant measures and use the most conservative one. Alphas that are highly vulnerable to certain event risks that can be known in advance (for example, central bank meetings and numbers announcements) should scale down or exit their positions in advance of the event or hedge with more-liquid instruments if they are unable to scale down in time.


Hedgehogging by Barton Biggs

activist fund / activist shareholder / activist investor, asset allocation, backtesting, barriers to entry, Bretton Woods, British Empire, business cycle, buy and hold, diversification, diversified portfolio, Elliott wave, family office, financial independence, fixed income, full employment, hiring and firing, index fund, Isaac Newton, job satisfaction, margin call, market bubble, Mikhail Gorbachev, new economy, oil shale / tar sands, paradox of thrift, Paul Samuelson, Ponzi scheme, random walk, Ronald Reagan, secular stagnation, Sharpe ratio, short selling, Silicon Valley, transaction costs, upwardly mobile, value at risk, Vanguard fund, zero-sum game, éminence grise

The Leuthold large-cap growth index of 90 companies is selling at 20.5 times earnings and the Leuthold value index is at 11.9 times, which is a growth to value price earnings ratio of 1.68 versus the historical median of 2.5. For IRAs the Vanguard index funds make sense to me. Sure, you can capture alpha, extra return, if you identify a winner mutual fund, but you are bucking a number of headwinds in terms of higher costs, performance cycles, manager turnover, and so on. When the time comes and small value is cheap again, Vanguard has a Small-Cap Value Index Fund.The stock selection is based on the MSCI Index, which, in making its selection, uses eight value and growth factors including price/book value, dividend yield, earnings yield, sales growth, and longterm-earnings growth. MSCI defines U.S. small cap as those equities ranked from 751 to 2,500 in market capitalization.

As I mentioned earlier, history shows that the lifespan of growth stocks is short, and the fall from grace when it comes can wipe out years of gains.As for mutual funds, their managers come and go, and the fees are high. If you can find someone like Bill Miller at Legg Mason, it’s a gift from heaven.As I noted before, an attractive alternative is owning an index fund, and they come in all shapes and sizes with minuscule fees. At least you are going to capture the index return. The two biggest index fund firms by far are Vanguard and Fidelity. Growth investing, because of its bias toward a buy-and-hold strategy, is inherently more tax efficient. However, for tax-exempt investors, the hard evidence is that the actual portfolios of value managers beat those of growth managers.The New York research firm, Bernstein, publishes an index of growth versus value that is based on the actual portfolio style analysis of six consulting firms as shown in Table 17.1.

Of course, the dismal results for individual investors are partly their own fault as well.They are simply not equipped, either in terms of temperament, research resources, or time commitment, to compete with the professionals. Rational individuals wouldn’t dream of competing against professional athletes for money or against professional card players.Why would they in the financial markets? However, the individuals do need to make their own long-term asset allocations decisions. This can be done if they have at least a general concept of secular and cyclical cycles and some sense of contrarian investing. Index funds should be the means of implementation. THE DIFFERENCE BETWEEN SECULAR AND CYCLICAL BEAR MARKETS Let’s start with the definitions of secular and cyclical bear markets.To me, a secular bear market is a decline in the major stock averages of at least 40 percent—and considerably more in secondary stocks—where the decline lasts at least three to five years. The fall is then followed by a long hangover that drags on for a number of years as the excesses are purged.There can be cyclical bull markets during this period, but it will be a long time before a new secular bull market begins in which the popular averages exceed the old highs and climb toward new peaks.


pages: 375 words: 105,067

Pound Foolish: Exposing the Dark Side of the Personal Finance Industry by Helaine Olen

American ideology, asset allocation, Bernie Madoff, buy and hold, Cass Sunstein, Credit Default Swap, David Brooks, delayed gratification, diversification, diversified portfolio, Donald Trump, Elliott wave, en.wikipedia.org, estate planning, financial innovation, Flash crash, game design, greed is good, high net worth, impulse control, income inequality, index fund, London Whale, longitudinal study, Mark Zuckerberg, money market fund, mortgage debt, oil shock, payday loans, pension reform, Ponzi scheme, post-work, quantitative easing, Ralph Nader, RAND corporation, random walk, Richard Thaler, Ronald Reagan, Saturday Night Live, Stanford marshmallow experiment, stocks for the long run, too big to fail, transaction costs, Unsafe at Any Speed, upwardly mobile, Vanguard fund, wage slave, women in the workforce, working poor, éminence grise

Demand for journalists who could write about personal finance began to outpace supply in the 1990s as newspapers upped their coverage of this formerly ignored subject. “I was ignorant,” wrote an anonymous Fortune writer about his or her time recommending investments for an Internet publication in a 1999 piece titled “Confessions of a Former Mutual Funds Reporter.” “My only personal experience had been bumbling into a load fund until a colleague steered me to an S&P 500 index fund. I worried I’d misdirect readers, but I was assured that in personal finance journalism it doesn’t matter if the advice turns out to be right, as long as it’s logical.” There are any number of things you can take from my story and others like it. The first is about money and what it means to us. When you write about people and money, you write about much more than dollars and cents. You write about their lives.

Over the years Quinn made numerous enemies, ranging from brokers to heads of mutual fund companies, for relentlessly putting the financial interests of the consumer ahead of the financial interests of the financial services industry. Quinn sees herself as both a part of the consumer movement and the personal finance and investment communities. She names as her contemporaries such financial pioneers as Bruce Bent, the creator of the now ubiquitous money market fund, and John Bogle, the force behind Vanguard’s low-cost index funds. Yet a look at Quinn’s work demonstrates both the promise and the perils of the financial advice arena. A quick run through the many, many profiles of her penned over the years shows howlers mixed in with the prescient comments, sometimes in the same piece, proving how hard it is to get this forecasting thing right. In a USA Today interview in 1991, for example, she opines “You can no longer count on your real estate to make you rich,” a statement that was objectively untrue, at least at that time.

That will, of course, come on top of the fees you are already paying on the account. Fee-only financial planners and registered investment advisers (RIAs) are willing to help out too—provided, that is, they can count your savings toward their assets under management and collect the fees. Surveying the situation, no one less than John Bogle, the founder of the Vanguard Group and the man who pioneered the low-cost index fund, has come forward to say the mutual fund and retirement industries collect so much money in fees that the entire system is a “train wreck.” But a train wreck for your future retirement is a gravy train for those collecting the fees. As a result, the political influence of the industry can’t be oversold. According to OpenSecrets.org, a Washington-based non-profit that monitors and tracks the flow of money in American politics, companies ranging from Vanguard to Legg Mason have doubled the amount of money they dole out for lobbying expenses in recent years, while others such as Fidelity have political action committees that have donated hundreds of thousands of dollars to candidates for political office.


pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy and hold, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

A passive investor is defined as anyone sensible enough to realize you can’t beat the market. The passive investor puts all his money into a market portfolio of every stock in existence (roughly, an “index fund”). An active investor is anyone who suffers from the delusion that he can beat the market. The active investor puts his money into anything except a market portfolio. By Sharpe’s terminology, an active investor need not trade “actively.” A retired teacher who has two shares of AT&T in the bottom of her dresser drawer counts as an active investor. She is operating on the assumption that AT&T is a better stock to own than a total market index fund. Active investors include anyone who tries to pick “good” stocks and shun “bad” ones, or who hires someone else to do that by putting money in an actively managed mutual fund or investment partnership.

At the Kefauver hearings, Willie Moretti supplied a telling definition of the word mob: “People are mobs that make six percent more on the dollar than anyone else does.” It is not just criminals who cherish the belief that there is an easier way of getting rich. The small investor has long been inundated by mutual fund and brokerage ads implying that you’d be a sap to settle for “average” returns. It is an American credo that you can pick a “good” mutual fund from Morningstar ratings. “Good” presumably means that it will earn more cents on the dollar than an index fund. It is a more astonishing credo that the small investor can pick market-beating stocks him- or herself just by doing a little research on the Internet and watching pundits on CNBC. This raises an important point, the connection between market information and return. “In an efficient market,” Eugene Fama wrote, “competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effect of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future.”

His point was that a horse race is like a particularly fast-paced and vicious stock market. It would be alarming to visit a great stock exchange and find the floor littered with worthless stock certificates. Try visiting a racetrack. Most wager tickets become worthless within minutes. It is folly to bet everything on a favorite (horse or stock). The only way to survive is through diversification. Someone who bets on every horse—or buys an index fund—will at least enjoy average returns, minus transaction costs. “Average” isn’t so hot at the racetrack, given those steep track takes. “Average” is pretty decent for stocks, something like 6 percent above the inflation rate. For a buy-and-hold investor, commissions and taxes are small. Shannon was more interested in above average returns. The only way to beat the market (of stocks or horse wagers) is by knowing something that other people don’t.


pages: 368 words: 32,950

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile by Alexander Davidson

accounting loophole / creative accounting, algorithmic trading, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Big bang: deregulation of the City of London, buy and hold, capital asset pricing model, central bank independence, corporate governance, Credit Default Swap, dematerialisation, discounted cash flows, diversified portfolio, double entry bookkeeping, Edward Lloyd's coffeehouse, Elliott wave, Exxon Valdez, forensic accounting, global reserve currency, high net worth, index fund, inflation targeting, intangible asset, interest rate derivative, interest rate swap, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Nick Leeson, North Sea oil, Northern Rock, pension reform, Piper Alpha, price stability, purchasing power parity, Real Time Gross Settlement, reserve currency, Right to Buy, shareholder value, short selling, The Wealth of Nations by Adam Smith, transaction costs, value at risk, yield curve, zero-coupon bond

Most commodities investors put their money in index funds, of which the largest is the Goldman Sachs Commodity Index (GSCI), which Standard & Poor’s acquired in February 2007. The GSCI, which is heavily weighted towards energy, rose in value from US $4–5 billion in 2001 to US $60 billion in early 2007. Index funds can only take a long position, which means they cannot profit from a declining market by taking short positions, and they are not geared. Backwardation and contango Index funds will roll contracts at periods that the market can often predict. If the market is in backwardation, the forward price (agreement to buy or sell at an agreed future point) is lower than spot (agreement to buy and sell immediately and settle for cash). Index funds will gain because they sell high and buy low.

Index funds will gain because they sell high and buy low. If the market is in contango, the forward price is higher than spot, and index funds will lose money because they sell low and buy high. In early 2007, some commodities had switched into contango, which made it arguably a bad time to start investing in commodities. Some index funds are looking at rolling futures contracts differently to reduce the contango effect. Retail investment in commodities is negligible. But private investors can invest in managed funds that invest in underlying companies such as energy or mining companies, or directly in the companies themselves. This does not always achieve the same result as investing in pure commodities because a lot of corporate factors unrelated to commodities must be taken into account. Spread betting (see Chapter 9) is a way to trade commodity derivatives.

The industry showed an initial mixed reaction to the proposals that, as the second edition of this book went to press, were under consultation. There were concerns about the distinction between the two types of adviser and whether the ‘independent’ label would truly mean there was no bias. Some felt that the idea of primary products had been tried before and did not work, and could lead to mis-selling because some products like index funds were simple to explain but not low risk. Meanwhile, a review is underway to research and prepare a national approach to ‘generic’ financial advice, led by Otto Thoreson, chief executive at insurer Aegon UK. A generic adviser should take a holistic view of the consumer’s finances and recommend that the customer move to the stage of buying products only when it suited his or her circumstances. The generic adviser would not be regulated to sell products but might refer the client to a financial adviser.


pages: 229 words: 64,697

The Barefoot Investor: The Only Money Guide You'll Ever Need by Scott Pape

Albert Einstein, Asian financial crisis, diversified portfolio, Donald Trump, estate planning, financial independence, index fund, Jeff Bezos, Mark Zuckerberg, McMansion, Own Your Own Home, Robert Shiller, Robert Shiller, Snapchat

Thankfully, everything on Wall Street is studied and tracked — even investor stupidity. Respected US financial research firm Dalbar has been tracking investors' real returns for decades. And here's the shocker: their research shows that the average investor earned 3.7 per cent annually over the past 30 years, during a period in which a basic index fund returned 11.1 per cent annually. In other words, the average investor underperformed the market by approximately 7.4 per cent each year for three decades. Here's another way to explain it: Let's say you invested $100 000 in a no-brainer index fund (that automatically buys all the companies that make up a sharemarket index, and tracks the market), and then headed off to the Thai island of Ko Pha Ngan and did nothing but drink buckets of whisky on the beach for the next 30 years. When you return, your $100 000 investment would be worth $2 351 916.

More importantly, it teaches us that investing in businesses and holding shares for the long term is how you get incredibly rich. Pauline: I still think shares are risky. You: Pauline, the biggest risk is not owning shares. I need my shares to keep ahead of inflation when I get older. If I live another 50 years, a loaf of bread will cost $10! Pauline: But what if you invest in the wrong company? You: Warren Buffett, the world's greatest investor, is leaving his wife her entire inheritance in a simple index fund that automatically buys the 500 largest companies in America. We're talking about companies like Apple, Google, Facebook, McDonald's, Amazon and Nike. My super does the same thing, but it's also got the 200 biggest Aussie companies — like the banks, Telstra and BHP. Pauline: Well, I just don't understand shares. You: Honestly, I don't know a balance sheet from a bedsheet, but I have faith that the world has amazing businesspeople like Facebook's Mark Zuckerberg and Amazon's Jeff Bezos.

With an ‘SMSF Lite' you can take that $50 000 (or whatever you have) in your super fund and start investing it in shares to really boost your returns. The SMSF Lite that I use I have my SMSF Lite with Hostplus (because I'm already invested in their ultra-cheap Index Balanced Fund for my super). They call it ‘ChoicePlus', and it allows you to invest in any of Australia's biggest 300 companies on the stock exchange, together with a range of term deposits and ETFs (‘exchange traded funds' — basically index funds). To be invested in ChoicePlus, you need a minimum of $10 000 to kick things off, and at least $2000 must be kept in one of Hostplus's other investment options. It costs $180 a year, versus thousands for a traditional SMSF from an accountant. By combining ChoicePlus with the Indexed Balanced Fund, I get the best of both worlds: the cheapest super fund in the country together with the opportunity to pick and choose my own shares!


pages: 379 words: 114,807

The Land Grabbers: The New Fight Over Who Owns the Earth by Fred Pearce

activist lawyer, Asian financial crisis, banking crisis, big-box store, blood diamonds, British Empire, Buy land – they’re not making it any more, Cape to Cairo, carbon footprint, clean water, corporate raider, credit crunch, Deng Xiaoping, Elliott wave, en.wikipedia.org, energy security, farmers can use mobile phones to check market prices, index fund, Jeff Bezos, Kickstarter, land reform, land tenure, Mahatma Gandhi, market fundamentalism, megacity, Mohammed Bouazizi, Nelson Mandela, Nikolai Kondratiev, offshore financial centre, out of africa, quantitative easing, race to the bottom, Ronald Reagan, smart cities, structural adjustment programs, too big to fail, undersea cable, urban planning, urban sprawl, WikiLeaks

New kinds of financial derivatives were created, somewhat analogous to those behind the subprime mortgage business, whose collapse triggered the 2008 banking crisis. Traditional futures are themselves a form of derivative, of course. But the new forms began in 1991, when Goldman Sachs packaged up commodities futures of all sorts (from coffee and corn to oil and copper) into the Goldman Sachs Commodity Index. It then sold stakes in index funds. By buying them, investors were betting on the future price of a basket of commodities. The first index funds bumped along for years without attracting too much attention. Then in 2005, three things happened that suddenly made them extremely attractive to investors. First, real food prices started to push up after a long period of decline. Second, it started to look like investing in some of the other derivatives markets beloved by speculators, like subprime mortgages, might not be so clever.

Between 2005 and 2008, speculators piled into commodities index funds. The funds swiftly came to dominate key U.S. markets in corn, wheat, and soy. A report from Morgan Stanley estimated that the number of contracts in corn futures increased fivefold between 2003 and 2008. The distinguished Indian economist Jayati Ghosh said later: “From about late 2006, a lot of financial firms realized that there was really no more profit to be made in the US housing market.” They switched to commodities and began pushing up prices “so that what was a trickle in late 2006 becomes a flood from early 2007.” As the prices of shares, real estate, and other former wealth generators fell during the credit crunch of 2008, the prices of commodities index funds continued to rise, as investors poured in. This accelerated as governments in the United States and Europe tried to save the world banking system by pumping in new money—quantitative easing.

Rain and tornadoes put wheat crops in jeopardy in the U.S. and Canadian prairies, and La Niña messed with the harvests in Argentina and Brazil. But a bad situation was again made worse by rampant speculation. After federal reserve chairman Ben Bernanke pumped another $600 billion of “quantitative easing” into the U.S. economy in November 2010, Barclays Capital said speculators were pushing record amounts into index funds, in the hope of tapping more profits as prices rose. Investment in commodity index funds in the United States alone was reported at above $400 billion. The bubble inflated. Back in the real world, by mid-2011, wheat was up 98 percent from the previous May, beef 32 percent, sugar 48 percent, cocoa 80 percent, cooking oils 53 percent, and rice 33 percent. Food prices overall had tripled since 2004. It is becoming clear things have gone badly wrong.


pages: 284 words: 79,265

The Half-Life of Facts: Why Everything We Know Has an Expiration Date by Samuel Arbesman

Albert Einstein, Alfred Russel Wallace, Amazon Mechanical Turk, Andrew Wiles, bioinformatics, British Empire, Cesare Marchetti: Marchetti’s constant, Chelsea Manning, Clayton Christensen, cognitive bias, cognitive dissonance, conceptual framework, David Brooks, demographic transition, double entry bookkeeping, double helix, Galaxy Zoo, guest worker program, Gödel, Escher, Bach, Ignaz Semmelweis: hand washing, index fund, invention of movable type, Isaac Newton, John Harrison: Longitude, Kevin Kelly, life extension, Marc Andreessen, meta analysis, meta-analysis, Milgram experiment, Nicholas Carr, P = NP, p-value, Paul Erdős, Pluto: dwarf planet, publication bias, randomized controlled trial, Richard Feynman, Rodney Brooks, scientific worldview, social graph, social web, text mining, the scientific method, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, Tyler Cowen: Great Stagnation

It’s hard enough to have the newest knowledge in one’s own field, but dealing with knowledge that’s outside of one’s area of expertise is even harder. Unless we want to make it our jobs to figure out how to invest, just use index funds and don’t bother focusing too carefully on individual stocks. Perhaps the same advice can be used for knowledge. Unless it’s one’s job to keep abreast of a certain field of knowledge, simply use the informational equivalent of index funds. But what are informational index funds? They are publications and Web sites that aggregate changing knowledge all in a single place. These include magazines, blogs, and the “What’s News” column in the Wall Street Journal, among other sources. While informational index funds can help, reading omnivorously is still important, and we have already been given some help with this. The Atlantic has begun running a series called Media Diet, which asks influential thinkers what they read and how they get their facts and news.

., 174 Godwin’s law, 105 Goldbach’s Conjecture, 112–13 Goodman, Steven, 107–8 Gould, Stephen Jay, 82 grammar: descriptive, 188–89 prescriptive, 188–89, 194 Granovetter, Mark, 76–78 Graves’ disease, 111 Great Vowel Shift, 191–93 Green, George, 105–6 growth: exponential, 10–14, 44–45, 46–47, 54–55, 57, 59, 130, 204 hyperbolic, 59 linear, 10, 11 Gumbel, Bryant, 41 Gutenberg, Johannes, 71–73, 78, 95 Hamblin, Terry, 83 Harrison, John, 102 Hawthorne effect, 55–56 helium, 104 Helmann, John, 162 Henrich, Joseph, 58 hepatitis, 28–30 hidden knowledge, 96–120 h-index, 17 Hirsch, Jorge, 17 History of the Modern Fact, A (Poovey), 200 Holmes, Sherlock, 206 homeoteleuton, 89 Hooke, Robert, 21, 94 Hull, David, 187–88 human anatomy, 23 human computation, 20 hydrogen, 151 hyperbolic growth rate, 59 idiolect, 190 impact factors, 16–17 inattentional blindness (change blindness), 177–79 India, 140–41 informational index funds, 197 information transformation, 43–44, 46 InnoCentive, 96–98, 101, 102 innovation, 204 population size and, 135–37, 202 prizes for, 102–3 simultaneous, 104–5 integrated circuits, 42, 43, 55, 203 Intel Corporation, 42 interdisciplinary research, 68–69 International Bureau of Weights and Measures, 47 Internet, 2, 40–41, 53, 198, 208, 211 Ioannidis, John, 156–61, 162 iPhone, 123 iron: magnetic properties of, 49–50 in spinach, 83–84 Ising, Ernst, 124, 125–26, 138 isotopes, 151 Jackson, John Hughlings, 30 Johnson, Steven, 119 Journal of Physical and Chemical Reference Data, 33–35 journals, 9, 12, 16–17, 32 Kahneman, Daniel, 177 Kay, Alan, 173 Kelly, Kevin, 38, 46 Kelly, Stuart, 115 Kelvin, Lord, 142–43 Kennaway, Kristian, 86 Keynes, John Maynard, 172 kidney stones, 52 kilogram, 147–48 Kiribati, 203 Kissinger, Henry, 190 Kleinberg, Jon, 92–93 knowledge and facts, 5, 54 cumulative, 56–57 erroneous, 78–95, 211–14 half-lives of, 1–8, 202 hidden, 96–120 phase transitions in, 121–39, 185 spread of, 66–95 Koh, Heebyung, 43, 45–46, 56 Kremer, Michael, 58–61 Kuhn, Thomas, 163, 186 Lambton, William, 140 land bridges, 57, 59–60 language, 188–94 French Canadians and, 193–94 grammar and, 188–89, 194 Great Vowel Shift and, 191–93 idiolect and, 190 situation-based dialect and, 190 verbs in, 189 voice onset time and, 190 Large Hadron Collider, 159 Laughlin, Gregory, 129–31 “Laws Underlying the Physics of Everyday Life Really Are Completely Understood, The” (Carroll), 36–37 Lazarus taxa, 27–28 Le Fanu, James, 23 LEGO, 184–85, 194 Lehman, Harvey, 13–14, 15 Leibniz, Gottfried, 67 Lenat, Doug, 112 Levan, Albert, 1–2 Liben-Nowell, David, 92–93 libraries, 31–32 life span, 53–54 Lincoln, Abraham, 70 linear growth, 10, 11 Linnaeus, Carl, 22, 204 Lippincott, Sara, 86 Lipson, Hod, 113 Little Science, Big Science (Price), 13 logistic curves, 44–46, 50, 116, 130, 203–4 longitude, 102 Long Now Foundation, 195 long tails: of discovery, 38 of expertise, 96, 102 of life, 38 of popularity, 103 Lou Gehrig’s disease (ALS), 98, 100–101 machine intelligence, 207 Magee, Chris, 43, 45–46, 56, 207–8 magicians, 178–79 magnetic properties of iron, 49–50 Maldives, 203 Malthus, Thomas, 59 mammal species, 22, 23, 128 extinct, 28 manuscripts, 87–91, 114–16 Marchetti, Cesare, 64 Marsh, Othniel, 80–81, 169 mathematics, 19, 51, 112–14, 124–25, 132–35 Matthew effect, 103 Mauboussin, Michael, 84 Mayor, Michel, 122 McGovern, George, 66 McIntosh, J.


pages: 364 words: 101,286

The Misbehavior of Markets: A Fractal View of Financial Turbulence by Benoit Mandelbrot, Richard L. Hudson

Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John Meriwether, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, Myron Scholes, new economy, paper trading, passive investing, Paul Lévy, Paul Samuelson, plutocrats, Plutocrats, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, Vilfredo Pareto, volatility smile

As in many scientific fields, so in the dismal science a consensus emerges about what is right and what is wrong, what research is worthy a doctoral thesis and what is not. I have run counter-trend most of my professional career. In the 1960s, most theoretical economists were lionizing Bachelier and his heirs. The next decade, Wall Street embraced their theories. They were the intellectual foundation for stock-index funds, options exchanges, executive stock options, corporate capital-budgeting, bank risk-analysis, and much of the world financial industry as we know it today. Throughout this time, I was being heard, but as a near-lone voice denouncing the flaws in the logic. By the late 1980s and 1990s, however, I was no longer alone in seeing those flaws. The financial dislocations convinced many professional financiers that something was wrong.

And if you have special insights into a stock, you could profit from being the first in the market to act on it. But you cannot be sure you are right or first; after all, the market is full of people at least as smart as you. So, in sum, it may not be worth your while to spend all that time and money getting the information in the first place. Cheaper and safer to ride with the market. Buy a stock index fund. Relax. Be passive. Or as Samuelson at MIT put it: “They also serve who only sit and hold.” His advice, then:A respect for evidence compels me to incline toward the hypothesis that most portfolio decision makers should go out of business—take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed.

If fluctuations in stock prices suggested a second, better investment palette, then everybody would start moving their money into that new portfolio and abandoning the first. Soon, there would again be just one portfolio, the “market portfolio.” So the market, itself, was doing the Markowitz calculations. It was the most powerful computer of all, producing tick-by-tick the optimum investment fund. Thus was born the notion of a stock-index fund: a big pool of money, from thousands of investors, holding shares in exactly the same proportion as the real market overall. Of course, the details are not so simple. First decide what you mean by “the market”: just the thirty industrial stocks in the Dow, or the hundred shares in the British FTSE index? Should you include bonds? What about other risky assets, like home equity? And, whatever the market, you will still need to keep re-tuning the fund to track it.


pages: 305 words: 98,072

How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely by Andrew Craig

Airbnb, Albert Einstein, asset allocation, Berlin Wall, bitcoin, Black Swan, bonus culture, BRICs, business cycle, collaborative consumption, diversification, endowment effect, eurozone crisis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, index fund, information asymmetry, joint-stock company, Joseph Schumpeter, Long Term Capital Management, low cost airline, mortgage debt, negative equity, Northern Rock, offshore financial centre, oil shale / tar sands, oil shock, passive income, pensions crisis, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Silicon Valley, smart cities, stocks for the long run, the new new thing, The Wealth of Nations by Adam Smith, Yogi Berra, Zipcar

Which brings us to the second type of fund: passive funds are where a fund management company copies the performance of an index (see below). These funds are sometimes referred to as tracker or index funds (because they “track” an index). A good example would be a tracker on the FTSE 100. If you were to buy into such a fund it would aim to replicate as closely as possible the performance of the FTSE 100 Index. If you were to invest in a FTSE tracker, your money would essentially be divided between the 100 shares in the FTSE index. This is a crucial advantage of being in a fund, as you yourself would not be able to own all 100 stocks in the FTSE index unless you had a great deal of money and a great deal of time to devote to investment. These days even the super rich will tend to use a tracker or index fund to own the FTSE 100 stocks, as they would see too much of their potential return eaten up in fees if they actually bought all of the stocks in the FTSE 100 Index individually.

What this means is that you can now find indices and their related funds for pretty much any asset or country in the world: bonds, commodities, big companies, small companies, and stock market sectors such as banks, telecoms or pharmaceutical companies. The reason this is important for our purposes is that as a private investor you are able to “buy” these indices through a passive fund. There has been an explosion in the choice available for the private investor in recent years. If you have a strong view on the UK economy then you can buy a FTSE 100 index fund. Equally, if you think biotechnology companies are likely to have a good time, you can own them via a biotech index. If you feel that Singapore has a bright future, you can “own” Singapore. Within reason, you can own almost anything that occurs to you. If you read an article explaining why something has a bright future (graphene, thorium, tungsten, water, coal mining in Bangladesh, Brazilian oil, property in Montenegro, diamonds – the list is very, very long) you will be able to buy something that gives you financial exposure to that theme.

To do this, you buy a product that will make you money if the German stock market falls. Shorting is another great thing to be aware of. Many people have never heard of it and most have no idea that anyone can do it. You just need to know how. It should be noted that shorting is quite a risky and specialist activity and not be entered into lightly but it is well worth knowing that it is possible at the very least. The great thing about indices and index funds then is that they enable you to own or short hundreds of different shares even if you only have a small amount of money to invest – and to do so with low fees. Smart beta Something that has occurred since I wrote the first edition and is worth touching on briefly, is the development of so-called “smart beta” funds. These aim to give you the low cost and breadth of a passive or tracker fund but with the improved performance you would hope to achieve with an active fund.


pages: 139 words: 33,246

Money Moments: Simple Steps to Financial Well-Being by Jason Butler

Albert Einstein, asset allocation, buy and hold, Cass Sunstein, diversified portfolio, estate planning, financial independence, fixed income, happiness index / gross national happiness, index fund, intangible asset, longitudinal study, loss aversion, Lyft, Mark Zuckerberg, mortgage debt, passive income, placebo effect, Richard Thaler, ride hailing / ride sharing, Steve Jobs, time value of money, traffic fines, Travis Kalanick, Uber and Lyft, uber lyft, Vanguard fund, Yogi Berra

Costs are certain but returns aren’t and it makes no sense to pay any more than you have to in order to gain access to the stockmarket. Index funds basically deliver the returns of the overall stockmarket, but at much lower costs than funds managed by clever people who try to outperform the market. Jack Bogle is the founder of Vanguard, which with around £3 trillion is the second-largest mutual fund manager in the world. This is what he has to say about investing: ‘The index fund is a most unlikely hero for the typical investor. It is no more (nor less) than a broadly diversified portfolio, typically run at rock-bottom costs, without the putative benefit of a brilliant, resourceful, and highly skilled portfolio manager. The index fund simply buys and holds the securities in a particular index, in proportion to their weight in the index.


pages: 283 words: 81,376

The Doomsday Calculation: How an Equation That Predicts the Future Is Transforming Everything We Know About Life and the Universe by William Poundstone

Albert Einstein, anthropic principle, Any sufficiently advanced technology is indistinguishable from magic, Arthur Eddington, Bayesian statistics, Benoit Mandelbrot, Berlin Wall, bitcoin, Black Swan, conceptual framework, cosmic microwave background, cosmological constant, cosmological principle, cuban missile crisis, dark matter, digital map, discounted cash flows, Donald Trump, Doomsday Clock, double helix, Elon Musk, Gerolamo Cardano, index fund, Isaac Newton, Jaron Lanier, Jeff Bezos, John Markoff, John von Neumann, mandelbrot fractal, Mark Zuckerberg, Mars Rover, Peter Thiel, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, RAND corporation, random walk, Richard Feynman, ride hailing / ride sharing, Rodney Brooks, Ronald Reagan, Ronald Reagan: Tear down this wall, Sam Altman, Schrödinger's Cat, Search for Extraterrestrial Intelligence, self-driving car, Silicon Valley, Skype, Stanislav Petrov, Stephen Hawking, strong AI, Thomas Bayes, Thomas Malthus, time value of money, Turing test

The indexes quickly drop companies that have stopped winning, replacing them with new winners. Bessembinder’s data justify one familiar rule of personal investing: buy index funds (mutual funds or ETFs that hold a portfolio replicating a market index, such as the S&P 500). Many investors disdain the indexes’ returns as merely “average.” The error of this view is generally demonstrated when a small investor tries picking stocks himself. A few randomly chosen stocks are likely to perform much worse than “average.” We’ve all heard of the chimpanzee that throws darts at the stock listings. The ape is usually cited to dismiss the value of expertise. Most professional stock pickers do no better than the “random” picks of an index fund. But that chimp is not in fact a good metaphor for index funds. Consider a different experiment. The chimp throws a dart at the front page of the Wall Street Journal.

Nonetheless an incredible amount of effort goes into divining future stock performance from (what else?) the past. Statistics on corporate survival—and on tenure on ranked lists or indexes like the Fortune 500 or the S&P 500—show a Copernican effect. How long a company has existed (or been on the ranked list) is a rough predictor of how long it will survive (remain on the list). The Copernican principle has some relation to the survivor bias that plagues stock investors. At any given time, an index fund or portfolio tends to be weighted with stocks that have done well in the immediate past, but that are unlikely to perform comparably well in the long run. Investors are always grabbing gold that crumbles to ashes in their hands. A Broadway show is a special type of business. Like corporations, plays run for as long as their investors can hope to make a profit. But compared to corporations, Broadway shows are mayflies, with lifespans measured in weeks.

The Journal’s editorial policy is biased, naturally, toward companies with a large economic presence. Most of the firms that make the front page have already survived long past the average stock-issuing company’s lifespan. Another experiment would be for the ape to throw a dart at a listing of every share of stock—or better, every dollar invested in the stock market—and choose the company represented by that share or dollar. This is a better model of a capitalization-weighted index fund, such as one tracking the S&P 500. This form of random picking would also be skewed toward large-capitalization stocks that are, in some respects, not so average at all. Bessembinder’s findings imply that stocks are like lottery tickets. An investor needs to buy a large basket of them in order to have a fair shot at having a few winners—and thus matching the “average” returns we associate with indexes.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, business process, buy and hold, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, stocks for the long term, survivorship bias, The Great Moderation, Thomas Bayes, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

If Protégé wins, the money is to be given to Absolute Return for Kids (ARK), an international philanthropy based in London. If Buffett wins, the intended recipient is Girls Inc. of Omaha. To see more information about the bet, go to www.longbets.org. During the course of 2008, the Vanguard S&P 500 fund was down 37 percent and on average (net of all fees, costs, and expenses) the five funds-of-funds selected by Protégé were down 23.9 percent. At year-end 2009, the Vanguard 500 Index Fund’s (VFINX) return was 26.5 percent while the HFRI Fund of Funds Composite Index (a proxy for the five funds-of-hedge-funds) was up 11.2 percent for the year. After two years of performance, the approximate BAV (Bet Asset Value) is: Protégé 84.6; Buffett 79.7. You cannot have it both ways. Either you take an absolute return approach regardless of the market environment, or you just go for efficient beta and be happy with the outcome.

Speaking at a conference in the spring of 2008, I said there is a good chance the market goes to hell because the system needs to be cleaned and we have to pay for an orgy of credit. People thought I was crazy. A year ago I was a cash manager. Then I became a corporate bond buyer—I did not care about stocks. Six months ago I became a value stock buyer, buying all the deep value I could find. Now I am a long-only index fund, trying not to get whipsawed by the market’s gyrations and trying not to get distracted by people talking about the end of the rally. I am working from the principle that the big fear is behind us. Because people are only as good as their last six months in our industry, those who were negative and have not participated in the recent rally are looking for an excuse. In markets, you cannot be one thing or another; rather, you have to evolve according to different market environments.

But this year I probably made 10 times more money in bank stocks than a traditional mutual fund financial specialist made over the last few years because financials were completely wiped out. Identifying a new subject and having the flexibility and the skill to go trade it is what is required. So you read the papers and watch the tape all day, every day, in markets around the world? At times like the present, I do nothing—again, I am an index fund right now. I do not want to watch the tape—I do not care about the tape. Sometimes it is very important to look at the tape, but not right now. Sometimes, as a fund manager, it is very important to escape from the markets in order to avoid getting disturbed by the noise. I try to stay out of the office now. Every time the market has a wobble my traders get nervous and say it looks very bad—they want to sell everything, yet I tell them to buy.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stocks for the long run, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

(This could have been accepted, had they not as a group consistently underperformed index funds.) Lumping alpha and beta together in a tie-in sale made sense for sellers who could add some long-run value by providing access to the equity premium (and camouflaging any underperformance), but not for buyers, who could access the equity premium much more cheaply through index funds. Add a notion that HF managers can provide positive alpha even after their costs and fees—unlike traditional managers—and, voilà, alpha–beta separation is the way to go. A barbell of very cheap index funds (beta providers) and more expensive hedge funds (alpha providers) can be more cost-effective than investment in a traditional long-only fund. This argument became a great defense against institutional investors’ qualms about high HF fees: the blended fee in a portfolio of index funds and hedge funds is arguably competitive with traditional active long-only managers if we consider their alpha–beta mix (both contain equity beta but HFs much less than traditional long-only) and insist that beta exposure should earn only an index fund fee.

A key example is the S&P 500 inclusion effect—the finding that new entries to the S&P 500 index experience a sudden and persistent price jump, presumably due to new buying pressure from index funds. Shleifer (1986) argued that if stocks have horizontal demand curves, no price impact is expected, but if demand curves are downward sloping, the rightward shift in the demand curve implies a sudden price increase, consistent with the evidence. Later research shows that the degree of substitutability varies (some stocks to be included have close counterparts, while others have much lower correlations—and thus have greater arbitrage risk). Stocks lacking close substitutes experience higher price jumps upon inclusion into the S&P 500. Still, index funds are expected by their investors to hold every stock in the S&P 500 index and some price pressure effect should be observed for any stock added to that index, no matter how many close substitutes the stock has.

This argument became a great defense against institutional investors’ qualms about high HF fees: the blended fee in a portfolio of index funds and hedge funds is arguably competitive with traditional active long-only managers if we consider their alpha–beta mix (both contain equity beta but HFs much less than traditional long-only) and insist that beta exposure should earn only an index fund fee. Not surprisingly, most institutional inflows after the millennium have gone into the alpha–beta barbell—not to traditional managers. A variation on this strategy is alpha transport (portable alpha). A beta position is established using index derivatives, which do not tie up very much capital. Then, a portfolio of HFs is assembled to add alpha. (HFs do require that the investor put up capital.) This blend substitutes for the more traditional strategy of selecting active managers with the beta position as their benchmark. For years, the HF industry had a wonderful marketing story, especially as long as investors believed that all returns produced by the mythical “good” HF manager are pure alpha.


pages: 264 words: 115,489

Take the Money and Run: Sovereign Wealth Funds and the Demise of American Prosperity by Eric C. Anderson

asset allocation, banking crisis, Bretton Woods, business continuity plan, business process, buy and hold, collective bargaining, corporate governance, credit crunch, currency manipulation / currency intervention, currency peg, diversified portfolio, fixed income, floating exchange rates, housing crisis, index fund, Kenneth Rogoff, open economy, passive investing, profit maximization, profit motive, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, sovereign wealth fund, the market place, The Wealth of Nations by Adam Smith, too big to fail, Vanguard fund

Tan Wei, “China’s CIC likely to Diversify away from Further U.S. Banking Sector Investments, Source Says,” Financial Times, 30 December 2007. 120. An index fund is a passively managed mutual fund that tries to mirror the performance of a specific index, such as the S&P 500. An index fund aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions. Tracking can be achieved by trying to hold all of the securities in the index, in the same proportions as the index. Other methods include statistically sampling the market and holding “representative” securities. Many index funds rely on a computer model with 218 Notes little or no human input in the decision as to which securities to purchase and is therefore a form of passive management. 121.

In an effort to earn a greater return, the managers of Norway’s Government Pension Fund adopted a macro-level investment formula that calls for placing 60% of Oslo’s portfolio in indexed equities and the remaining 40% in fixed income instruments.30 The head of the Kuwait Investment Authority contends he seeks to follow a model employed at the Harvard and Yale endowment funds—a mix of stocks, private equity funds, and real estate.31 The manager of Russia’s stabilization fund reports he is required to pursue an even broader mix of investments ranging from foreign currencies to shares in investment funds.32 Unfortunately, this turn to private equity does not mean simply shifting the monies from Washington to New York. As investors at Harvard and Yale have discovered, a long-term commitment to indexed funds listed on Wall Street is not as profitable as many Americans would like to believe. Increasingly, diversification in the sovereign wealth fund world means placing the money in assets Sovereign Wealth Funds: The Peril and Potential for America 9 outside the United States. All of this suggests that the big losers here are not just the U.S. Treasury; corporate America is also poised to begin paying more for the privilege of borrowing money.

According to the Norges Bank Investment Management team, their performance could best be attributed to two events: (1) the fund’s move to place more than 40% of its investments in the equity market since 1998, and (2) the “worst decline in global equities markets since the 1930s,” which began in 2000.37 Needless to say, this performance has garnered significant criticism at home, with at least one critic claiming the fund’s investment managers only “make Norway more poor.”38 (The Norges Bank team actually did not do as poorly as one might first suspect. A review of stock performance using a buy-and-hold model for the same time period (1998–2006) reveals that the following rates of return could have been expected by purchasing only “name brand” shares: Dow Jones Industrials 6.11%, Standard & Poor’s 500 Index 4.94%, Vanguard 500 Index Fund 7.37%, and NASDAQ Composite Index 5.88%.) China’s new sovereign wealth fund managers have also suffered setbacks in their efforts to wisely invest the approximately $200 billion39 Beijing has placed in their hands.40 The China Investment Corporation (CIC) purchased a 9.3% share of the Blackstone Group private equity firm for $3 billion prior to the firm’s initial public offering (IPO) in June 2007.


pages: 263 words: 89,368

925 Ideas to Help You Save Money, Get Out of Debt and Retire a Millionaire So You Can Leave Your Mark on the World by Devin D. Thorpe

asset allocation, buy and hold, call centre, diversification, estate planning, fixed income, Home mortgage interest deduction, index fund, knowledge economy, money market fund, mortgage tax deduction, payday loans, random walk, risk tolerance, Skype, Steve Jobs, transaction costs, women in the workforce, zero-sum game

Fees vary widely from fund to fund. Funds that seek to beat market returns are often called actively managed funds; these funds tend to charge more. Funds that seek to match the return of a market index are called index funds. They can match market returns more easily because they simply buy a basket of stocks (or bonds) that represent the index well. The composition of most indexes changes infrequently so little management of index funds is required so their costs are much lower. Since most funds don’t beat the market consistently and those that try have higher fees, buying index funds with low expense ratios seems a good bet. Other Fees and Expenses: Mutual funds may charge you a variety of fees and expenses, but all must be disclosed before you make your purchase. It is impossible to predict accurately the returns you’ll earn on a mutual fund investment.

Consider the costs: mutual fund managers collect their money by charging the investors small fees to enter the fund and for managing the money each year. The “load” refers to the fee to enter the investment and the “expense ratio” refers to the annual cost. If you invest in a fund with a 6% load and a 2% expense ratio, your fund will need to generate an 8% annual return (tough to do) just for you to break even in the first year. Look for “no load” funds and funds with low expense ratios. Many of the lowest cost funds are “index” funds that don’t try to beat a market index, they just try to match it. Given that very few funds consistently beat the market, focusing on fees is a great way to keep your money growing. Evaluate the risk: consider your personal appetite for risk and screen mutual funds to find those that appeal to your sense of adventure or your fear of falling, as the case may be. Remember that risk is generally compared among funds of the same class.

Any bond fund has the potential to lose value, but generally they tend to be more stable in value than stock funds. Bond funds are suitable investments for both retirement savings and college savings accounts. For college funds, emphasize short and intermediate term funds. Sector Funds: There are number of funds that focus all of their investments on stocks in a particular sector. These funds tend to be much riskier. The broad index funds provide real diversification because they invest in a variety of companies from across the economic landscape. Sector funds concentrate their bets on a single industry. All of the companies in an industry face the same economic challenges—and benefits together. Hence, these funds behave much more like individual stocks with much greater swings in value. As a general rule, these are not suitable investments.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

"Robert Solow", Albert Einstein, Bayesian statistics, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, Thales and the olive presses, Thales of Miletus, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

For instance, he produced a discrete-time binomial option pricing procedure that offered a readily applicable procedure for BlackScholes securities pricing, which will be covered in the next part of this book. He also developed the Sharpe ratio, a measure of the risk of a mutual or index fund versus its reward. Sharpe continued to work to make financial concepts more democratic and more accessible. He helped develop Financial Engines, an Internetbased application to deliver investment advice online. 78 The Rise of the Quants Ever concerned about the practitioner’s side of finance, Sharpe began to consult with investment houses, first Merrill Lynch and then Wells Fargo. At Merrill Lynch, he helped set up their CAPM analysis capacity. At Wells Fargo, he helped develop methodologies for the creation of index funds and the assessment of portfolio risk. In 1986 Sharpe collaborated with the Frank Russell Company to establish the Sharpe-Russell Research firm.

By this we mean that there are no transactions costs or taxes, that no trader has the power to influence prices and all are equally and costlessly informed, that assets can be traded in infinitely divisible amounts, and that expectations are homogenous while investors are rational maximizers in the domain of security means and variances. In addition, the market portfolio must contain all securities in proportion to their relative capitalization, and each security is efficiently priced according to its risk. If we accept these premises, there is an important consequence. An individual investor is freed from analyzing the entire market and can simply hold a market portfolio, or an efficient index fund. The investor can price additions to the portfolio by simply considering the security’s beta. Then the market acts as a pool of the risk aversion of all participants, weighted by their holdings, and each individual security is simply priced relative to its covariance relative to the market variance. All securities price risk efficiently and hence the combination of any two securities could replicate the market portfolio.

Lorie (1922–2005) and the CBOE’s champion and first Vice Chairman, Edmund O’Connor. Lorie was renowned at the time for his creation of the Center for Research in Stock Prices (CRSP) database, still the most commonly employed finance database for financial academics today. He had also Applications 119 come across Black when Black and Associates was advocating for Wells Fargo to create various index funds. At the same time, O’Connor had risen to leadership at the CBOT and had convinced skeptics on the Board that the time was ripe for the world’s first options exchange. O’Connor was convincing and helped bring the CBOE to fruition in 1973, within months of Black and Scholes’ publication. William Brodsky, Chairman of the CBOE, reported that: “Although the idea came from Ed and a couple of others at the Board of Trade, they were constantly fighting at the Board of Trade about whether it should even happen and whether it should continue to be funded.


One Up on Wall Street by Peter Lynch

air freight, Apple's 1984 Super Bowl advert, buy and hold, corporate raider, cuban missile crisis, Donald Trump, fixed income, index fund, Irwin Jacobs, Isaac Newton, large denomination, money market fund, prediction markets, random walk, shareholder value, Silicon Valley, Y2K, Yom Kippur War, zero-sum game

You can get ten percent, over time, by investing in a no-load mutual fund that buys all 500 stocks in the S&P 500 Index, thus duplicating the average automatically. That this return can be achieved without your having to do any homework or spending any extra money is a useful benchmark against which you can measure your own performance, and also the performance of the managed equity funds such as Magellan. If professionals who are employed to pick stocks can’t outdo the index funds that buy everything at large, then we aren’t earning our keep. But give us a chance. First consider the kind of fund you’ve invested in. The best managers in the world won’t do well with a gold-stock fund when gold prices are dropping. Nor is it fair to judge a fund for a single year’s performance. But if after three to five years or so you find that you’d be just as well off if you’d invested in the S&P 500, then either buy the S&P 500 or look for a managed equity fund with a better record.

Even so, it still costs between one and two percent for Houndstooth to buy or sell a stock. So if Houndstooth turns over the portfolio once a year, he’s lost as much as four percent to commissions. This means he’s four percent in the hole before he starts. So to get his 12–15 percent after expenses, he’s going to have to make 16–19 percent from picking stocks. And the more he trades, the harder it’s going to be to outperform the index funds or any other funds. (The newer “families” of funds may charge you a 3–8½ percent fee to join, but that’s the end of it, and from then on you can switch from stocks to bonds to money-market funds and back again without ever paying another commission.) All these pitfalls notwithstanding, the individual investor who manages to make, say, 15 percent over ten years when the market average is 10 percent has done himself a considerable favor.

In the 1970s a forty-to sixty-million-share day was normal, and in the 1980s it became 100–120 million shares. Now if we don’t have 150-million-share days, people think something is wrong. I know I do my part to contribute to the cause, because I buy and sell every day. But my biggest winners continue to be stocks I’ve held for three and even four years. The rapid and wholesale turnover has been accelerated by the popular index funds, which buy and sell billions of shares without regard to the individual characteristics of the companies involved, and also by the “switch funds,” which enable investors to pull out of stocks and into cash, or out of cash and into stocks, without delay or penalty. Soon enough we’ll have a 100 percent annual turnover in stocks. If it’s Tuesday, then I must own General Motors! How do these poor companies keep up with where to send the annual reports?


Systematic Trading: A Unique New Method for Designing Trading and Investing Systems by Robert Carver

asset allocation, automated trading system, backtesting, barriers to entry, Black Swan, buy and hold, cognitive bias, commodity trading advisor, Credit Default Swap, diversification, diversified portfolio, easy for humans, difficult for computers, Edward Thorp, Elliott wave, fixed income, implied volatility, index fund, interest rate swap, Long Term Capital Management, margin call, merger arbitrage, Nick Leeson, paper trading, performance metric, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, survivorship bias, systematic trading, technology bubble, transaction costs, Y Combinator, yield curve

Technical systems are easier to build and run, but in another example of barriers to entry the additional effort required for including fundamental rules is usually rewarded with higher returns. The examples in this book are all technical, but only because they are simpler to explain. Portfolio size There are successful traders who only ever trade one futures contract. At the other extreme large equity index funds could have thousands of holdings. Remember that the law of active management shows that diversification is the best source of additional risk adjusted returns. Both traders and investors should hold more positions when they can; ideally across several asset classes to get the greatest possible benefit. With larger portfolios you’re also less exposed to instrument specific problems such as bad data or temporary liquidity issues.

However there are certain instruments that should be completely avoided for systematic trading. Others have characteristics which make them worse than other alternatives, or would force you to trade them in a particular way. Finally there is often a choice of how you can access a particular market; you could get Euro Stoxx 50 European equity index exposure by buying the individual shares, trading a future, a spread bet, a contract for difference, a passive index fund or an active fund. Which is best? 101 Systematic Trading Chapter overview Necessities The minimum requirements that need to be met before you can trade an instrument. Instrument choice and trading style Characteristics that influence instrument choice alternatives and how to trade particular instruments. Access Different ways to get exposure to instruments, and the benefits and downside of each.

Normally more expensive than passive funds, as active fund managers think they can generate, and charge for, alpha. Hedge funds are an extreme example of active funds. As distinct from passive funds and passive management. See page 106. Alpha The returns of an active manager or trader can be split into beta and alpha. The beta are the returns you could get from investing in the general market, i.e. in a passive index fund. Any additional return due to the manager’s skill is alpha. Alternative beta A kind of beta, but which requires active trading to achieve. So for example to earn the equity value premium, which is the return from being long low price:earnings (PE) and short high PE equities, you need to buy and sell the appropriate shares at the right time. Like beta, and unlike alpha, this kind of return does not require skill.


pages: 249 words: 77,342

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, Black Swan, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impulse control, index fund, Isaac Newton, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta analysis, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, passive investing, pattern recognition, Ponzi scheme, prediction markets, random walk, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, Thales of Miletus, The Signal and the Noise by Nate Silver, tulip mania, Vanguard fund

The rise of passive investing also means that stocks included in large indices tend to be less informationally efficient than those not in such company. Michael Mauboussin and company report that, “in mid-2016, passive index funds and ETFs owned 10 percent or more of 458 of the 500 companies in the S&P 500. In 2005, that was true for only 2 of the 500.” Increasingly, large swaths of a corporation are being bought and sold out of habit and not conviction, meaning that prices are less and less reflective of true value. Speaking to this phenomenon Jesse Felder has said, “‘passive investing’ will ultimately become a victim of its own success. The massive shift to index funds over the past 15 years or so drove the valuations of the largest index components to levels which guarantee poor returns going forward. Poor returns, in turn, will guarantee these inflows will turn to outflows and the virtuous cycle will become a vicious one.”

Passive management, which makes the yardstick the investment vehicle, falls prey to some of the shortcomings of the Cobra Effect as a result. But before I render a nuanced behavioral critique of passive investing (and anger an army of Bogleheads with pitchforks), let me speak to some of its considerable strengths. To be as direct as possible, passive investing should be the de facto choice of those uninterested in the art and science of investment management. By buying a diversified basket of index funds that covers a variety of asset classes, know nothing investors (who often know a great deal) are likely to beat more than 90% of active managers and have time to focus on pursuits more meaningful than compounding wealth. Since passive management eschews costly research and rock star managers, passive vehicles tend to be far less expensive than their active brethren; a huge win for investors. All else being equal, investors should always choose the least expensive fund as fees cut directly into performance and can dramatically reduce wealth over a lifetime of investing.

But if there is one lesson to be learned from financial history, it is that universal consensus tends to portend bad news. As Aaron Task said in his thoughtful blog piece, ‘Pride Cometh Before the Fall: Indexing Edition’: “when ‘everybody’ knows something, it’s usually a good time to head in the opposite direction. And what ‘everybody’ knows now is that the very best, smartest investment you can make is an index fund.” Is it possible that indexing being the de facto right answer is somehow making it less right? A victim of success One Cobra Effect of indexing is that the very inclusion of a company in an index leads to an immediate increase in the price-to-earnings and price-to-book ratios of the stock. Being a part of an index means that millions of investors will buy the stock, not based on any fundamental belief in its goodness, but rather lockstep adherence.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

"Robert Solow", Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Blythe Masters, Bretton Woods, British Empire, business cycle, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, different worldview, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Kickstarter, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

Most immediately, it raised the popularity of “index funds”—mutual funds that bought large baskets of stocks, seeking to replicate the performance of the overall market. If fundamental analysis doesn’t work and most fund managers routinely fail to outperform the market, there can be no justification for the hefty fees that actively managed mutual funds charge investors. Investing in index funds, which keep their fees at minimal levels, is much more sensible. By 2000, tens of millions of Americans had taken Malkiel’s advice and placed much of their retirement money in these types of savings vehicles. (For many years, Malkiel served as a director of the Vanguard Group, which pioneered index funds. Fama joined another firm that manages index funds, Dimensional Fund Advisors.) The rise of efficient market theory also signaled the beginning of quantitative finance.

Wall Street had three answers: diversification, subordination, and the building up of reserves. The argument for diversification was the same one that applies to salting away your retirement savings in mutual funds rather than investing in individual stocks. If you put all of your money in one company and it goes bankrupt, you lose everything; if you invest in five hundred companies, through an index fund, say, and one of them goes out of business, it shouldn’t have much impact on the value of the fund. A bit more formally, the Nobel-winning financial theorist Harry Markowitz demonstrated back in the 1950s that diversification allows investors to minimize the impact of particular damaging events, or what is often referred to as “idiosyncratic risk.” If the oil price plummets, the oil stocks in your retirement fund will probably go down, but cheaper gas frees up cash that gets spent on other things, and the stock in the sectors that benefit, such as retailers and restaurants, should go up.

.”: Quoted in John Cassidy, Dot.con: The Greatest Story Ever Sold (New York: HarperPerennial, 2002), 122–23. 179 “[I]f they want to beat their . . .”: Quoted in “Valuing Those Internet Stocks,” BusinessWeek, February 8, 1999. 179 “I simply can’t analyze . . .”: Quoted in Fidelity Magellan Annual Report, March 31, 1999, available at www.secinfo.com/d1RUq.6c.htm. 179 “Time has come . . .”: “Fidelity Magellan Fund-FMAGX-Rated ‘Aggressive Buy’ and Vanguard 500 Index Fund-VFINX-Rated ‘Buy’ by FidelityAdviser.com,” Business Wire, April 1, 1999. 180 “Is the stock market in a speculative bubble?”: Lauren R. Rublin, “Party On! America’s Portfolio Managers Grow More Bullish on Stocks and Interest Rates,” Barron’s, May 3, 1999, 31–38. 181 Pension fund investment in the Internet bubble: Eli Ofek and Matthew Richardson, “DotCom Mania: The Rise and Fall of Internet Stock Prices,” Journal of Finance 57, no. 3 (June 2003): 1122. 181 “From an efficient markets perspective . . .”: Markus K.


Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, Franklin Allen

3Com Palm IPO, accounting loophole / creative accounting, Airbus A320, Asian financial crisis, asset allocation, asset-backed security, banking crisis, Bernie Madoff, big-box store, Black-Scholes formula, break the buck, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, carried interest, collateralized debt obligation, compound rate of return, computerized trading, conceptual framework, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, discounted cash flows, disintermediation, diversified portfolio, equity premium, eurozone crisis, financial innovation, financial intermediation, fixed income, frictionless, fudge factor, German hyperinflation, implied volatility, index fund, information asymmetry, intangible asset, interest rate swap, inventory management, Iridium satellite, Kenneth Rogoff, law of one price, linear programming, Livingstone, I presume, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, market friction, money market fund, moral hazard, Myron Scholes, new economy, Nick Leeson, Northern Rock, offshore financial centre, Ponzi scheme, prediction markets, price discrimination, principal–agent problem, profit maximization, purchasing power parity, QR code, quantitative trading / quantitative finance, random walk, Real Time Gross Settlement, risk tolerance, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, Silicon Valley, Skype, Steve Jobs, The Nature of the Firm, the payments system, the rule of 72, time value of money, too big to fail, transaction costs, University of East Anglia, urban renewal, VA Linux, value at risk, Vanguard fund, yield curve, zero-coupon bond, zero-sum game, Zipcar

This bond portfolio’s expected annual rate of return is 9%, and the annual standard deviation is 10%. Amanda Reckonwith, Percival’s financial adviser, recommends that Percival consider investing in an index fund that closely tracks the Standard & Poor’s 500 Index. The index has an expected return of 14%, and its standard deviation is 16%. a. Suppose Percival puts all his money in a combination of the index fund and Treasury bills. Can he thereby improve his expected rate of return without changing the risk of his portfolio? The Treasury bill yield is 6%. b. Could Percival do even better by investing equal amounts in the corporate bond portfolio and the index fund? The correlation between the bond portfolio and the index fund is +.1. 17. Cost of capital Gianni Schicchi is evaluating an expansion of his business. The cash-flow forecasts for the project are as follows: The firm’s existing assets have a beta of 1.4.

Calculate beta for each stock using the Excel function SLOPE, where the “y” range refers to the stock return (the dependent variable) and the “x” range is the market return (the independent variable). c. How have the betas changed from those reported in Table 7.5? 3. A large mutual fund group such as Fidelity offers a variety of funds. They include sector funds that specialize in particular industries and index funds that simply invest in the market index. Log on to www.fidelity.com and find first the standard deviation of returns on the Fidelity Spartan 500 Index Fund, which replicates the S&P 500. Now find the standard deviations for different sector funds. Are they larger or smaller than the figure for the index fund? How do you interpret your findings? ___________ 1See E. Dimson, P. R. Marsh, and M. Staunton, Triumph of the Optimists: 101 Years of Investment Returns (Princeton, NJ: Princeton University Press, 2002). 2Treasury bills were not issued before 1919.

BEYOND THE PAGE ● ● ● ● ● Mutual fund cumulative returns brealey.mhhe.com/c13 BEYOND THE PAGE ● ● ● ● ● Mutual fund performance brealey.mhhe.com/c13 The evidence on efficient markets has convinced many professional and individual investors to give up pursuit of superior performance. They simply “buy the index,” which maximizes diversification and cuts costs to the bone. Individual investors can buy index funds, which are mutual funds that track stock market indexes. There is no active management, so costs are very low. For example, management fees for the Vanguard 500 Index Fund, which tracks the S&P 500 Index, were .17% per year in 2011 (.06% per year for investments over $10,000). The size of this fund was $102 billion. How far could indexing go? Not to 100%: If all investors hold index funds then nobody will be collecting information and prices will not respond to new information when it arrives. An efficient market needs some smart investors who gather information and attempt to profit from it.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, tulip mania, wage slave

Long-term, investors were better off investing in the index fund than with active managers. Like Gary Kasparov being beaten by Deep Blue, a low-cost, mechanical rule of holding US equities in proportion to their company size turns out to eventually perform better than most managers. Even though by chance some active managers may beat the market in the long term, it is hard to figure out in advance who will outperform. Why does the indexation policy grind its competitors into dust? Simple: low fees and low trading costs. Active managers are expensive. They do a lot of research; they gather and digest information. They maintain staffs of analysts covering the prospects for various industries. They monitor economic developments that might affect the value of their securities. In contrast, index funds simply hold everything.

Following Lowenfeld’s maxim to diversify internationally, as a group, London’s investors in the golden age of globalization appear to have held assets in near-optimal proportion, as given by a Markowitz model.2 The CAPM is not only an elegant—though abstract—theory, but it is actually widely used for many things in finance. The prediction it makes about equilibrium rates of expected return for high-beta stocks and low-beta stocks is used in corporate decision-making and risk analysis. The prediction about the universal demand for holding a capital-weighted portfolio of assets led to the development of a new type of investment product, an index fund. INDEXATION The development of passive index-based investing came about from the convergence of two streams of academic research in the 1970s. The first is the CAPM result about the market portfolio. Sharpe’s model was a marketer’s dream, because it predicts immediate, widespread demand for a very simple product. The second was a re-consideration of the case for equity investment. In the 1970s, with Edgar Lawrence Smith mostly forgotten, two young Chicago professors, Roger Ibbotson and Rex Sinquefield, decided to return to the basic question of whether stocks were a good long-term investment.

See Great Depression derivatives, financial, 276; on Law’s Mississippi Company shares, 357; pricing models for, 284; Regnault’s valuation of, 281 Detroit, bankruptcy of, 517 development: China’s Self-Strengthening Movement and, 430; imperialism associated with, 418–19; World Bank and, 459. See also economic growth De Witt, Johan, 255–57, 262, 266, 270 Dilmun, in Mesopotamian copper trade, 53–55, 58, 59, 64 Dimson, Elroy, 464 discovery. See exploration Disraeli, Benjamin, 420 diversification of investments: in ancient Near East, 58, 61, 64; in Athenian maritime trade, 79; with first British investment funds, 417; globalization of equity and, 403; by index funds, 508, 509–11; by investment trusts, 473–74; limited liability and, 119–20; Lowenfeld’s science of, 414–16, 453, 470; modern science of, 404; portfolio optimization models for, 504–8; Roman publican societies and, 123. See also mutual funds dividend futures, of Casa di San Giorgio, 292 dividends: of Casa di San Giorgio, 291–92; of China Merchants Steamship Navigation Company, 431, 432; of Dutch East India Company, 317, 318; of Honor del Bazacle, 297, 298, 299; in Marxist analysis, 408; from Smith’s investment funds, 473; of South Sea Company, 339, 340 divination, Chinese, 146–47, 271 Dodd, David, 473, 489–90, 507 double-entry bookkeeping, 246–47 Dow, Charles Henry, 486 Dow Theory, 486–88 Drehem tablet, 37–40, 44, 70, 71 Drew, Daniel, 470 Dunhuang, 177 Dutch canal and dike system, 249–52 Dutch East India Company (VOC), 305, 316–19, 331; Rotterdam and, 363; stock prices in 1720, 369; tradable shares of, 316, 317–18 Dutch finance.


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The Little Book of Hedge Funds by Anthony Scaramucci

Andrei Shleifer, asset allocation, Bernie Madoff, business process, carried interest, corporate raider, Credit Default Swap, diversification, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, fixed income, follow your passion, Gordon Gekko, high net worth, index fund, John Meriwether, Long Term Capital Management, mail merge, margin call, mass immigration, merger arbitrage, money market fund, Myron Scholes, NetJets, Ponzi scheme, profit motive, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, risk/return, Ronald Reagan, Saturday Night Live, Sharpe ratio, short selling, Silicon Valley, Thales and the olive presses, Thales of Miletus, the new new thing, too big to fail, transaction costs, Vanguard fund, Y2K, Yogi Berra, zero-sum game

Scott Frush, Understanding Hedge Funds (New York: McGraw-Hill, 2006). 4. Mark J. P. Anson, The Handbook of Alternative Assets (Hoboken, NJ: John Wiley & Sons, 2006), 123. Chapter One What Is a Hedge Fund? The Traditional Long-Only Portfolio versus the Alternative Hedge Fund Portfolio Hedge funds are generally perceived to be the investment of choice of the rich and the informed, and they are more interesting and fun to discuss than your Vanguard index fund. —Cliff Asness, AQR Capital Management The year was 1989. I had just started working at Goldman Sachs in the world of investment banking—the industry adored by many Ivy League students and business school graduates. A few floors up, legendary research director Lee Cooperman was asked by Goldman Sachs to create a mutual fund and lead the Asset Management Division. This long-only equity mutual fund was called GS Capital Growth.

—John Brooks, The Go-Go Years Think about it: If it didn’t exist somebody would have invented it. A system of money management that allows the manager and the capital to have an efficient, symbiotic, and symmetrical relationship. Here’s the deal. There are boring ways to run money, the blunt instruments of asset management—long-only mutual funds and their arch nemeses, the exchange-traded fund (ETF) and the index fund. These products have their followers, and, of course, the true believers will assert the sanctity of their respective product lines with religious ferocity and certainty. Then there are the curmudgeons of finance, the Old Salts who have been there and done that. Can’t fool them—ever—and while there is a sucker born every minute there are 10 sages born in a century, and each of them knows it all.

Chapter Nine The Men Behind the Curtains Fund of Hedge Funds A fund of funds due to the fees involved will, over time, underperform the ETF on the S&P 500. I’ll betcha. —Warren Buffett (well, not really) Okay. Warren buffett never uttered the words above, but he may as well have. In 2008, the Oracle of Omaha bet Protégé Partners LLC—a money management firm that runs a fund of hedge funds—that the returns from a low-cost S&P 500 Index fund sold by Vanguard will outperform the average returns delivered by 5 fund of hedge funds (net of fees, costs, and expenses) over 10 years. Having put up roughly $320,000 on each side, this winner-takes-all wager is serious business. Although the 2007 to 2009 economic crisis put Buffett behind, he is now closing the gap. But, the fact remains that many people question the validity of this alternative investment vehicle that provides investors with access to the historically inaccessible world of hedge funds and their legendary managers.


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The Dhandho Investor: The Low-Risk Value Method to High Returns by Mohnish Pabrai

asset allocation, backtesting, beat the dealer, Black-Scholes formula, business intelligence, call centre, cuban missile crisis, discounted cash flows, Edward Thorp, Exxon Valdez, fixed income, hiring and firing, index fund, inventory management, Mahatma Gandhi, merger arbitrage, passive investing, price mechanism, Silicon Valley, time value of money, transaction costs, zero-sum game

Because of these fundamental facts, investors are better off investing in an index fund versus most of the actively managed mutual fund universe. My take on Mr. Buffett’s fee structure was that it was very fair. If stocks on average deliver 10 percent a year, the typical mutual fund investor would net about 8.5 percent, the typical hedge fund investor would net about 6.8 percent (assuming a 1.5 percent and 20 percent structure), and an index fund investor would net around 9.7 percent. In this scenario, an investor in the Buffett Partnerships would net 9 percent—higher than virtually all active management options. If markets were up just 5 percent in a given year, the average mutual fund investor would net 3.5 percent, the hedge fund investor would net just 2.8 percent, the index fund investor would net 4.7 percent, and Buffett Partnership investors would net the full 5 percent—higher than all options.


pages: 200 words: 54,897

Flash Boys: Not So Fast: An Insider's Perspective on High-Frequency Trading by Peter Kovac

bank run, barriers to entry, bash_history, Bernie Madoff, computerized markets, computerized trading, Flash crash, housing crisis, index fund, locking in a profit, London Whale, market microstructure, merger arbitrage, prediction markets, price discovery process, Sergey Aleynikov, Spread Networks laid a new fibre optics cable between New York and Chicago, transaction costs, zero day

As any experienced trader will tell you, sometimes odd lots are necessary when you need to precisely offset or hedge your risk in something else. For example, P&G is a large component of the Dow Jones Industrials stock index. If you sold 3,000 shares of the Dow index fund, you might hedge that sale by purchasing the number of shares of P&G that trade represents – about 190 shares. Or if you sold 2,000 shares of the Dow index fund, you might hedge that sale by purchasing the number of shares of P&G that trade represents – about 130 shares. (The ratios change over time, and vary slightly based on the precise model used.) So imagine this: some trader sells 3,000 shares of DIA, an exchange-traded index fund that represents the Dow Jones index. He wants to immediately hedge his risk in P&G and looks to buy the equivalent number of shares. He could buy those shares at the displayed offer in the public markets of $80.52.


pages: 201 words: 62,593

The Automatic Millionaire, Expanded and Updated: A Powerful One-Step Plan to Live and Finish Rich by David Bach

asset allocation, diversified portfolio, financial independence, index fund, job automation, late fees, money market fund, Own Your Own Home, risk tolerance, transaction costs, Vanguard fund

The only bummer is that the account minimum, as I write this, is $50,000 for these services. THE ROBO ADVISORS—NEW PLAYERS TO MAKE IT AUTOMATIC One of the biggest changes in investing since I wrote the original version of this book is the appearance of a new type of investment advisory service generally referred to as “robo advisors.” Using technology, these primarily online-only firms offer professionally managed portfolios made up of low-cost funds (usually ETFs and index funds). Here’s how it works: You go online and answer a series of questions on an automated form. Based on the information you provide, the system automatically builds a model portfolio for you in seconds. These professionally managed portfolios are then run on “autopilot” for a fraction of what it would cost to work with a traditional human advisor. Think “Automatic Millionaire” money management, and you really have the idea.

Some of these funds have a specific year in their name (for example, the 2030 fund or the 2040 fund), the idea being that you select the fund closest to your projected retirement date. Most companies also offer what is called a balanced fund. A balanced fund offers professional management and an asset allocation that is typically 60 percent stock and 40 percent bonds. Some companies may be now offering a version of the robo advisor model I discussed before, primarily using ETFs and index funds to keep costs low. Also many companies are now offering a service provided by a company called FinancialEngines (www.​financialengines.​com) to help you build, monitor, and rebalance your investments in your 401(k) retirement account automatically. You may want to check them out to help you build your portfolio and plan for retirement. (Review their fees with them, however, before you hire them—it’s not a free service and the fees are based on how much money is in your account).

If you invest your money according to the Automatic Millionaire Investment Pyramid, as I suggest on this page, you will end up with a well-diversified portfolio that is professionally managed. Even better, if you invest in one balanced fund or asset allocation fund that diversifies your portfolio for you AND you automate your contributions—which, after all, is the point of this little book—you’ll have a really boring financial life. The same is true if you use a robo advisory firm or a model portfolio of index funds and ETFs. Your money will be totally diversified, professionally balanced and managed, and your savings plan will be on automatic pilot. Of course, if you did this, you’d have nothing to talk about at cocktail parties when people bring up the subject of how they are investing their money. No one brags about having a really simple, well-diversified investment portfolio. So you’d need to find something else to talk about at parties.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, buy and hold, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, disruptive innovation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, John Meriwether, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost airline, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, money market fund, moral hazard, mortgage debt, Myron Scholes, NetJets, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

Vanguard – the largest asset management firm after Black-Rock and Allianz – was established in 1975 by Jack Bogle, an evangelical promoter of passive investment.7 Bogle’s thesis was that, since the chances of out-performing a stock market index on a sustained basis were slight, replicating that index was a simple and inexpensive investment strategy. Passive investment has steadily grown in scale, and much of the activity of BlackRock, Vanguard and State Street is in the management of indexed funds, an activity that can now be entrusted to a computer. There are significant economies of scale in passive investment, and these large incumbents derive competitive advantage from their size. The total costs of intermediation include management fees, administrative, custodial and regulatory costs, the costs of remunerating intermediaries, paying trading commissions and spreads between bid and offer price. If you invest directly in an indexed fund, you might be able to reduce these annual costs to 25–50 basis points (the finance sector describes one-hundredth of 1 per cent as a ‘basis point’). This figure is the minimum cost of using the investment channel.

The persuasive rationale of passive management was that most active management was not worth what it cost; the motivation of savers in seeking passive funds is to secure better value for money, not to minimise tracking error, and tracking error is a measure of risk for fund managers, not investors. A passive fund that buys and holds a well-considered selection of stocks achieves the same goal as an index fund, probably more effectively – and avoids the problem, evident on the London Stock Exchange, in which companies of doubtful reputation seek listings in order to force holders of passive funds to buy their stock. There should be more managed intermediation. Transparency and liquidity seem at first sight a good thing, and so of course is the prevention of fraud, and certainly the regulatory provisions have been made with good intentions.

There are many studies of this. See, for example, Malkiel, B. G., 2012, A Random Walk down Wall Street, 10th edn, New York and London, W.W. Norton. pp. 177–83. Porter, G.E., and Trifts, J.W., 2014, ‘The Career Paths of Mutual Fund Managers: The Role of Merit’, Financial Analysts Journal, 70 (4), July/August, pp. 55–71. Philips, C.B., Kinniry Jr, F.M., Schlanger, T., and Hirt, J.M., 2014, ‘The Case for Index-Fund Investing’, Vanguard Research, April, https://advisors.vanguard.com/VGApp/iip/site/advisor/researchcommentary/article/IWE_InvComCase4Index. 20. Kahneman himself is not guilty of this: Kahneman, D., 2011, Thinking Fast and Slow, New York, Farrar, Straus and Giroux. 21. Rubin, R., 2004, In an Uncertain World, New York, Random House. 22. The unknown unknown was famously described by Donald Rumsfeld; see Taleb, N.N., 2007, The Black Swan: The Impact of the Highly Improbable, London, Penguin. 23.


How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business cycle, business process, butter production in bangladesh, buy and hold, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

In the mid-1960s, he had led an effort to rethink equity management at Wells Fargo bank. He had brought in Fischer Black and Myron Scholes, among many other finance notables, to work on the problem, and the ultimate outcome had been the creation of index funds. In that era he had met Oldrich, newly arrived from Czechoslovakia, and convinced him he should come work on finance problems at Wells (rather than analyzing dolphin communications, another offer Oldrich was contemplating at the time). Mac had departed Wells in the early 1970s for the life of an entrepreneur. At the time I met him, he had been involved with starting a small stock index fund, Dimensional Fund Advisors, in Los Angeles, as well as a premium California wine producer, Chalone Group. Mac had a reputation as a bit of a wild man, but I was struck by his interest in people and the world.

I found it very rewarding to build teams and see them succeed in a highly competitive activity. As the Japanese products started to generate great investment returns, I switched to heading BGI’s active equity business in the United States. In early 2001, our biggest challenge was not investment performance, as our equity products had impressive track records. Instead, it was convincing prospects that we were more than just a big index fund provider. In part, this was just BGI’s problem. But in part it also spoke to the very limited legitimacy of quantitative active management. Over a two-year period, my colleague Scott Clifford and I devoted considerable amounts of our time toward changing these perceptions. As investors began to JWPR007-Lindsey 46 May 7, 2007 16:30 h ow i b e cam e a quant notice how BGI and other quantitative managers had managed to deliver on return promises while controlling risk over long periods of time, perceptions changed.

Along with math and physics, I had studied international economics in college. In business school, I also studied taxation and accounting. When I graduated from business school in 1983, I was offered a job in the treasurer’s department at Exxon. It was a dream come true. At the time, Exxon’s treasurer’s department was considered one of the spots in finance. Exxon managed much of its pension fund internally, including a large S&P500 index fund. It had also begun to issue its own debt, bypassing Wall Street bankers and fees. Exxon had global operations and had applied the latest thinking in project analysis using discounted cash flow methods and was analyzing and hedging the impact of currency changes on its operations. It should have been exciting. All in all, there couldn’t have been a more stifling place to work. JWPR007-Lindsey 180 April 30, 2007 18:1 h ow i b e cam e a quant Exxon had layers and layers of management.


pages: 346 words: 102,625

Early Retirement Extreme by Jacob Lund Fisker

8-hour work day, active transport: walking or cycling, barriers to entry, buy and hold, clean water, Community Supported Agriculture, delayed gratification, discounted cash flows, diversification, dogs of the Dow, don't be evil, dumpster diving, financial independence, game design, index fund, invention of the steam engine, inventory management, lateral thinking, loose coupling, market bubble, McMansion, passive income, peak oil, place-making, Ponzi scheme, psychological pricing, the scientific method, time value of money, transaction costs, wage slave, working poor

Since the risk-reward profiles of most, but not all fund advisors are skewed--that is, fail conventionally and you're okay; fail unconventionally and you're fired; win conventionally and you're okay; win unconventionally and you're a genius--mutual fund advisors that wish to keep their jobs tend to flock together and behave like a herd. This has resulted in the growing popularity of "buy and hold" index funds, which simply mimic what everybody else is doing, on average, at less cost. Of course, the emerging behavior of such a strategy is eventual chaos, as nobody leads and everybody follows each other. Buy and hold is an investment strategy with no exit strategy. What this typically means is that stocks are usually liquidated when money is needed, rather than taking into account when a given stock is overvalued.

It would be a big mistake to think that a choice made now will also be valid only 10 years from now, just as any particular investment vehicle I could suggest now will probably sound silly a decade from now. Thirty years ago everybody hated stocks but loved gold. Twenty years ago mutual funds were the hottest thing. Then after a decade of trending stock markets, which moved up no matter what people owned, it was decided that the managers weren't needed and index funds came into fashion--why do you need a manager if markets go up all on their own? At that point nobody wanted to own gold. In the past 10 years the market has been in a trading range and now gold is more expensive than ever, so who knows what the future will bring? My suggestion is not to presume that one can pick an asset class and then stick with it forever. Despite this, there are a few established principles in the art of investing.

As a result, I always feel slightly worried when I hear the phrase, "They'll think of something..." This changed my attitude towards problems and solutions and I began to use the same approach that I used for my research job in the rest of my life, always trying to understand why something was the way it was, whether it could be different, and if so, how? Instead of adopting the standard moneymanagement plan of saving 15% in an index fund in my retirement plan while getting in debt up to my eyeballs thanks to a "starter home," I started looking into the principles behind the system I was living in. I realized that the standard option of becoming an indebted consumer was just one of many, but that if anyone wanted different options, they'd have to take a different and more active approach rather than just asking "what?" and "when?"


pages: 224 words: 13,238

Electronic and Algorithmic Trading Technology: The Complete Guide by Kendall Kim

algorithmic trading, automated trading system, backtesting, commoditize, computerized trading, corporate governance, Credit Default Swap, diversification, en.wikipedia.org, family office, financial innovation, fixed income, index arbitrage, index fund, interest rate swap, linked data, market fragmentation, money market fund, natural language processing, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, short selling, statistical arbitrage, Steven Levy, transaction costs, yield curve

Investment managers and traders executing on behalf of disciplines focused on value and growth with long-term horizons may lack the skill-set to be savvy enough to execute at the best available execution price. 96 Electronic and Algorithmic Trading Technology Management Style Trade Motivation Liquidity Demands Execution Costs Opportunity Costs Value Value Low Low Low Growth Value Low Low Low Information High High High Passive Variable Variable High Passive High High High Earnings Surprise Index-Fund Large-Cap Index-Fund Small-Cap Exhibit 9.3 Expectations—cost and management style. Source: David J. Leinweber, Trading and Portfolio Management: Ten Years Later, California Institute of Technology, May 2002. These traders may lack close relationships with the street to get the best prices through comparison shopping. Traders executing on behalf of investment strategies that depend on quick execution based on market reaction may have better relationships with broker-dealers who may offer price discounts to give incentive for quick execution traders to come back and Net Transaction Costs (Basis Points) Observations- Cost vs.

Costs and Management Style Can transaction costs be predicted through investment management style? Patient disciplines such as value and growth investing with longer time horizons may be expected to have lower transaction costs. Investment strategies that depend on quicker execution to capture the market’s reaction to differences between expected and actual earnings may have higher transactions. Index funds tracking small capitalization stocks would theoretically be expected to have larger transaction costs because of the characteristics of smaller stock made up in those indexes. The theoretical expectations are shown in Exhibit 9.3. However, the actual observations are listed in Exhibit 9.4. Why is there such a wide deviation between the expectations summarized versus the actual observations? Several explanations can be made regarding the results.


pages: 121 words: 31,813

The Art of Execution: How the World's Best Investors Get It Wrong and Still Make Millions by Lee Freeman-Shor

Black Swan, buy and hold, cognitive bias, collapse of Lehman Brothers, credit crunch, Daniel Kahneman / Amos Tversky, diversified portfolio, family office, I think there is a world market for maybe five computers, index fund, Isaac Newton, Jeff Bezos, Long Term Capital Management, loss aversion, Richard Thaler, Robert Shiller, Robert Shiller, rolodex, Skype, South Sea Bubble, Stanford marshmallow experiment, Steve Jobs, technology bubble, The Wisdom of Crowds, too big to fail, tulip mania, zero-sum game

Relativity Finally, many fund managers think in relative terms. A fund manager’s performance is assessed relative to an index or his peers. His or her reviewers (employer and clients) are trying to decide whether the manager has been doing a good job. A comparison with an index is suitable because anyone invested in the fund is paying an active fund manager more than it costs to invest in a passive fund (an index fund or exchange-traded fund) that simply replicates the benchmark. For that extra fee, the client is expecting the fund manager to materially outperform. A comparison with peers is also fair because the client who has decided that he or she wants to pay for active management could have invested with a number of other active managers. Many studies over the years have shown that clients have a bias to investing in the best performing funds.

This was a period that captured both the massive technology bubble of the late 1990s and the subsequent popping of that bubble and stock market crash from 2000 to 2002. Given the fact that it is a requirement for most funds to file their holdings with the SEC, their study captured the majority of funds in existence that people could invest in during that period. The only caveat was that the fund had to have net assets of at least $5m and contain at least 20 stocks. Index funds were excluded for the obvious reason that they try to replicate the performance of an index, and the largest holdings cannot be said to represent an active manager’s best ideas. Their findings were startling. They discovered: •The single highest-conviction stock of every manager taken together outperformed the market, as well as the other stocks in those managers’ portfolios, by approximately 1–14%.


pages: 319 words: 106,772

Irrational Exuberance: With a New Preface by the Author by Robert J. Shiller

Andrei Shleifer, asset allocation, banking crisis, Benoit Mandelbrot, business cycle, buy and hold, computer age, correlation does not imply causation, Daniel Kahneman / Amos Tversky, demographic transition, diversification, diversified portfolio, equity premium, Everybody Ought to Be Rich, experimental subject, hindsight bias, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Joseph Schumpeter, Long Term Capital Management, loss aversion, mandelbrot fractal, market bubble, market design, market fundamentalism, Mexican peso crisis / tequila crisis, Milgram experiment, money market fund, moral hazard, new economy, open economy, pattern recognition, Ponzi scheme, price anchoring, random walk, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Small Order Execution System, spice trade, statistical model, stocks for the long run, survivorship bias, the market place, Tobin tax, transaction costs, tulip mania, urban decay, Y2K

To cite only one among numerous examples, a 1999 article in USA Weekend, a national Sunday magazine insert for newspapers, carried an article entitled “How to (Really) Get Rich in America.” The article gives examples of investor successes and offers the hypothetical story of a twenty-two-year-old college graduate earning $30,000 a year with annual real income raises of 1%. “If she saved only 10% of her income and invested the savings in an S&P index fund she’d have a net worth of $1.4 million on retirement at age 67, in today’s dollars.”8 These calculations assume that the S&P index fund earns a riskless 8% real (inflation-corrected) return. There is no mention of the possibility that the return might not be so high over time, and that she might not end up a millionaire. An article with a very similar title, “Everybody Ought to Be Rich,” appeared in the Ladies’ Home Journal in 1929.9 It performed some very similar calculations, yet similarly omitted to describe the possibility that anything could go wrong in the long term.

See Rudolph Weissman, The Investment Company and the Investor (New York: Harper and Brothers, 1951), p. 144. 27. Indeed, the flow of investment dollars into mutual funds seems to bear an important relation to market performance, as mutual fund inflows show an immediate and substantial reaction when the stock market goes up. See Vincent A. Warther, “Aggregate Mutual Fund Flows and Security Returns,” Journal of Financial Economics, 39 (1995): 209–35; and William Goetzmann and Massimo Massa, “Index Fund Investors,” unpublished paper, Yale University, 1999. 28. See my article “Why Do People Dislike Inflation?” in Christina D. Romer and David H. Romer (eds.), Reducing Inflation: Motivation and Strategy (Chicago: University of Chicago Press and National Bureau of Economic Research, 1997), pp. 13–65. 29. See Franco Modigliani and Richard A. Cohn, “Inflation, Rational Valuation, and the Market,” Financial Analysts’ Journal, 35 (1979): 22–44; see also Robert J.

Personality and Individual Differences, 19(4) (1995): 513–16. Glassman, James K., and Kevin A. Hassett. Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market. New York: Times Business/ Random House, 1999. Goetzmann, William, and Roger Ibbotson. “Do Winners Repeat? Patterns in Mutual Fund Performance.” Journal of Portfolio Management, 20 (1994): 9–17. Goetzmann, William, and Massimo Massa. “Index Fund Investors.” Unpublished paper, Yale University, 1999. Graham, Benjamin, and David Dodd. Securities Analysis. New York: McGraw-Hill, 1934. Grant, James. The Trouble with Prosperity: A Contrarian Tale of Boom, Bust, and Speculation. New York: John Wiley and Sons, 1996. Greetham, Trevor, Owain Evans, and Charles I. Clough, Jr. “Fund Manager Survey: November 1999.” London: Merrill Lynch & Co., Global Securities Research and Economics Group, 1999.


pages: 398 words: 111,333

The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham by Joe Carlen

Albert Einstein, asset allocation, Bernie Madoff, Bretton Woods, business cycle, business intelligence, discounted cash flows, Eugene Fama: efficient market hypothesis, full employment, index card, index fund, intangible asset, invisible hand, Isaac Newton, laissez-faire capitalism, margin call, means of production, Norman Mailer, oil shock, post-industrial society, price anchoring, price stability, reserve currency, Robert Shiller, Robert Shiller, the scientific method, Vanguard fund, young professional

Let him emphasize diversification more than individual selection.49 In his commentary in the 2003 edition of The Intelligent Investor, Jason Zweig recommends that modern defensive investors place 90 percent of their investment funds in an index fund (a fund modeled after a market index such as the S&P 500), leaving 10 percent with which to select their own individual securities. Such an approach is probably sensible for most defensive investors despite the fact that all components of an index do not necessarily adhere to Graham's principles. Nonetheless, since all represented companies tend to be large and well established, indexing generally provides a strong measure of both safety and diversification. Moreover, as a “passive” form of fund management (in the sense that an index fund merely replicates the composition of an existing market index (such as the S&P 500) and does not need to hire professionals to make independent investment-allocation decisions), index-fund management fees are considerably less expensive than those of actively managed mutual funds.

See Graham, Isaac Grossbaum, Louis, 70 Grossbaum & Sons, 21–24, 26 gross domestic product (GDP), 141 “group think,” 197 Guerin, Rick, 253 Guggenheim Exploration Company, dissolution of, 105 Guru Focus's Fair Value Calculator, 43–44 Hadassah (Women's Zionist Organization of America), 110 Hagstrom, Robert, 44, 49, 127, 130, 244 Hamburger, Robert, 270, 296, 301 Hamburger, Sonia, 270, 296 Harley-Davidson, 172, 176–78 Harris, Lou, 118, 141–43 Harris Raincoat Company, 118 Hawkes, Herbert, 71 Hayek, Friedrich, 210, 216, 293–94 Health South, 290 hedging, 112 Heilbrunn, Robert, 218 Herbert, Victor, 109 “herd instinct,” 37 Heseltine, Pi (granddaughter), 275, 295 H. Hentz and Co., 148 high-frequency trading (HFT), 127–28 Hobson, John A., 204 holding period, 127 Hood, Randolph, 166 Howard Marks/Oaktree Capital Management, 257 Hyman, Maxwell, 116 Hyman brothers, 143 importing business, 17 income statements, 121 independent judgment, 171 index fund, 93–94 “industrials,” 48 information technology, 168 Institute of Chartered Financial Analysts, 308 intangible assets, 96 Internal Revenue Service (IRS), 183 International Monetary Fund (IMF), 214 “Internet bubble,” 37 Interstate Commerce Commission (ICC), 145 intrinsic value, 39–43, 52–54, 125, 130 investment and speculation, distinction between, 38 investment capital, 122–23 “investment grade” securities, 39 investment operation, 36 investment research department, 104 investments, speculative, 130 Isaacson, Walter, 310 Janis, Cathy (granddaughter), 197 Janis, Irving (son-in-law), 197 Janis, Marjorie.


pages: 258 words: 74,942

Company of One: Why Staying Small Is the Next Big Thing for Business by Paul Jarvis

Airbnb, big-box store, Cal Newport, call centre, corporate social responsibility, David Heinemeier Hansson, effective altruism, Elon Musk, en.wikipedia.org, endowment effect, follow your passion, gender pay gap, glass ceiling, Inbox Zero, index fund, job automation, Kickstarter, Lyft, Mark Zuckerberg, Naomi Klein, passive investing, Paul Graham, pets.com, remote working, Results Only Work Environment, ride hailing / ride sharing, Ruby on Rails, side project, Silicon Valley, Skype, Snapchat, software as a service, Steve Jobs, supply-chain management, Tim Cook: Apple, too big to fail, uber lyft, web application, Y Combinator, Y2K

Third, with your salary and runway buffer covered, you can reinvest money in your company; if things are going well, you should be able to get a better than 3 percent return on such an investment. Alternatively, if you don’t need to invest more in your company—maybe your business costs are covered and you have no reason to grow them—you can invest any extra money in something like index funds. I use a robo-investor with very low management fees and keep my money in index funds that require no upkeep on my end. Once a quarter, I check in on my investments, and if I have questions I talk to someone at the company. But since these investments are long-term, I’m not worried about daily or even monthly losses or gains. I just want to see my money grow over decades. Health Coverage Depending on the country you live in, medical coverage and insurance can be a huge factor in deciding if you’re going to go on your own and start a company of one.

Having a runway buffer of liquid savings also helps when unexpected events come up. A family member falling ill or passing away can require you to take time off that you hadn’t planned for. In this event a recurring income stream and runway buffer can be a great help at a difficult time. Savings Alongside a salary and a runway buffer, I truly think companies of one should invest as much money as they can save up in passive investments like index funds. If inflation is approximately 3 percent per year, then you’re losing money on any assets you’ve got that aren’t making at least 3 percent per year in returns. This applies, by the way, to all the money in your bank account, since checking and savings accounts pay barely any interest. Since I don’t have an employer putting money into a 401(k) or Registered Retirement Savings Plan, created by the Canadian government for Canadians like me, I’ve got to consider how I can make the most of being in the prime of my earning potential and save for the future, when that might not be the case.


pages: 270 words: 75,803

Wall Street Meat by Andy Kessler

accounting loophole / creative accounting, Andy Kessler, automated trading system, banking crisis, Bob Noyce, George Gilder, index fund, Jeff Bezos, market bubble, Menlo Park, Pepto Bismol, pets.com, Robert Metcalfe, rolodex, Sand Hill Road, Silicon Valley, Small Order Execution System, Steve Jobs, technology bubble, undersea cable, Y2K

Books were being written about chimpanzees and dart throwers doing better than professional money managers. John Bogle at Vanguard in Pennsylvania had a solution, i.e., if you can’t beat the market, just become the market. Index the whole thing. The bulk of the market was represented by the Standards and Poor (S&P) 500 index, the top 500 valuable public companies in the U.S. Bogle offered an index fund that did neither better, nor worse than the market, and it caught on as a savior of investors. Money came out of banks and into mutual funds, much of which were index funds. By 1996, over $1 trillion was in mutual funds. Quacking Ducks But indexing is dull. Those looking for better returns tried other ways to beat the market. General Electric, worth $240 billion makes up 4% of the $8 trillion S&P 500 index. If it halves in value one day, but two $60 billion valued companies double in value that same day, the index doesn’t budge.

Despite lowering their standards, the damn thing worked. It was worth $1 billion on its first day of trading. I thought it was a bargain at half the price. Shows you what I know, it kept going up. The problem was that there just weren’t that many Internet companies to go around. Every momo had to own a piece of Yahoo, and bid it up. As the performance of momo funds improved, more money came out of index funds and into momo funds. What was needed was more public Internet companies. Not a problem, for there were plenty of companies that 173 Wall Street Meat could quickly adopt the Internet, put dotcom at the end of their name, and get fed to the ducks. Wall Street was happy to oblige, for a modest 7% fee. · · · One of the first high profile deals Frank won was Amazon.com, an online bookseller in Seattle.


pages: 253 words: 79,214

The Money Machine: How the City Works by Philip Coggan

activist fund / activist shareholder / activist investor, algorithmic trading, asset-backed security, Bernie Madoff, Big bang: deregulation of the City of London, bonus culture, Bretton Woods, call centre, capital controls, carried interest, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, disintermediation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, endowment effect, financial deregulation, financial independence, floating exchange rates, Hyman Minsky, index fund, intangible asset, interest rate swap, Isaac Newton, joint-stock company, labour market flexibility, large denomination, London Interbank Offered Rate, Long Term Capital Management, merger arbitrage, money market fund, moral hazard, mortgage debt, negative equity, Nick Leeson, Northern Rock, pattern recognition, purchasing power parity, quantitative easing, reserve currency, Right to Buy, Ronald Reagan, shareholder value, South Sea Bubble, sovereign wealth fund, technology bubble, time value of money, too big to fail, tulip mania, Washington Consensus, yield curve, zero-coupon bond

Charges are certainly higher on unit trusts; but the existence of the discount adds an extra layer of risk for those buying shares in investment trusts. Both offer savings schemes, ways of investing on a monthly basis to smooth out some of the market peaks and troughs. If an investor can find a fund with a good performance record and a low-cost savings scheme, it probably does not matter whether it is a unit or investment trust. INDEX FUNDS One type of fund that has only become available to small investors in recent years is the index-tracker. Rather than research the market and look for attractive stocks, an index fund attempts to match the performance of a particular benchmark, such as the FTSE 100 Index. Investors can buy index-trackers in the form of a unit trust or as an exchange traded fund (see Chapter 8). The advantage of trackers is their lower costs. The components of an index change only rarely, so a fund manager who tracks the index faces few dealing costs.

So if you notice that everyone is using mobile phones and rush out to buy shares in a mobile phone company, you will be too late; other people will have noticed first and pushed the shares up to reflect the sector’s improved prospects. The only thing that will cause a share price to move is genuine ‘news’ which by definition cannot be known in advance. Efficient market theory still prompts much debate among academics and is derided by many fund managers, but the facts are that only around 20 per cent of fund managers beat the index over the long run. Index funds will almost never be the best performers but their low costs and broad spread means that they will not be the worst. They are an attractive option for private investors. All the above funds, however, will fall in value when the general market drops, as it did in 2008. Buying any kind of equity-linked investment is only for the long-term, i.e. several years. 16 Controlling the City The credit crunch caused politicians and regulators to rethink their approach to the financial sector completely.


pages: 403 words: 119,206

Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith

bank run, banking crisis, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, income inequality, index arbitrage, index fund, joint-stock company, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market clearing, merger arbitrage, money market fund, Myron Scholes, Paul Samuelson, price stability, random walk, Richard Thaler, risk tolerance, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, stocks for the long run, the market place, transaction costs

Sharpe’s work on the Capital Asset Pricing Model eventually led to a revolutionary conclusion. Given the assumptions of the model, the most risk-efficient portfolio that an investor could select was the market itself; in other words, an investor should buy proportional amounts of all stocks in the market rather than attempting to select only certain stocks that would hopefully outperform the market. This startling assertion ultimately provided the intellectual basis for “index” funds—that is, mutual funds that arbitrarily invested in all stocks included in a given index, such as the Standard & Poor’s 500 Industrials. But that would come much later. In 1964, Sharpe’s research, like that of Markowitz before him, was largely ignored by the Wall Street community. One man who could not be ignored was Eugene Fama. A third-generation Italian American from Boston born in 1939, Fama had first been introduced to the stock market while working his way through college.

He recognizes that the best he can expect to accomplish by doing this is to roughly match the performance of the specific market index chosen—such as the Standard & Poor’s 500. In spite of this limitation, however, the dollar amount invested in equity index mutual funds has grown dramatically over the last two decades, indicating that many people have come to accept the idea that it is very difficult, if not impossible, to consistently “beat” the market. But what if all investors took this advice, and simply invested in index funds? Would the market still be efficient? The answer is clearly no, and represents an interesting paradox. For a market to be efficient, most participants must believe that it isn’t. The diligent work of sophisticated analysts like Benjamin Graham is required to search out stocks that are mispriced; their buying and selling of these stocks then moves prices back into line. But if the Ben Grahams of the world become convinced that few such opportunities exist (that is, that the market is largely efficient), they will cease their efforts.

Harrison, George Hartwell, John Harvard University; Business School Hassert, Kevin Haupt, Ira, & Company Hay, William Hayden, Stone brokerage firm hedge funds hedging Hediger, Fred Heimann, John Heinze, Frederick Augustus Hertz, John D. Hill, James Jerome Hirohito, emperor of Japan Homer, Sidney Honeywell Hoover, Herbert Hopping Foods House of Representatives, U.S.; Pujo Committee Hudson and Mohawk Railroad Hume, David Humphrey, George Hunt brothers Immigration Service, U.S. income taxation index arbitrage index funds Individual Retirement Accounts (IRAs) industrial revolution industrials inflation; Federal Reserve policies to control; growth investing and; OPEC oil price increases and Inland Steel insider trading; outlawed Institutional Investor institutional investors; and crash of 1962; Nifty Fifty and; portfolio insurance and; reduction in transaction costs for; see also mutual funds; pension funds insurance companies: investments by; stocks of Internal Revenue Service (IRS) International Business Machines (IBM) International Mercantile Marine Internet investment trusts Investors Overseas Services (IOS) ITT Izvestia Johnson, Edward Crosby, II Johnson, Lyndon B.


pages: 354 words: 118,970

Transaction Man: The Rise of the Deal and the Decline of the American Dream by Nicholas Lemann

Affordable Care Act / Obamacare, Airbnb, airline deregulation, Albert Einstein, augmented reality, basic income, Bernie Sanders, Black-Scholes formula, buy and hold, capital controls, computerized trading, corporate governance, cryptocurrency, Daniel Kahneman / Amos Tversky, dematerialisation, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, fixed income, future of work, George Akerlof, gig economy, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, index fund, information asymmetry, invisible hand, Irwin Jacobs, Joi Ito, Joseph Schumpeter, Kenneth Arrow, Kickstarter, life extension, Long Term Capital Management, Mark Zuckerberg, mass immigration, means of production, Metcalfe’s law, money market fund, Mont Pelerin Society, moral hazard, Myron Scholes, new economy, Norman Mailer, obamacare, Paul Samuelson, Peter Thiel, price mechanism, principal–agent problem, profit maximization, quantitative trading / quantitative finance, Ralph Nader, Richard Thaler, road to serfdom, Robert Bork, Robert Metcalfe, rolodex, Ronald Coase, Ronald Reagan, Sand Hill Road, shareholder value, short selling, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, TaskRabbit, The Nature of the Firm, the payments system, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, too big to fail, transaction costs, universal basic income, War on Poverty, white flight, working poor

By this time, the early 1970s, the power of computers had increased so much that the work of Black, Scholes, and Merton (all of whom later won the Nobel Prize in economics for these discoveries) did not sit on a shelf for years, as had the work of the other pioneer financial economists. The Chicago Board of Trade created the Chicago Board Options Exchange, the world’s first public marketplace for options, in 1973, and the new techniques were being used there almost immediately. The first index fund was founded in 1971. Wells Fargo Bank launched a short-lived mutual fund in 1974 that was based on a model devised by Black, Scholes, and Jensen. Within just a few years, the derivatives markets—options, futures, index funds, swaps, mortgage-backed securities; anything that could be assembled out of existing financial instruments and then priced, packaged, and traded—had gone from being insignificantly small to producing billions of dollars in activity every year, far more than the traditional stock and bond markets.

Did the professionals produce a premium over the market’s overall movement—something he named “alpha,” a term that has become part of the basic vocabulary of the investing world? The answer, he found, was a resounding no. As Jensen drily noted, “The mutual fund industry … shows very little evidence of an ability to forecast security prices.” There was an obvious application of Jensen’s result, which would be for somebody to invent what we’d now call an index fund—a mutual fund based on replicating the overall performance of the market rather than quixotically attempting to find alpha by handpicking just the right stocks. That didn’t happen immediately, owing to a lack of computing power. Still, Jensen’s findings powerfully reinforced the theories of his Chicago colleagues. Once again, markets themselves, operating independently, were better at determining the proper prices of stocks and bonds than any supposed expert.

Hofstadter, Richard Holy Cross Hospital home equity loans Honda H-1B visas Hong Kong Hoover, Herbert Hoover, Larry Hopkins, Harry hostile takeovers; see also leveraged buyouts House of Mirth, The (Wharton) housing: abandoned; discrimination in; price of; in projects; see also mortgages How to Win Friends and Influence People (Carnegie) Hoyer, Steny Hubbard, L. Ron Hubler, Howie Huffington, Arianna Hyde Park Iacocca, Lee IBM Icahn, Carl identity politics Illinois legislature immigrants, undocumented index funds, invention of India individualism; end of Industrial Revolution; corporate revolution compared to inequality: economic, see wealth, concentration of; racial, see racism inflation; interest rates and; wages and information asymmetry Inner-City Muslim Action Network Instagram institutions: individualism vs.; loss of faith in; as mature groups; as necessary for pluralism; transaction-based order vs.; see also corporations; federal government; Organization Man insurance companies Intel Interest Equalization Tax interest groups; desire to eliminate; successes of; types of interest rates; deregulation and; Greenspan and; inflation and; on mortgages Internal Revenue Service International Nickel International Typographical Union Internet; bubble of 2000; early conceptions of; financial industry on; as predicted in fiction; regulation of; see also networks; Silicon Valley interstate banking Interstate Commerce Commission Investing in US investment banking; academic paradigm shift in; antitrust suit against; changes to in 1970s; commercial banking vs.; computerization of; deregulation of, see deregulation; diversified portfolios in; Glass-Steagall Act and, see Glass-Steagall Act; SEC and, see Securities and Exchange Commission; shifting clients of; see also Morgan Stanley; specific financial instruments Irish Americans Italian Americans Itô, Kiyosi ITT Jackson, Andrew Jackson, Jesse Jackson, Mahalia Jacobs, Irwin Japan; auto industry in Jdate Jefferson, Thomas Jensen, Michael; as advocate for free markets; background of; character of; corporations studied by; at Harvard; on integrity; in Landmark; mind shift of; at Rochester; at University of Chicago Jensen, Stephanie Jews; in finance Jhering, Rudolf von Jobs, Steve Johns Hopkins University Johnson, Earl Johnson, Jonathan Jones, Doug Journal of Applied Corporate Finance Journal of Financial Economics J.P.


pages: 130 words: 11,880

Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu

asset allocation, call centre, constrained optimization, correlation coefficient, diversification, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk

This last problem can be solved using the techniques we discussed for convex quadratic programming problems. 5.3. RETURNS-BASED STYLE ANALYSIS 5.3 63 Returns-Based Style Analysis In two ground-breaking articles, Sharpe described how constrained optimization techniques can be used to determine the effective asset mix of a fund using only the return time series for the fund and a number of carefully chosen asset classes [13, 14]. Often, passive indices or index funds are used to represent the chosen asset classes and one tries to determine a portfolio of these funds/indices whose returns provide the best match for the returns of the fund being analyzed. The allocations in the portfolio can be interpreted as the fund’s style and consequently, this approach has become to known as returns-based style analysis, or RBSA. RBSA provides an inexpensive and timely alternative to fundamental analysis of a fund to determine its style/asset mix.

(5.8) In this equation, wit quantities represent the sensitivities of Rt to each one of the n fach iT tors, and t represents the non-factor return. We use the notation wt = w1t , . . . , wnt h i and Ft = F1t , . . . , Fnt . The linear factor model (5.8) has the following convenient interpretation when the factor returns Fit correspond to the returns of passive investments, such as those in an index fund for an asset class: One can form a benchmark portfolio of the passive investments (with weights wit ) and the difference between the fund return Rt and the return of the benchmark portfolio Ft wt is the non-factor return contributed by the fund manager using stock selection, market timing, etc. In other words, t represents the additional return resulting from active management of the fund. Of course, this additional return can be negative.


pages: 317 words: 84,400

Automate This: How Algorithms Came to Rule Our World by Christopher Steiner

23andMe, Ada Lovelace, airport security, Al Roth, algorithmic trading, backtesting, big-box store, Black-Scholes formula, call centre, cloud computing, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, Donald Trump, Douglas Hofstadter, dumpster diving, Flash crash, G4S, Gödel, Escher, Bach, High speed trading, Howard Rheingold, index fund, Isaac Newton, John Markoff, John Maynard Keynes: technological unemployment, knowledge economy, late fees, Marc Andreessen, Mark Zuckerberg, market bubble, medical residency, money market fund, Myron Scholes, Narrative Science, PageRank, pattern recognition, Paul Graham, Pierre-Simon Laplace, prediction markets, quantitative hedge fund, Renaissance Technologies, ride hailing / ride sharing, risk tolerance, Robert Mercer, Sergey Aleynikov, side project, Silicon Valley, Skype, speech recognition, Spread Networks laid a new fibre optics cable between New York and Chicago, transaction costs, upwardly mobile, Watson beat the top human players on Jeopardy!, Y Combinator

O’Connor & Associates, also in Chicago, was employing very similar tactics to Peterffy’s, outfitting its traders with cheat sheets for valuing options and supplementing that information with computers that constantly crunched data upstairs while piping new numbers down to the pits. O’Connor was so secretive about its methods that when it bought two hundred Symbolics computers in the mid-1980s, executives shredded the packaging so Dumpster-diving competitors couldn’t determine what technology the firm used.6 THE ALGORITHMS SPREAD COAST TO COAST By 1987, index funds, which tracked groups of stocks such as the S&P 500, had grown popular not only with the public but also with professional traders. But certain indexes, the S&P 500 included, could only be licensed for trade in one market. In the case of the S&P 500, the license belonged to the Chicago Mercantile Exchange. So other exchanges employed indexes that were not exactly the same, but close. The Chicago Board Options Exchange traded the OEX, which was the same as the S&P 100; the New York Stock Exchange traded the NYSE composite, which tracked the entire NYSE; the AMEX traded the Major Market Index, which tracked the thirty biggest stocks; and the Pacific Exchange had what it called the PSE, which was based on technology companies, a growing share of the market.

., 170 NASA mission control in, 166, 175 Howes, Ash, 78–79 Hull, Blair, 40, 46 Hull Trading, 40, 46 human intuition, algorithms and, 127, 129 human irrationality, 132–33 humanities, education in, 139–40, 219 human personalities, 61, 163–83 compatibility among types of, 174–76 Kahler’s types of, 172–74 and NASA predictive science, 61, 164, 165–72, 174–77, 180 Hungary, 18, 20 Huygens, Christiaan, 67 hybrid vigor, 161 hyperparathyroidism, 162 IBM, 33, 144, 214 Brown and Mercer at, 178–79 Deep Blue chess-playing computer developed by, 126–27, 129, 133, 141 options on stock of, 21–22 Watson computer by, 127, 161–62 IBM PCs, Peterffy’s trading via, 12–16 identity theft, 193 “I Kissed a Girl,” 89 ILLIAC computer, 92 Illiac Suite, 92 Illinois, University of, 91–92, 188 at Urbana-Champaign, 95, 116, 219 Illinois Institute of Technology, 115 indexes of refraction, 115 index funds, 40–46 index futures, 113 India, 154, 218 Indiana University, 97 infants, preterm delivery of, 158 Infinite Ascent (Berlinski), 60 Infinium Capital Management, 51–52, 116 influencers, social, 212–14 “In My Life,” 110–11 inputs, in algorithms, 54 insider trading, 30 insurance, 66–67 health, 162, 181 intelligence: backgrounds of personnel in, 139–40 game theory and algorithms in, 135–40 information gathering by, 138 subjective calls in, 137 Interactive Brokers, 47–48 interest: compound, 68 payment systems, 57 rates, 22, 130 Intermountain Medical Center, algorithms used by, 157–58 international nuclear weapons nonproliferation treaty, 139 Internet, 116, 205 algorithms and, 112 dial-up, 117 hubs and authorities on, 214 influencers on, 213 Internet dating sites, algorithms for, 144–45, 214 “Into the Great Wide Open,” 84 Investigation of the Laws of Thought (Boole), 72 investment banks, 189, 192, 201, 206, 208, 210 algorithms used by, 46 iPads, 37, 159 iPhones, 159 IPO, for Interactive Brokers, 47–48 Iran, 137, 138–39 IRAs, 50 Ireland, 72, 193 Isaacson, Leonard, 92 Israel, 138 Istanbul Museum, 55 Italy, 56, 80 “I’ve Got a Feeling,” 78 Iverson, Allen, 143 Ivy League, 140, 143, 207 “I Want to Hold Your Hand,” 103 Jackson, Miss., 116 James, Brent, 157–58 Jarecki, Henry, 20, 21–24, 26–27, 34 Java, 189 Jennings, Ken, 127 Jeopardy!

., 140, 165 Nobel Prize, 23, 106 North Carolina, 48, 204 Northwestern University, 145, 186 Kellogg School of Management at, 10 Novak, Ben, 77–79, 83, 85, 86 NSA, 137 NuclearPhynance, 124 nuclear power, 139 nuclear weapons, in Iran, 137, 138–39 number theory, 65 numerals: Arabic-Indian, 56 Roman, 56 NYSE composite index, 40, 41 Oakland Athletics, 141 Obama, Barack, 46, 218–19 Occupy Wall Street, 210 O’Connor & Associates, 40, 46 OEX, see S&P 100 index Ohio, 91 oil prices, 54 OkCupid, 144–45 Olivetti home computers, 27 opera, 92, 93, 95 Operation Match, 144 opinions-driven people, 173, 174, 175 OptionMonster, 119 option prices, probability and statistics in, 27 options: Black-Scholes formula and, 23 call, 21–22 commodities, 22 definition of, 21 pricing of, 22 put, 22 options contracts, 30 options trading, 36 algorithms in, 22–23, 24, 114–15 Oregon, University of, 96–97 organ donor networks: algorithms in, 149–51, 152, 214 game theory in, 147–49 oscilloscopes, 32 Outkast, 102 outliers, 63 musical, 102 outputs, algorithmic, 54 Pacific Exchange, 40 Page, Larry, 213 PageRank, 213–14 pairs matching, 148–51 pairs trading, 31 Pakistan, 191 Pandora, 6–7, 83 Papanikolaou, Georgios, 153 Pap tests, 152, 153–54 Parham, Peter, 161 Paris, 56, 59, 121 Paris Stock Exchange, 122 Parse.ly, 201 partial differential equations, 23 Pascal, Blaise, 59, 66–67 pathologists, 153 patient data, real-time, 158–59 patterns, in music, 89, 93, 96 Patterson, Nick, 160–61 PayPal, 188 PCs, Quotron data for, 33, 37, 39 pecking orders, social, 212–14 Pennsylvania, 115, 116 Pennsylvania, University of, 49 pension funds, 202 Pentagon, 168 Perfectmatch.com, 144 Perry, Katy, 89 Persia, 54 Peru, 91 Peterffy, Thomas: ambitions of, 27 on AMEX, 28–38 automated trading by, 41–42, 47–48, 113, 116 background and early career of, 18–20 Correlator algorithm of, 42–45 early handheld computers developed by, 36–39, 41, 44–45 earnings of, 17, 37, 46, 48, 51 fear that algorithms have gone too far by, 51 hackers hired by, 24–27 independence retained by, 46–47 on index funds, 41–46 at Interactive Brokers, 47–48 as market maker, 31, 35–36, 38, 51 at Mocatta, 20–28, 31 Nasdaq and, 11–18, 32, 42, 47–48, 185 new technology innovated by, 15–16 options trading algorithm of, 22–23, 24 as outsider, 31–32 profit guidelines of, 29 as programmer, 12, 15–16, 17, 20–21, 26–27, 38, 48, 62 Quotron hack of, 32–35 stock options algorithm as goal of, 27 Timber Hill trading operation of, see Timber Hill traders eliminated by, 12–18 trading floor methods of, 28–34 trading instincts of, 18, 26 World Trade Center offices of, 11, 39, 42, 43, 44 Petty, Tom, 84 pharmaceutical companies, 146, 155, 186 pharmacists, automation and, 154–56 Philips, 159 philosophy, Leibniz on, 57 phone lines: cross-country, 41 dedicated, 39, 42 phones, cell, 124–25 phosphate levels, 162 Physicians’ Desk Reference (PDR), 146 physicists, 62, 157 algorithms and, 6 on Wall Street, 14, 37, 119, 185, 190, 207 pianos, 108–9 Pincus, Mark, 206 Pisa, 56 pitch, 82, 93, 106 Pittsburgh International Airport, security algorithm at, 136 Pittsburgh Pirates, 141 Pius II, Pope, 69 Plimpton, George, 141–42 pneumonia, 158 poetry, composed by algorithm, 100–101 poker, 127–28 algorithms for, 129–35, 147, 150 Poland, 69, 91 Polyphonic HMI, 77–79, 82–83, 85 predictive algorithms, 54, 61, 62–65 prescriptions, mistakes with, 151, 155–56 present value, of future money streams, 57 pressure, thriving under, 169–70 prime numbers, general distribution pattern of, 65 probability theory, 66–68 in option prices, 27 problem solving, cooperative, 145 Procter & Gamble, 3 programmers: Cope as, 92–93 at eLoyalty, 182–83 Peterffy as, 12, 15–16, 17, 20–21, 26–27, 38, 48, 62 on Wall Street, 13, 14, 24, 46, 47, 53, 188, 191, 203, 207 programming, 188 education for, 218–20 learning, 9–10 simple algorithms in, 54 Progress Energy, 48 Project TACT (Technical Automated Compatibility Testing), 144 proprietary code, 190 proprietary trading, algorithmic, 184 Prussia, 69, 121 PSE, 40 pseudocholinesterase deficiency, 160 psychiatry, 163, 171 psychology, 178 Pu, Yihao, 190 Pulitzer Prize, 97 Purdue University, 170, 172 put options, 22, 43–45 Pythagorean algorithm, 64 quadratic equations, 63, 65 quants (quantitative analysts), 6, 46, 124, 133, 198, 200, 202–3, 204, 205 Leibniz as, 60 Wall Street’s monopoly on, 183, 190, 191, 192 Queen’s College, 72 quizzes, and OkCupid’s algorithms, 145 Quotron machine, 32–35, 37 Rachmaninoff, Sergei, 91, 96 Radiohead, 86 radiologists, 154 radio transmitters, in trading, 39, 41 railroad rights-of-way, 115–17 reactions-based people, 173–74, 195 ReadyForZero, 207 real estate, 192 on Redfin, 207 recruitment, of math and engineering students, 24 Redfin, 192, 206–7, 210 reflections-driven people, 173, 174, 182 refraction, indexes of, 15 regression analysis, 62 Relativity Technologies, 189 Renaissance Technologies, 160, 179–80, 207–8 Medallion Fund of, 207–8 retirement, 50, 214 Reuter, Paul Julius, 122 Rhode Island hold ‘em poker, 131 rhythms, 82, 86, 87, 89 Richmond, Va., 95 Richmond Times-Dispatch, 95 rickets, 162 ride sharing, algorithm for, 130 riffs, 86 Riker, William H., 136 Ritchie, Joe, 40, 46 Rochester, N.Y., 154 Rolling Stones, 86 Rondo, Rajon, 143 Ross, Robert, 143–44 Roth, Al, 147–49 Rothschild, Nathan, 121–22 Royal Society, London, 59 RSB40, 143 runners, 39, 122 Russia, 69, 193 intelligence of, 136 Russian debt default of 1998, 64 Rutgers University, 144 Ryan, Lee, 79 Saint Petersburg Academy of Sciences, 69 Sam Goody, 83 Sandberg, Martin (Max Martin), 88–89 Sandholm, Tuomas: organ donor matching algorithm of, 147–51 poker algorithm of, 128–33, 147, 150 S&P 100 index, 40–41 S&P 500 index, 40–41, 51, 114–15, 218 Santa Cruz, Calif., 90, 95, 99 satellites, 60 Savage Beast, 83 Saverin, Eduardo, 199 Scholes, Myron, 23, 62, 105–6 schools, matching algorithm for, 147–48 Schubert, Franz, 98 Schwartz, Pepper, 144 science, education in, 139–40, 218–20 scientists, on Wall Street, 46, 186 Scott, Riley, 9 scripts, algorithms for writing, 76 Seattle, Wash., 192, 207 securities, 113, 114–15 mortgage-backed, 203 options on, 21 Securities and Exchange Commission (SEC), 185 semiconductors, 60, 186 sentence structure, 62 Sequoia Capital, 158 Seven Bridges of Königsberg, 69, 111 Shannon, Claude, 73–74 Shuruppak, 55 Silicon Valley, 53, 81, 90, 116, 188, 189, 215 hackers in, 8 resurgence of, 198–211, 216 Y Combinator program in, 9, 207 silver, 27 Simons, James, 179–80, 208, 219 Simpson, O.


pages: 219 words: 15,438

The Essays of Warren Buffett: Lessons for Corporate America by Warren E. Buffett, Lawrence A. Cunningham

buy and hold, compound rate of return, corporate governance, Dissolution of the Soviet Union, diversified portfolio, dividend-yielding stocks, fixed income, George Santayana, index fund, intangible asset, invisible hand, large denomination, low cost airline, low cost carrier, oil shock, passive investing, price stability, Ronald Reagan, the market place, transaction costs, Yogi Berra, zero-coupon bond

In dismissing Buffett, modern finance enthusiasts still insist that an investor's best strategy is to diversify based on betas or dart throwing, and constantly reconfigure one's portfolio of investments. Buffett responds with a quip and some advice: the quip is that devotees of his investment philosophy should probably endow chairs to ensure the perpetual teaching of efficient market dogma; the advice is to ignore modern finance theory and other quasi-sophisticated views of the market and stick to investment knitting. That can best be done for many people through long-term investment in an index fund. Or it can be done by conducting hardheaded analyses of businesses within an investor's competence to evaluate. In that kind of thinking, the risk that matters is not beta or volatility, but the possibility of loss or injury from an investment. Assessing that kind of investment risk requires thinking about a company's management, products, competitors, and debt levels. The inquiry is whether after-tax returns on an investment are at least equal to the purchasing power of the initial investment plus a fair rate of return.

Should you choose to pursue this course, you should adopt the outlook of the casino that owns a roulette wheel, which will want to see lots of action because it is favored by probabilities; but will refuse to accept a single, huge bet. Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb. On the other hand, if you are a know-something investor, able to understand business economics and to find five to ten sensiblypriced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you.

All too often, we've seen value stagnate in the presence of hubris or of boredom that caused the attention of managers to wander. That's not going to happen again at Coke and Gillette, however-not given their current and prospective managements. * * * * * Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals. Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses.


pages: 266 words: 86,324

The Drunkard's Walk: How Randomness Rules Our Lives by Leonard Mlodinow

Albert Einstein, Alfred Russel Wallace, Antoine Gombaud: Chevalier de Méré, Atul Gawande, Brownian motion, butterfly effect, correlation coefficient, Daniel Kahneman / Amos Tversky, Donald Trump, feminist movement, forensic accounting, Gerolamo Cardano, Henri Poincaré, index fund, Isaac Newton, law of one price, pattern recognition, Paul Erdős, Pepto Bismol, probability theory / Blaise Pascal / Pierre de Fermat, RAND corporation, random walk, Richard Feynman, Ronald Reagan, Stephen Hawking, Steve Jobs, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, V2 rocket, Watson beat the top human players on Jeopardy!

Nordin, “Perceptual Learning in Olfaction: Professional Wine Tasters Versus Controls,” Physiology and Behavior 62, no. 5 (November 1997): 1065–70. 22. Gregg E. A. Solomon, “Psychology of Novice and Expert Wine Talk,” American Journal of Psychology 103, no. 4 (Winter 1990): 495–517. 23. Rivlin, “In Vino Veritas.” 24. Ibid. 25. Hal Stern, “On the Probability of Winning a Football Game,” American Statistician 45, no. 3 (August 1991): 179–82. 26. The graph is from Index Funds Advisors, “Index Funds.com: Take the Risk Capacity Survey,” http://www.indexfunds3.com/step3page2.php, where it is credited to Walter Good and Roy Hermansen, Index Your Way to Investment Success (New York: New York Institute of Finance, 1997). The performance of 300 mutual fund managers was tabulated for ten years (1987–1996), based on the Morningstar Principia database. 27. Polling Report, “President Bush—Overall Job Rating,” http://pollingreport.com/BushJob.htm. 28.

And though many studies show that these past market successes are not good indicators of future success—that is, that the successes were largely just luck—most people feel that the recommendations of their stockbrokers or the expertise of those running mutual funds are worth paying for. Many people, even intelligent investors, therefore buy funds that charge exorbitant management fees. In fact, when a group of savvy students from the Wharton business school were given a hypothetical $10,000 and prospectuses describing four index funds, each composed in order to mirror the S&P 500, the students overwhelmingly failed to choose the funds with the lowest fees.19 Since paying even an extra 1 percent per year in fees could, over the years, diminish your retirement fund by as much as one-third or even one-half, the savvy students didn’t exhibit very savvy behavior. Of course, as Spencer-Brown’s example illustrates, if you look long enough, you’re bound to find someone who, through sheer luck, really has made startlingly successful predictions.


pages: 293 words: 81,183

Doing Good Better: How Effective Altruism Can Help You Make a Difference by William MacAskill

barriers to entry, basic income, Black Swan, Branko Milanovic, Cal Newport, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, clean water, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Brooks, effective altruism, en.wikipedia.org, end world poverty, experimental subject, follow your passion, food miles, immigration reform, income inequality, index fund, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, job automation, job satisfaction, Lean Startup, M-Pesa, mass immigration, meta analysis, meta-analysis, microcredit, Nate Silver, Peter Singer: altruism, purchasing power parity, quantitative trading / quantitative finance, randomized controlled trial, self-driving car, Skype, Stanislav Petrov, Steve Jobs, Steve Wozniak, Steven Pinker, The Future of Employment, The Wealth of Nations by Adam Smith, universal basic income, women in the workforce

Finally, the independent development think tank Innovations for Poverty Action has run a randomized controlled trial on GiveDirectly, so we can be confident not just about the efficacy of cash transfers in general but also about cash transfers as implemented by GiveDirectly. Because cash transfers is such a simple program, and because the evidence in favor of them is so robust, we could think about them as like the “index fund” of giving. Money invested in an index fund grows (or shrinks) at the same rate as the stock market; investing in an index fund is the lowest-fee way to invest in stocks. Actively managed mutual funds, in contrast, take higher management fees, and it’s only worth investing in one if that fund manages to beat the market by a big enough margin that the additional returns on investment are greater than the additional management costs. In the same way, one might think, it’s only worth it to donate to charitable programs rather than simply transfer cash directly to the poor if the other programs provide a benefit great enough to outweigh the additional costs incurred in implementing them.


pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, buy low sell high, capital controls, central bank independence, commoditize, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, diversification, diversified portfolio, family office, fixed income, glass ceiling, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, John Meriwether, Long Term Capital Management, margin call, market bubble, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shale / tar sands, oil shock, out of africa, paper trading, Paul Samuelson, Peter Thiel, price anchoring, purchasing power parity, reserve currency, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond, zero-sum game

If you were advising an institution—let’s say a conservative university endowment—where would you recommend they invest their funds? Commodities and non–U.S. dollar assets. Fifty-fifty or how would you split it up? If I had told the board of trustees of Princeton University to put all its money into an S&P index fund in 1982, they would have run me out of town. But that is what they should have done. THE PIONEER 221 Now, in 2005, a large amount of their assets should go into commodities either via a commodity index fund, which is probably the best way, or via a manager, which traditionally has not been the best way.They should have a large part of their assets in raw materials.At what percentage, I leave that to you, but the rest of the assets, if there are any left over, should go into non–U.S. dollar investments.

There seem to be a lot of artificial opportunities in the investment world because money management companies have rules such as “You can’t buy a stock below ten dollars.” Absolutely. Another favorite of mine, obviously, is commodities. It was the end of 1998 when I started this commodities index fund because I was convinced that the 20-year bear market in commodities was coming to an end.You cannot believe the ridicule I used to get on CNBC.They were all giggling and drooling and talking about dot-com this and dot-com that, while I was sitting there saying, “I am starting a commodities index fund and China is a great place to invest.”Well, you know the rest of that story. That has been a nice one.There are many mistakes I could tell you about, but you asked about my favorites. I’d love to hear about some of your mistakes and what you learned from them.


pages: 317 words: 106,130

The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

asset allocation, backtesting, Bernie Madoff, Black Swan, business cycle, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index fund, interest rate swap, invisible hand, market microstructure, merger arbitrage, moral hazard, Myron Scholes, passive investing, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, statistical model, stocks for the long run, survivorship bias, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve, zero-sum game

., minimum asset floor) investment models are used, which permit an investor to feel assured that the minimum investment level is protected while automatically increasing investment and potential return through alternative investments as the minimum investment level is systematically increased and investor wealth or investment levels increase. (Of course, if 118 THE NEW SCIENCE OF ASSET ALLOCATION EXHIBIT 6.5 Comparison Correlations for Benchmark, Core, and Satellite Groupings Benchmark Core Correlations to Benchmark Satellite 1 Investments Correlations to Benchmark Satellite 1 Investments Correlations to Core ■ Russell 1000 Russell 2000 iShares Russell 1000 Index Fund iShares Russell 2000 Index Fund 1.00 1.00 Lipper Lg-Cap Core Lipper Sm-Cap Core 1.00 0.98 Lipper Lg-Cap Core 1.00 MSCI EAFE MSCI EM BarCap US Gov BarCap US Agg iShares MSCI EAFE iShares MSCI EM iShares Barclays Government/ Credit Bond Fund iShares Barclays Aggregate Bond Fund 0.98 Lipper Non US Stock 0.97 Lipper Emerg Mkt Fd 0.86 0.95 Lipper A Rated Bnd Fd Lipper Gen US Govt Fd 0.99 Lipper Emerg Mkt Fd 0.97 0.94 Lipper Sm-Cap Core 0.93 Lipper Non US Stock Lipper A Rated Bnd Fd Lipper Gen US Govt Fd 0.98 0.95 0.97 0.89 0.87 wealth or investment levels decrease, systematic reductions would also be conducted.)

., invest in unfamiliar asset classes). 119 Core and Satellite Investment: Market/Manager Based Alternatives BarCap US Corporate High-Yield Private Equity Index SPDR Barclays Capital High Yield Bond ETF S&P GSCI FTSE NAREIT ALL REITS CISDM EW HF Index CISDM CTA EW Index PowerShares Listed Private Equity Portfolio iShares S&P GSCI Commodity Indexed Trust iShares FTSE NAREIT Real Estate 50 Index Fund HF Replication CTA Replication 0.95 0.94 0.99 0.99 0.94 Lipper HI Cur Yld Bd Private Equity MF Lipper Nat Res Fd IX Lipper Real Estate Fd HF Investable (Mgr. Based) 0.73 CTA Investable (Mgr. Based) 0.98 0.68 0.63 0.99 0.90 Lipper HI Cur Yld Bd Private Equity MF Lipper Nat Res Fd IX Lipper Real Estate Fd HF Investable (Mgr. Based) 0.41 CTA Investable (Mgr. Based) 0.90 0.83 0.85 0.98 0.91 0.73 ■ Personal Character: Optimism, entrepreneurship, and the discipline of staying with a predefined strategy.


pages: 306 words: 97,211

Value Investing: From Graham to Buffett and Beyond by Bruce C. N. Greenwald, Judd Kahn, Paul D. Sonkin, Michael van Biema

Andrei Shleifer, barriers to entry, Berlin Wall, business cycle, capital asset pricing model, corporate raider, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index fund, intangible asset, Long Term Capital Management, naked short selling, new economy, place-making, price mechanism, quantitative trading / quantitative finance, Richard Thaler, shareholder value, short selling, Silicon Valley, stocks for the long run, Telecommunications Act of 1996, time value of money, tulip mania, Y2K, zero-sum game

Value investors would not be in business if they did not believe that fundamental analysis done from the value perspective can, in some but not all cases, identify an intrinsic value for a security that varies substantially from the price Mr. Market is quoting. Information and understanding do make a difference. But when the value investor's search for new ideas fails to turn up anything promising, then the default option may indeed be a broad-based index fund or some variant of it. If the manager is being measured against other equity managers, the option of sitting with large amounts of cash may not be wise. The justification for holding an index fund as a portion of the portfolio is straightforward. Historically, the stock market has outperformed bonds or cash over most five-year periods.' In the absence of particular knowledge or information, an index is indeed the best choice available. In fact, if the manager has no special insights at all, then the index is the choice for the entire portfolio, in which case the manager is superfluous.

When Venator, the name Woolworth chose to make people forget its notso-illustrious recent history, lost its place in the S&P 500, the share price dropped from $6 to around $3 in a few days. Less than three months later, it was selling at $10. When assets are sold for noneconomic reasons, the most common explanation is that some type of institutional constraint obligated the owner to move. An index fund's charter is one such constraint-own only the securities in the index. Some of the other constraints that have given Klarman an opening include the following: • Spin-offs, in which a large company takes a division, creates a new firm, and sends shares in the new company to existing stockholders in some proportion to their holdings. Unlike initial public offerings (IPOs), spin-offs are not supported by investment banks; they do not receive the powerful sales push that these banks use to market their IPOs, and there are few if any analysts covering them.


pages: 234 words: 53,078

The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer by Dean Baker

accounting loophole / creative accounting, affirmative action, Asian financial crisis, Bretton Woods, business cycle, corporate governance, declining real wages, full employment, index fund, Jeff Bezos, medical malpractice, medical residency, money market fund, offshore financial centre, price discrimination, risk tolerance, spread of share-ownership

They recognized the high administrative costs associated with the existing system of defined contribution pensions in the United States, as well as the costs of privatized Social Security systems in other countries. In order to reduce the costs of a privatized system, they proposed having a single centralized system which would pool workers’ savings from all over the country. Their proposal called for having a limited number of investments options (e.g. a stock index fund, a bond index fund, a money market fund, and possibly one or two other options) and limited opportunities to switch between funds. According to the Bush commission’s estimates, the administrative costs of this bare-bones system would be approximately 5 percent of the money paid into the system. While this is still very expensive compared to the 0.5 percent in administrative fees charged by Social Security, it is far less than the 15-20 percent in fees charged by financial firms for operating private sector defined contribution pensions in the United States, or that financial firms charge to operate privatized Social Security accounts in other countries.


pages: 829 words: 186,976

The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

"Robert Solow", airport security, availability heuristic, Bayesian statistics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, business cycle, buy and hold, Carmen Reinhart, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Freestyle chess, fudge factor, George Akerlof, global pandemic, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, Laplace demon, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, negative equity, new economy, Norbert Wiener, PageRank, pattern recognition, pets.com, Pierre-Simon Laplace, prediction markets, Productivity paradox, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, wikimedia commons

.* And while most individual, retail-level investors make common mistakes like trading too often and do worse than the market average, a select handful probably do beat the street.91 Buy High, Sell Low You should not rush out and become an options trader. As the legendary investor Benjamin Graham advises, a little bit of knowledge can be a dangerous thing in the stock market.92 After all, any investor can do as well as the average investor with almost no effort. All he needs to do is buy an index fund that tracks the average of the S&P 500.93 In so doing he will come extremely close to replicating the average portfolio of every other trader, from Harvard MBAs to noise traders to George Soros’s hedge fund manager. You have to be really good—or foolhardy—to turn that proposition down. In the stock market, the competition is fierce. The average trader, particularly in today’s market, in which trading is dominated by institutional investors, is someone who will have ample credentials, a high IQ, and a fair amount of experience.

Few investors beat the stock market over the long run relative to their level of risk and accounting for their transaction costs, unless they have inside information. It is hard to tell how many investors beat the stock market over the long run, because the data is very noisy, but we know that most cannot relative to their level of risk, since trading produces no net excess return but entails transaction costs, so unless you have inside information, you are probably better off investing in an index fund. The first approximation—the unqualified statement that no investor can beat the stock market—seems to be extremely powerful. By the time we get to the last one, which is full of expressions of uncertainty, we have nothing that would fit on a bumper sticker. But it is also a more complete description of the objective world. There is nothing wrong with an approximation here and there.

res=F00614F8355F127A93C1AB178ED85F458785F9. 28. William F. Sharpe, “Mutual Fund Performance,” Journal of Business, 39, 1 (January 1966), part 2: Supplement on Security Prices, pp. 119–138. http://finance.martinsewell.com/fund-performance/Sharpe1966.pdf. 29. The sample consists of all mutual funds listed as balanced large-capitalization American equities funds by E*Trade’s mutual funds screener as of May 1, 2012, excluding index funds. Funds also had to have reported results for each of the ten years from 2002 through 2006. There may be a slight bias introduced in that some funds that performed badly from 2002 through 2011 may no longer be offered to investors. 30. Charts A, B, C, and E are fake. Chart D depicts the actual movement of the Dow over the first 1,000 days of the 1970s, and chart F depicts the actual movement of the Dow over the first 1,000 days of the 1980s.


pages: 850 words: 254,117

Basic Economics by Thomas Sowell

affirmative action, air freight, airline deregulation, American Legislative Exchange Council, bank run, barriers to entry, big-box store, British Empire, business cycle, clean water, collective bargaining, colonial rule, corporate governance, correlation does not imply causation, cross-subsidies, David Brooks, David Ricardo: comparative advantage, declining real wages, Dissolution of the Soviet Union, diversified portfolio, European colonialism, fixed income, Fractional reserve banking, full employment, global village, Gunnar Myrdal, Hernando de Soto, hiring and firing, housing crisis, income inequality, income per capita, index fund, informal economy, inventory management, invisible hand, John Maynard Keynes: technological unemployment, joint-stock company, Just-in-time delivery, Kenneth Arrow, knowledge economy, labor-force participation, land reform, late fees, low cost airline, low cost carrier, low skilled workers, means of production, Mikhail Gorbachev, minimum wage unemployment, moral hazard, offshore financial centre, oil shale / tar sands, payday loans, price discrimination, price stability, profit motive, quantitative easing, Ralph Nader, rent control, road to serfdom, Ronald Reagan, Silicon Valley, surplus humans, The Bell Curve by Richard Herrnstein and Charles Murray, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, transcontinental railway, Vanguard fund, War on Poverty

Mutual funds manage vast sums of investors’ money: More than fifty mutual funds have assets of at least $10 billion each.{488} Theoretically, those mutual funds where the managers actively follow the various markets and then pick and choose which stocks to buy and sell should average a higher rate of return than those mutual funds which simply buy whatever stocks happen to make up the Dow Jones average or Standard & Poor’s Index. Some actively managed mutual funds do in fact do better than index mutual funds, but in many years the index funds have had higher rates of return than most of the actively managed funds, much to the embarrassment of the latter. In 2005, for example, of 1,137 actively managed mutual funds dealing in large corporate stocks, just 55.5 percent did better than the Standard & Poor’s Index.{489} On the other hand, the index funds offer little chance of a big killing, such as a highly successful actively managed fund might. A reporter for the Wall Street Journal who recommended index funds for people who don’t have the time or the confidence to buy their own stocks individually said: “True, you might not laugh all the way to the bank. But you will probably smile smugly.”{490} However, index mutual funds lost 9 percent of their value in the year 2000,{491} so there is no complete freedom from risk anywhere.

In other words, money invested in bonds during those inflationary decades would not buy as much when these bonds were cashed in as when the bonds were bought, even though larger sums of money were received in the end. With the restoration of price stability in the last two decades of the twentieth century, both stocks and bonds had positive rates of real returns.{483} But, during the first decade of the twenty-first century, all that changed, as the New York Times reported: If you invested $100,000 on Jan. 1, 2000, in the Vanguard index fund that tracks the Standard & Poor’s 500, you would have ended up with $89,072 by mid-December of 2009. Adjust that for inflation by putting it in January 2000 dollars and you’re left with $69,114.{484} With a more diversified portfolio and a more complex investment strategy, however, the original $100,000 investment would have grown to $313,747 over the same time period, worth $260,102 in January 2000 dollars, taking inflation into account.{485} Risk is always specific to the time at which a decision is made.

But you will probably smile smugly.”{490} However, index mutual funds lost 9 percent of their value in the year 2000,{491} so there is no complete freedom from risk anywhere. For mutual funds as a whole—both managed funds and index funds—a $10,000 investment in early 1998 would by early 2003 be worth less than $9,000.{492} Out of a thousand established mutual funds, just one made money every year of the decade ending in 2003.{493} What matters, however, is whether they usually make money. While mutual funds made their first appearance in the last quarter of the twentieth century, the economic principles of risk-spreading have long been understood by those investing their own money. In centuries past, shipowners often found it more prudent to own 10 percent of ten different ships, rather than own one ship outright.


pages: 202 words: 58,823

Willful: How We Choose What We Do by Richard Robb

activist fund / activist shareholder / activist investor, Alvin Roth, Asian financial crisis, asset-backed security, Bernie Madoff, capital asset pricing model, cognitive bias, collapse of Lehman Brothers, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, delayed gratification, diversification, diversified portfolio, effective altruism, endowment effect, Eratosthenes, experimental subject, family office, George Akerlof, index fund, information asymmetry, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, lake wobegon effect, loss aversion, market bubble, market clearing, money market fund, Pareto efficiency, Paul Samuelson, Peter Singer: altruism, principal–agent problem, profit maximization, profit motive, Richard Thaler, Silicon Valley, sovereign wealth fund, survivorship bias, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, ultimatum game

The policy usually splits the fund into “buckets,” “sectors,” or “asset classes.” Sectors can include domestic public equity, global equity, credit, illiquid credit, private equity, cash, absolute return (hedge funds), and the like. The CIO assigns specialists to look after each sector. Equity managers handle equity; credit managers handle credit. For the public equities sector, some CIOs farm out stock selection to outside managers, and others invest passively in an index fund to hold down costs. Often a risk management department monitors the entire portfolio. In the case of pension funds, the board pays attention to how assets match liabilities to pensioners. Funds define risk mainly in terms of exposure to the market as a whole. The term “alpha” is supposed to describe the expected return beyond what can be explained by correlation with the stock market. When trustees want to take on more risk, they dial up allocations to volatile investments, such as stocks.

See also mercy ambiguity effect, 24 American Work-Sports (Zarnowski), 191 Anaximander, 190 anchoring, 168 angel investors, 212–213n1 “animal spirits,” 169 Antipater of Tarsus, 134–135, 137 “anxious vigilance,” 73, 82 arbitrage, 70, 78 Aristotle, 200, 220n24 Asian financial crisis (1997–1998), 13 asset-backed securities, 93–95 asset classes, 75 astrology, 67 asymmetric information, 96, 210n2 authenticity, 32–37, 114 of challenges, 176–179 autism, 58, 59 auto safety, 139 Bank of New York Mellon, 61 Battle of Waterloo, 71, 205 Bear Stearns, 85 Becker, Gary, 33, 108–109 behavioral economics, 4, 10, 198–199 assumptions underlying, 24 insights of, 24–25 rational choice complemented by, 6 Belgium, 191 beliefs: attachment to, 51 defined, 50 evidence inconsistent with, 54, 57–58 formation of, 53, 92 persistence of, 26–28, 54 transmissibility of, 92–93, 95–96 Bentham, Jeremy, 127, 197–198 “black swans,” 62–64 blame aversion, 57, 72 brain hemispheres, 161 Brexit, 181–185 “bull markets,” 78 capital asset pricing model, 64 care altruism, 38, 104, 108–114, 115, 120, 135, 201 Casablanca (film), 120, 125 The Cask of Amontillado (Poe), 126–127 challenges, 202–203 authenticity of, 176–179 staying in the game linked to, 179–181 changes of mind, 147–164 charity, 40, 45–46, 119, 128 choice: abundance of, 172–174 intertemporal, 149–158, 166 purposeful vs. rational, 22–23 Christofferson, Johan, 83, 86, 87, 88 Cicero, 133–134 Clark, John Bates, 167 cognitive bias, 6, 23, 51, 147–148, 167, 198–199 confirmation bias, 200 experimental evidence of, 10–11, 24 for-itself behavior disguised as, 200–201 gain-loss asymmetry, 10–11 hostile attribution bias, 59 hyperbolic discounting as, 158 lawn-mowing paradox and, 33–34 obstinacy linked to, 57 omission bias, 200 rational choice disguised as, 10–11, 33–34, 199–200 salience and, 29, 147 survivor bias, 180 zero risk bias, 24 Colbert, Claudette, 7 Columbia University, 17 commitment devices, 149–151 commodities, 80, 86, 89 commuting, 26, 38–39 competitiveness, 11, 31, 41, 149, 189 complementary skills, 71–72 compound interest, 79 confirmation bias, 57, 200 conspicuous consumption, 31 consumption planning, 151–159 contrarian strategy, 78 cooperation, 104, 105 coordination, 216n15 corner solutions, 214n8 cost-benefit analysis: disregard of, in military campaigns, 117 of human life, 138–143 credit risk, 11 crime, 208 Dai-Ichi Kangyo Bank (DKB), 12–14, 15, 17, 87, 192–193 Darwin, Charles, 62–63 depression, psychological, 62 de Waal, Frans, 118 Diogenes of Seleucia, 134–135, 137 discounting of the future, 10, 162–164 hyperbolic, 158, 201 disjunction effect, 174–176 diversification, 64–65 divestment, 65–66 Dostoevsky, Fyodor, 18 drowning husband problem, 6–7, 110, 116, 123–125 effective altruism, 110–112, 126, 130, 135–136 efficient market hypothesis, 69–74, 81–82, 96 Empire State Building, 211–212n12 endowment effect, 4 endowments, of universities, 74 entrepreneurism, 27, 90, 91–92 Eratosthenes, 190 ethics, 6, 104, 106–108, 116, 125 European Union, 181–182 experiential knowledge, 59–61 expert opinion, 27–28, 53, 54, 56–57 extreme unexpected events, 61–64 fairness, 108, 179 family offices, 94 Fear and Trembling (Kierkegaard), 53–54 “felicific calculus,” 197–198 financial crisis of 2007–2009, 61, 76, 85, 93–94, 95 firemen’s muster, 191 flow, and well-being, 201–202 Foot, Philippa, 133–134, 135 for-itself behavior, 6–7, 19, 21, 27, 36, 116, 133–134, 204–205, 207–208 acting in character as, 51–53, 55–56, 94–95, 203 acting out of character as, 69, 72 analyzing, 20 authenticity and, 33–35 charity as, 39–40, 45–46 comparison and ranking lacking from, 19, 24, 181 consequences of, 55–64 constituents of, 26–31 defined, 23–24 difficulty of modeling, 204 expert opinion and, 57 extreme unexpected events and, 63–64 flow of time and, 30 free choice linked to, 169–172 in groups, 91–100 incommensurability of, 140–143 in individual investing, 77–78 in institutional investing, 76 intertemporal choice and, 168, 175, 176 job satisfaction as, 189 mercy as, 114 misclassification of, 42, 44, 200–201 out-of-character trading as, 68–69 purposeful choice commingled with, 40–43, 129, 171 rationalizations for, 194–195 in trolley problem, 137 unemployment and, 186 France, 191 Fuji Bank, 14 futures, 80–81 gain-loss asymmetry, 10–11 Galperti, Simone, 217n1 gambler’s fallacy, 199 gamifying, 177 Garber, Peter, 212n1 Germany, 191 global equity, 75 Good Samaritan (biblical figure), 103, 129–130, 206 governance, of institutional investors, 74 Great Britain, 191 Great Depression, 94 Greek antiquity, 190 guilt, 127 habituation, 201 happiness research (positive psychology), 25–26, 201–202 Hayek, Friedrich, 61, 70 hedge funds, 15–17, 65, 75, 78–79, 93, 95 herd mentality, 96 heroism, 6–7, 19–20 hindsight effect, 199 holding, of investments, 79–80 home country bias, 64–65 Homer, 149 Homo ludens, 167–168 hostile attribution bias, 59 housing market, 94 Huizinga, Johan, 167–168 human life, valuation of, 138–143 Hume, David, 62, 209n5 hyperbolic discounting, 158, 201 illiquid markets, 74, 94 index funds, 75 individual investing, 76–82 Industrial Bank of Japan, 14 information asymmetry, 96, 210n2 innovation, 190 institutional investing, 74–76, 82, 93–95, 205 intergenerational transfers, 217n1, 218n4 interlocking utility, 108 intertemporal choice, 149–159, 166 investing: personal beliefs and, 52–53 in start-ups, 27 Joseph (biblical figure), 97–99 Kahneman, Daniel, 168 Kantianism, 135–136 Keynes, John Maynard, 12, 58, 167, 169, 188–189 Kierkegaard, Søren, 30, 53, 65, 88 Knight, Frank, 145, 187 Kranton, Rachel E., 210–211n2 labor supply, 185–189 Lake Wobegon effect, 4 lawn-mowing paradox, 33–34, 206 Lehman Brothers, 61, 86, 89, 184 leisure, 14, 17, 41, 154, 187 Libet, Benjamin, 161 life, valuation of, 138–143 Life of Alexander (Plutarch), 180–181 Locher, Roger, 117, 124 long-term vs. short-term planning, 148–149 loss aversion, 70, 199 lottery: as rational choice, 199–200 Winner’s Curse, 34–36 love altruism, 104, 116, 123–125, 126, 203 lying, vs. omitting, 134 Macbeth (Shakespeare), 63 MacFarquhar, Larissa, 214n6 Madoff, Bernard, 170 malevolence, 125–127 Malthus, Thomas, 212n2 manners, in social interactions, 104, 106, 107, 116, 125 market equilibrium, 33 Markowitz, Harry, 65 Marshall, Alfred, 41, 167 Mass Flourishing (Phelps), 189–191 materialism, 5 merchant’s choice, 133–134, 137–138 mercy, 104, 114–116, 203 examples of, 116–120 inexplicable, 45–46, 120–122 uniqueness of, 119, 129 mergers and acquisitions, 192 “money pump,” 159 monks’ parable, 114, 124 Montaigne, Michel de, 114, 118 mortgage-backed securities, 93 Nagel, Thomas, 161 Napoleon I, emperor of the French, 71 neoclassical economics, 8, 10, 11, 22, 33 Nietzsche, Friedrich, 21, 43, 209n5 norms, 104, 106–108, 123 Norway, 66 Nozick, Robert, 162 observed care altruism, 108–112 Odyssey (Homer), 149–150 omission bias, 200 On the Fourfold Root of the Principle of Sufficient Reason (Schopenhauer), 209n5 “on the spot” knowledge, 61, 70, 80, 94, 205 Orico, 13 overconfidence, 57, 200 “overearning,” 44–45 The Palm Beach Story (film), 7 The Paradox of Choice (Schwartz), 172 parenting, 108, 141, 170–171 Pareto efficiency, 132–133, 136, 139–140 Peirce, Charles Sanders, 53–54, 67, 94 pension funds, 66, 74–75, 93, 95 permanent income hypothesis, 179 Pharaoh (biblical figure), 97–99 Phelps, Edmund, 17, 189–191 Philip II, king of Macedonia, 181 planning, 149–151 for consumption, 154–157 long-term vs. short-term, 148–149 rational choice applied to, 152–158, 162 play, 44–45, 167, 202 pleasure-pain principle, 18 Plutarch, 180–181 Poe, Edgar Allan, 126 pollution, 132–133 Popeye the Sailor Man, 19 portfolio theory, 64–65 positive psychology (happiness research), 25–26, 201–202 preferences, 18–19, 198 aggregating, 38–39, 132, 164 altruism and, 28, 38, 45, 104, 110, 111, 116 in behavioral economics, 24, 168 beliefs’ feedback into, 51, 55 defined, 23 intransitive, 158–159 in purposeful behavior, 25, 36 risk aversion and, 51 stability of, 33, 115, 147, 207, 208 “time-inconsistent,” 158, 159, 166, 203 present value, 7, 139 principal-agent problem, 72 Principles of Economics (Marshall), 41 prisoner’s dilemma, 105 private equity, 75 procrastination, 3, 4, 19, 177–178 prospect theory, 168 protectionism, 185–187 Prussia, 191 public equities, 75 punishment, 109 purposeful choice, 22–26, 27, 34, 36, 56, 133–134, 204–205 altruism compatible with, 104, 113–114, 115–116 commensurability and, 153–154 as default rule, 43–46 expert opinion and, 57 extreme unexpected events and, 62–63 flow of time and, 30 for-itself behavior commingled with, 40–43, 129, 171 mechanistic quality of, 68 in merchant’s choice, 135, 137–138 Pareto efficiency linked to, 132 rational choice distinguished from, 22–23 regret linked to, 128 social relations linked to, 28 stable preferences linked to, 33 in trolley problem, 135–136 vaccination and, 58–59 wage increases and, 187.


pages: 398 words: 108,889

The Paypal Wars: Battles With Ebay, the Media, the Mafia, and the Rest of Planet Earth by Eric M. Jackson

bank run, business process, call centre, creative destruction, disintermediation, Elon Musk, index fund, Internet Archive, iterative process, Joseph Schumpeter, market design, Menlo Park, Metcalfe’s law,