Book Review on Performance Chasing and Market Timing

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I have an odd goal today. By the end of this post, I hope you’ll have a healthy distaste for financial “experts” and magazines, Wall Street’s hype, and the random people you hear pontificating about what the market will do next week. Basically, I hope you start scoffing at everyone after today.

But first, a little background. Today, I’m reviewing chapter 13 of The Bogleheads’ Guide to Investing, one of the most excellent books on investing anywhere. If you’re looking for a book to get started investing, I recommend this one–it has no hype, just sensible advice for long-term investing, based on John Bogle’s ideas (he founded the Vanguard Group).

Also, here’s an interesting twist: Each chapter is being reviewed by a different blogger, so you can get to know some of the other bloggers in the personal-finance community. Check out the full list here.

Chapter 13 is called Performance Chasing and Market Timing, so let’s get to it.

* * *

Everyone’s got an opinion, and when it comes to investments, it seems the louder someone shouts or the bigger font a magazine uses, the more attention it gets. Too bad iwillteachyoutoberich readers are too smart to get swayed by this idiotic hype. I’ve said it before and I’ll say it again: There’s a difference between being sexy and being rich.

That’s why when I’m reading some blog’s comments and I see people absolutely sure about which direction interest rates are going, or whether we’re in a bubble, or how likely P/E ratios are to stabilize to pre-2000 levels, I just ignore them (or mock them). We love to talk. But that doesn’t make us right.

So today, before we get to some actual data, I thought I’d ask when the last time you saw one of these things happen was:

  • A financial magazine proclaimed the “Ten Best Ways To Make Money This Year”
  • Your friend told you about his amazing investment and bragged about the returns
  • You saw anybody online discussing macroeconomic concepts like interest rates, etc, with a firm semse of what would happen next
  • A pundit on CNBC shared a hot stock or explained what would happen next in the near future in the stock market

If so, then you know the odd confidence that comes along with these predictions. Unfortunately, most people–experts included–are usually wrong.

Why We Can’t Time The Market
We’re really bad at predicting what’s going to happen next. The chapter goes into great detail about market timing, or trying to guess what the market will do, so I’ll just summarize some of the key points here. We’ve talked about hindsight bias, a psychological phenomenon in which things seem clearer in retrospect and we think we knew it all along. This applies to personal finance, too. As the Bogleheads authors write, they launched a contest in 2002 to predict the closing price of the Wilshire 5000 Index (it’s kind of like the S&P 500). The contest included “177 predictions [and] the forecasts of 11 major Wall Street brokerage firms. Here’s what happened:

  • 133 Bogleheads predicted a gain
  • The S&P fell from 1148 to 880–a decline of 23 percent.
  • Only three Bogleheads predicted the index would go as low as it did.
  • Only one Wall Street strategist could even guess the direction of the stock market.”

Stunning. And that was just the direction of the market. It turns out we also chase performance, meaning we buy when things are high and sell when they’re low.

  • “Over the past decade Morningstar’s five-star equity funds have earned an average 5.7 percent against a 10.3 percent return for the Wilshire 5000 (February 2, 2004).”
  • “Barksdale and Green studied 144 institutional equity portfolios between January 1, 1975 and December 31, 1989. They found that the portfolios that finished the first five years in the top quintile were the least likely to finish in the top half over the next five years.”
  • “Vanguard did a study of past performance for institutional investors. It found that of the top-20 U.S. equity funds during the 10-year period through 1993, only one stayed in the top 100 in the subsequent 10-year period.”
  • And in one of the most damning findings, “Of the 50 top-performing funds in 2000, not a single one appeared on the top-50 list in either 1999 or 1998.”

Unfortunately, we often use heuristics to make our own decisions about which funds to invest in, decisions which are usually biased. Take the Janus “Ratings & Rankings page,” which lists impressive rankings for their many funds. Wow! I better invest right now!

Not so fast. There’s a little thing called survivorship bias, which is “the tendency for failed companies to be excluded for performance studies due to the fact that they no longer exist.” This can profoundly affect the performance rates you read about in financial magazines. An analogy helped me understand when I first learned about survivorship bias, and fortunately someone named Patri Friedman has written about it (using examples of poker and mutual funds). “There is a particularly clever scam,” he writes:

Get a list of email addresses of people interested in sports betting. Say you have 32,000. Email 16,000 of them to say that the home team will win this week’s big team, and 16,000 to say the home team will lose. Now, half of the people will have gotten the correct prediction, and the next week, you do the same thing with them. After 5 weeks, you’ll have 1,000 email addresses of people who have seen you pick the winner five times in a row!. Now you pitch your 1-900 number or paid email list subscription to this amazed group.

Are The Financial Experts Right?
This part of the chapter was my favorite. It shows just how much faith we put in financial “experts” who actually aren’t very good at predicting the future (it’s really hard), are subject to hugely distorting cognitive biases, and are rarely held accountable for their calls. Some examples from the book:

  • “Mark Hulbert…did a study of newsletter portfolios. His statistics are startling. For example, Mr. Hylbert constructed a hypothetical portfolio made up of each year’s top-performing newsletter portfolio from 1981 through 2003. Over the last 12 months following their top showing, these former winners produced an annualized loss of 32.2 percent. Compare this dismal second-year performance to the Wilshire 5000 total stock market index, which, during the same second-year period, had an annualized gain of 13.1 percent.”
  • The Granville Market Letter produced an amazing return of 245 percent in 1991.” (With those kind of returns, wouldn’t you be tempted to invest? Honestly, I would.) Unfortunately, in 1992, the same newsletter dropped 84%. The result isn’t just a total 161% gain (245 – 84 percent). Instead, “the actual two-year loss is 61%…The Granville Market Letter suffered an average annualized loss from June 30, 1980 through December 31, 2004 of minus 21.5 percent. Compare that with the Wilshire 5000 Index gain of 13.0 percent during the same period.” Two key lessons for me: First, think long-term; results from a given year should hold very little weight in your decision-making process. Second, past performance really doesn’t guarantee future results.

Further Thoughts
This chapter isn’t perfect. I know of many more persuasive stories on market timing that could have gone into the book, but the authors didn’t include it. Also, even though the book was published in 2006, it’s impossible to keep up with the current news online. That’s why stories like this one, about code-breaking contest in which a group of three women who beat engineering and cryptanalysis experts from places like the NSA, couldn’t make it. If it were up to me, I would have included a recent New Yorker article on experts (one of the best I’ve ever read), and another from researcher Susan Blackmore. These disparate articles help to poke holes in our theories about experts and point out, quite convincingly, that just because someone’s an expert doesn’t mean he’s right. In fact, it’s often quite the contrary.

Still, I love this chapter and I love this book. You won’t find a size 81-font headline screaming at you about THIS YEAR’S BIGGEST OPPORTUNITIES!!! You won’t find some sexy angle on investing. You will find a sensible way to invest–one that, unfortunately, won’t seem very extraordinary to your friends. But frankly, once I’m educated about risks, investing, and the research, I don’t give a damn what other people think when I’m working towards my financial goals. By the way, the chapter had a lot of points about people not being very smart predicting what’s next.

That’s partially true and partially not. We’re not very good at predicting short-term results, which I’ve always said. But we can set up diversified systems (like index funds in different sectors, for example) that mitigate our lack of predictive power and actually work to get us superior returns. Even after you read this chapter, you’ll see that it’s not all doom and gloom about investing. There are ways to make significant amounts of money. They just don’t involve chasing the best-performing fund or investing in the stock du jour. With this book (and a few other good ones), you can use actual, real data to see what results in the best return. Instead of just being a blowhard who talks loudly about globalization this, and real-estate bubble that, you can look for trends that help you understand what’s going on–and, yes, what to do next.

Special note: JLP from AllFinancialMatters was happy enough to coordinate the publishers sending me a review copy of this book, which I’m giving away to a random commenter on this post. (I already had a copy before they sent this to me.)

What now?

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48 Comments

 
  1. Most excellent! Thanks for agreeing to review a chapter. I know things must be REALLY busy for you right now.

    Take care,

    JLP

  2. Excellent review. The info on Friedman’s scam was revealing and insightful. Keep it up.

  3. I saw this book the other day at the store and I started flipping through it. It seemed very good, and now I see everyone talking about it. I may pick it up soon.

    I also came across a book called Yes, You Can Time the Market! by Ben Stein. This odded (new word) me a little because I always thought of Ben Stein as a really smart guy. He even gives advice to not do market timing in other books, so it’s like he’s contradicting himself. Oh well – I guess everyone goofs up sometimes.

  4. In a sense, you’d expect people willing enough to defer gratification that they invest in stocks in the first place would have some immunity to these get-rich-quick schemes. It’s telling that even within the subset of people with that amount of foresight and patience, these schemes continue to prosper.

  5. Timing and picking stocks is 100% gambling; like poker against millions of other people. Chances are good you’ll lose.

    Analysis of performance supports this all the time — 99% of the pros suck, and then we check back later we find that the last % sucks too. DO NOT PICK STOCKS UNLESS YOU SPECIFICALLY WANT TO PIT YOUR MONEY AGAINST SOMEONE ELSE IN A GAME OF SKILL.

  6. I see the point, however people as a group tend to behave rather rationally in terms of investing – check out the book “The wisdom of crowds”.

  7. Have you read any other chapters in the book? What’s your take on the other chapters? Anything in partiular that stuck out as extremely excellent in your mind?

  8. Thanks again for helping me pull my head out of my ass once again.

    …I’m really not sure how the hell it keeps finding itself up in there.

  9. Ah, yes, I have read this book and it is a good one. A couple other books that tie in real well are the “Guide” books by Larry Swedroe (a Boglehead)–one on indexing and one on bonds. The indexing book was the first investment book I ever read and probably still my favorite.

    And I saw your post about bonds not being for young people (BTW-dumbest thing I’ve heard a smart person say in a long time), but it’s still a good book. The only possible caveat I can think of is if you don’t have enough money to ladder bonds and can only afford some individual bonds. But then you just get a bond fund. Someone that says subtract your age from this number or that number to get your bond percentage doesn’t really know why they should own bonds in the first place; they’re just following someone’s advice. But a prudent investor can determine that the proper allocation of bonds to an overall portfolio can actually return similar results while decreasing risks. Of course, most people in their twenties don’t actually know what risk means because it’s just a number in an equation to them and it’s not real dollars (or lack thereof) in retirement. Being in my twenties myself, I am EXTREMELY lucky to have learned this by watching my father-in-law and not by losing my own money–he lost over 60% of a very large number in the tech bust.

  10. Good review Ramit, very detailed!

    I wish I had more time to read all this good information, maybe I need to get rid of this day job…

    NG

  11. By the end of this post, I hope you’ll have a healthy distaste for financial “experts” and magazines, Wall Street’s hype, and the random people you hear pontificating about what the market will do next week. Basically, I hope you start scoffing at everyone after today.

    Mission accomplished, but in all fairness to the twenty something crowd (for whom you write to) it needs to be said when and why you work with financial advisors. Popular as it is to claim that advisors deflate performance through fees and don’t know anymore than you do, there are exceptions. You owe it to yourself to seek them out and not get cynical over the median.

    For a lot of people the value proposition of active management for their portfolio is an easy decision. You either devote the time yourself to monitoring each issue you own or you pay someone to do it for you. Alternatively you can just go with index of ETF issues, but there are drawbacks there as well.

  12. Fabulous review (and more). In your analysis of “experts” I kept hearing that old saw about how it’s time to get out of the market when the crowds are rushing in. Research, goal-setting, patience and persistence offer better payouts.

  13. As a fervent follower of the Vanguard school of thought, I can’t wait to check this book out — or see if I can win it =)

    As an aside, I’d like to inquire about anyone’s thoughts on “balanced” funds — those that automatically rebalance themselves as time wears on. It seems like a win-win to me…am i missing anything?

  14. Something is very wrong in my employer’s 401(k) fund lineup when it includes seven Fidelity sector funds — loaded with fees for buying, selling, and timing — and only TWO index funds. Bogle is right. Those exchange and administration fees are better vested in my pocket, not some cokehead active-manager-type’s midlife crisismobile. Thanks for routing me to the book!

  15. For Jim in comment 12: I’m also a big fan of Vanguard and indexing. I enjoy spending some of my free time on the Boglehead chatroom at Morningstar.com. I’m still not fully convinced of the Efficient Market Hypothesis (EMH) that goes hand-in-hand with indexing because you can see how other factors–psychological or whatever–influence stock pricing. However, I don’t have the time or energy to try to benefit from it–without any guarantee that I will–so I mostly index. Not to mention that EMH did win a Nobel prize.

    Anyway, to the point: FWIW, I think balanced funds have both advantages and disadvantages like anything else. For those that like to handle every little detail of their asset allocation–of which I am one–a balanced fund takes that control out of your hand. (It also may or may not take certain tax implications out of your hand depending on the fund and how much you might be working with inside tax-sheltered accounts vs. outside.) But, for people who are procrastinators or otherwise don’t like to deal with it and would probably only rebalance every 5 years or so, these seem like good options.

    I guess you just have to decide which category you fall into.

  16. This post brings up some good points about investing. Timing the market is very tempting to try but will rarely pay off, if ever (one of the reasons I chose Sharebuilder). As for individual investing in stocks, I feel that very few people truly want to and have the time to research the stocks they choose. It’s most dangerous shortly after reading a quick blurb about what all of the stats on Yahoo Finance mean and it all ‘makes sense.’

    As for balanced funds, if you’re talking about the Vanguard Target Retirement Funds then I’d say you’re right – they only use index funds (stock AND bond), have low expense ratios, re-balance over time, and don’t charge the sub-$10,000 account minumum fee of the S&P500 index fund (or all of their other index funds) which is a nice way to save a few bucks during your first few years of having an IRA.

    Lastly, Schizoheron- There’s nothing wrong with only having the 2 index funds – just make sure that you balance those out with the rest of your portfolio (whether it be a brokerage account or an IRA).

    Great site, Ramit. I’ve been reading for 3 months now and have been following your advice. I’m very impressed with how easy it was to get my finances in order (thank goodness it’s so easy now since I’m only 20). Thanks!

  17. Very interesting – as always. I’ve been hearing a lot about that book and will get to reading it some day.

    That sports betting scam is kind of like continually making predictions until one of them eventually comes true. If you can hide your other predictions, then you look really knowledgable.

  18. The thing to watch out for on balanced funds is the layering of fees. If the balanced fund invests in other funds, you end up paying the balanced funds fees PLUS the fees of the funds it invests in. Also be careful of how often the fund rebalances, because that could generate reduce your returns because of trading fees incurred by the fund.

  19. Duane in comment #10, I disagree with your last paragraph. Going with an actively managed mutual fund vs. picking stocks yourself is probably an easy choice to make for most, but when comparing passively managed index funds vs. actively managed funds there are no advantages to active funds because you’re paying more for smaller returns. There really are no downsides to index funds, and it’s more a question of tax advantages with different types of ETFs, than anything else.

    On the topic of balanced funds, John in #15 has already said it (and some others), but repetition is good. There is nothing wrong with holding just one balanced fund as your whole portfolio. There is definitely value in simplicity including in finance. If you manage your own funds, then you can take advantage of some “tricks” where you can lower how much you pay in taxes, which makes you more money. However, for most people the time isn’t worth the small gain (even though that can add up nicely over time). Also, you could create a portfolio that might be less corrolated and more diverse, than a balanced fund, but few people have the knowledge to even attempt that kind of calculation, let alone get it right.

  20. Good review. Definitely makes me want to go get this.

    Did you choose the chapter to review? (Just wondering whether you picked a chapter that you particularly liked, which might obviously influence your enthusiasm)

  21. David, yeah, I chose this specific one to review (it seemed like the most fun for what I wanted to write about).

  22. Great review of the chapter Ramit! Ive followed your blog a lot but am posting after a long time.

    For comments about balanced funds. Dont get into the trap of thinking they have expense ratios less and 0.10%. They fact is that they invest in various funds and the total expense ends up being close to ~1.1%. Check morningstar.com with the fund ticker for the correct expense ratio and other info. Also my personal suggestion is to ignore the star rating.

  23. Interesting chapter – I can’t wait to read the book.

  24. I should have clarified my lack of enthusiasm for index funds. Probably the best explanation comes by way of Dan Melson’s excellent site:

    http://www.searchlightcrusade.net/posts/1147577266.shtml

    This isn’t to say that you shouldn’t buy indexed funds, but once you have a sizable portfolio you can afford to avail yourself of professionals if you wish.

  25. Great review. But I ask what is said in this book that is actually new? I assume that ultimately the book recommends we invest in low-cost index funds on a reguar basis.

    Getting rich is as simple as spending less than you make and putting your money into index funds. I’m amazed that there are so many books, articles, etc. that are written based on what I’ve summed up in one sentence. You can put the steps to being rich on a flyer and hand it out for free. But then again, where’s the money in that?

  26. I completely agree with Mr P’s suggestion to ignore the star rating. So many people take these things as the Almighty Word. The first financial advisor I ever went to see tried to convince me that I should invest in some front-end load funds that he was pushing because they had 4- or 5-star ratings. Fortunately, I wised up to what was going on before I handed over any of my money.

    Star Ratings are particularly useful if you happen to own a time travel machine because they strictly report what has happened in the past. Otherwise, they’re not nearly as helpful as Morningstar and many others would like you to think. In fact, I’ve seen the results of research showing a group of 1-star funds outperforming 5-star funds over the next 10- or 20-year period.

    Back to balanced funds (or funds-of-funds): the best ones of these don’t have an extra fee tacked on top of the underlying fees and really can be had with very low ER’s.

    BTW, Ramit, keep up the good work. I really like your blog. I enjoy the posts that I disagree with because it gives me something to talk about, but I love the ones I agree with and didn’t even know it because you have introduced me to a new perspective! Thanks.

  27. Great chapter review. So far the most thorough review of the 13 chapters reviewed so far! :-) Thanks.

    Very interesting info on the Patri Friedman scam. As well as the Janus Hype. I own some Janus funds already.

  28. I’ve been researching this topic for a while, and what I’ve discovered is more or less well reflected in Ramit’s review.

    However, one aspect of investing that I’ve been interested in over the last year has been quantitative methodologies – where ‘expert’ opinion and ‘stock picking/timing’ do not play a role in the selection of stocks – however models are used to determine suitable porfolio’s. (fixed mathematical variables) Three examples where emotion, ‘expertness’ and variability do not seemingly come into play would be http://www.validea.com, http://www.valuengine.com and the Zacks rank http://www.zacks.com. Due to the mathematical nature of the investing, many have historical data on performance on up to 20 years. Just wondering what everyone here thinks of these investment strategies ?

    With brokerage costs offered at companies like http://www.foliofn.com, it seems much more feasibly for someone to have extremely high turnover in stocks, decently low brokerage fees and closely follow the holdings of these quantitative models which are easily spread over 5-200 stocks at any given time, and consistently beat the market. (or so it seems?) Of course, another downside would be the 30% tax rate you’ll be hit for on returns, based on the short term capital holdings rate, which is a downside.

    Another example with further information provided by whats close to an ‘unbisased’ party would be the data provided by a large non-profit in Chicago, http://www.aaii.com , which also has tested these models, with some phenomenal gains.

    Anyone out there have any experience/interest/ views on this particular strategy? The largest downside I see is that the markets might change in such a way that the models can no longer accomodate good screening without a tweak in variables (thus, the emergece of a ‘human factor’), but then perhaps the same could be said about asset allocation and rebalancing of ETF’s by an expert – if done right it can work for you?

    Looking forward to hearing from the community…

  29. To John in post 8, or anyone else who wants to answer:

    What do you mean a prudent investor can do well similarily with bonds? Is there a way to invest in bonds that earn the same rate as a stock index fund, such as the Vanguard 500?

  30. Oh, I’m great at timing the market. After I do my research, decide upon a stock, and buy, the stock usually goes down. Every single friggin’ time. Can never catch the bottom.

    But over the longer run, it goes up and I mostly invest for income.

  31. I was the Anonymous poster in #19 by accident. Anand #28, quantiative methologies are expert opinion and market timing disguised as unbiased and infallable math, and many of them are formulas that include variables for human emotion and irrationality. It’s trying to take the expert out of being an expert by quantifying what an expert does.

    The mathematical nature of investing, or at least the kind used with technical analysis, is a false sense of security. The kind of math that you should be worried about is the kind that tells you that experts are wrong 90+% of the time over a time span of more than three years, and that includes the quant guys. The kind of math that you should worry about is the math from the right experts, which are the academics, who have shown (decades ago) that 95% of the performance or return from a portfolio is based on the asset allocation of that portfolio. The other 5% is luck, which is also known as management style.

    Going the brokerage high turnover route (day trading) with sites like foliofn is also extremely expensive (once you look beyond the marketing hype of low costs) and proven as one of the best ways to lose your money based on research from the right experts (http://faculty.haas.berkeley.edu/odean/papers/Day%20Traders/Day%20Trade%20040330.pdf)
    (http://faculty.haas.berkeley.edu/odean/papers/returns/returns.html)

    The largest downsides to day trading, or any kind of frequent trading, are 1) that you probably don’t really know what you’re doing, or the person you’re trusting doesn’t know what they’re actually doing, and 2) significantly higher costs. There are basically two things you control when trading, diversity of portfolio and costs. Costs breaks down into fees and taxes. Worry about the things you can actually control and not things like stock performance (by buying and selling the “right” stocks).

  32. Compliments on the blog, and great links in this post, especially Dr. Blackmore’s article. I’ve been struggling with the index fund vs. managed fund issue recently myself, hearing convincing arguments coming from both camps. It’s tough, since at my post undergrad age, a small difference in performance (a few percent, say) compounded over the next 40 years would make a big difference in my ending portfolio. This tends to magnifying the importance of making intelligent decisions to start with and maintaining effective strategies throughout my investing lifetime. It makes for some decent pressure to “get it right.”

    My default perspective was built up on Motley Foolery, which is consistent with the Boglehead wisdom of indexing, minimizing expenses, and especially avoiding load funds. I think that avoiding unnecessary and unusual costs is a smart move, and indexes and ETF’s are a very good way to do that. Now here’s where the big “BUT” comes in:

    I don’t believe in the efficient market hypothesis, and thus I don’t believe that all securities are rationally priced. This opens the door to believing that a fund manager with a strategy that takes advantage of this mispricing can achieve excess returns. I think skilled investors can and do exist, and that if you hand your money over to a fund manager with a skill edge that is greater than the costs of expenses for his fund, that in the long term you will benefit from these excess returns.

    This perspective could be easily dismissed by a reader agreeing with the excellent “New Yorker” article you cited: I’m placing my faith in an “expert” fund manager with no greater ability to predict the future (and select winning stocks) than anyone else, and I’d be better off indexing. I can’t seem to satisfy myself with this answer, however. This could indicate either the dogged persistence of my innate biases and heuristics, or alternately a sense that there is something not quite right with the blanket assertion that indexing is always the best bet. It certainly *feels* like the Warren Buffets and Bill Millers of this world can beat the market…is it actually all just random chance playing on the fantasies of those hopeful to get rich?

    I’ve long understood the dangers of trusting intuition on such questions, but I can’t say that I have any hard data to support the hypothesis that fund managers can provide returns in excess of chance variation over the long term (any finance or econ readers know of any useful studies?). The commonly cited statistics arguing that most funds lose out to the index don’t answer my questions. I’m not interested in “most” mutual funds, or the “average fund” when it comes to funds. I’m interested in whether there are certain fund managers that consistently add excess value through their stock picking skills. Are there indicators which can point an investor to a *particular* fund likely to post superior performance over time? This is my real question.

    It seems reasonable to suggest that a fund manager who consistently beats both managers of similar funds and market indices over long periods of time may be adding positive value to his fund. But buying into such a fund could easily be cast as “performance chasing.” If this fund’s high performance is due to random chance, then future performance is likely to be lower, since in the past it has just been lucky (the regression to the mean argument). But if long term outperformance reflects some skill advantage as well as some luck, then the mean performance to which the fund regresses might in fact still be higher than the performance of an appropriate index, even after factoring out the expenses involved in active management investing (and especially if those expenses are particularly low). I believe Vangaurd itself offers both index and low fee actively managed funds, so it seems possible, even from the Boglehead camp, to argue that active managers may be capable of adding long term value.

    I fear that I have only raised more questions, and have no real solutions to offer, but, as Dr. Blackmore illustrated in her article, attempting to achieve an open mind and see to the truth of an issue is quite hard, so I hope that just the exercise of considering both viewpoints will be beneficial (even for you Vanguard Diehards!). In my gut, I suspect that markets are human inventions which fall prey to the aggregate irrationality of human minds, and thus lead to opportunities for select investors who learn to milk these inefficiencies for profit. To this end, some of the unemotional “Quant” strategies mentioned by Anand in post 28 are interesting, but I also believe that human managers who recognize inefficiencies, keep their own emotions in check, and execute a consistent and long term strategy can beat the market as well, even after costs. My gut reasoning is still fighting for dominance, however, and whether I ultimately go active or index is still up in the air. Since I suspect the readers here aspire to more than the average (else why would you be reading a blog named “iwillteachyoutoberich”?), I’d be very interested to hear any comments on whether they think indexing is the most profitable long term option, or if anyone out there has pinned their hopes on a favorite manager?

    Thanks for reading. I hope it’s been interesting enough to stimulate some positive discussion.

  33. The problem I have with market timing strategies is this: if it works now, it won’t work for long. Once everyone finds out that it works, and everybody starts doing it, then it will no longer work.

    It’s the same with index funds. If everyone started investing in index funds tomorrow, and stopped going into debt, our economy would go WAAAAH.

  34. ccoutlee #32. I understand where you’re coming from with the EFT, and not exactly trusting it. You’re right that there are some managers who can beat the market. There are a bunch that do every year. The problem is that very few can do that for more than three years, and usually end up at the bottom of the pile where they’re losing money after that time. And yes, there might be a few that can beat the market long term, however, your strategy then becomes that of picking that person. And lets be honest, looking at the stats, the odds of even having such a gold child is almost nil, and then you being smart or lucky enough to find that person is even worse, so I wouldn’t bet your fortunes on it.

    There is also a problem where a fund performs well for say three or five years, and gets a good five M* rating. What happens is that the fund’s strategy breaks apart from a large influx of cash, and what you had before anyone took notice (meaing you where invested with them before they achieved a 5 star rating), is now completely different. The problem with starting with those funds that get the highest rating is that they’re actually the most likely to be at the bottom the year or two after, and they’ll take you there at a higher cost than an index fund. Index funds have unbiased passive managers. Truly unbiased unlike how a quant strategy might feel.

    The great thing about index funds is that you A) don’t have to worry about performance, B) save money on fee and taxes, and C) don’t have a spend hours researching your investment only to lose money because you were wrong. For most people, index funds are unbeatable.

  35. http://www.ifa.com contains an enormous amount of information, tools, and historical data supporting investment in index funds.

    Check it out and save the $20 you would have otherwise spent on a book. In fact, the content of the site has been packaged as a book and sells for $20 on amazon .

  36. To Jonathan in 29: Let me ask you this. Can you tell me what the Vanguard 500 Index Fund (which I happen to own, so I obviously like it) is going to return over, let’s say, the next 20 years? Of course not; none of us can answer that. But I ask it to prove a point: We don’t know exactly what is going to happen in the future. All we can do is statistically analyze the data we have to make a prediction of the expected annualized return in the future and the standard deviation around that return (aka the risk).

    I apologize for any confusion, but I did not say that someone can make similar returns with only bonds as they could with only stocks. What I said was that an OVERALL portfolio that includes a certain allocation of bonds can be expected to realize a similar annual return as a portfolio consisting solely of stocks while decreasing the risk. In real terms, that means that maybe you give up 0.4% in annual expected returns to lower the annual standard deviation by 1%. And that point is just as true for bonds as it is for any other asset class (value, growth, large, small, foreign, emerging markets, precious metals, real estate, and so on and so on). Now, are there classes of bonds that can rival the expected return rates of the S&P 500? Sure, but they call them junk bonds for a reason! They have very high risk—it’s like letting your friend with the 500 credit score borrow money from you.

    The whole point I was trying to make is really about as vanilla as it gets. The more diverse your portfolio, the less likely you are to end up in the poor house having lost all your money. Of course, you’re also less likely to wake up one morning to a 15000% increase in your assets because you bet the farm on that start-up pharmaceutical company that got Phase III approval or that hot new internet company. But, most of us aren’t willing to lose all of our money chasing that pipe dream.

  37. Cool review – i’ll probably buy the book.

    Even cooler that you had bought the book before you got the free one.

  38. Hmmmm, this sort of goes with an article I read comparing Phil Fisher to Ben Graham yesterday. Supposedly, Fisher had a good track record with picking growth companies, but he never held more than 30 at a time, he knew the industries inside and out and his strategy was to buy and hold and hold and hold and hold. He also avoided hype.

  39. This seems like a very instructive book, from the reviews I’ve read on different blogs. I look forward to reading it. My husband and I have also been reading “The Warren Buffet Way,” and it also has great investing advice.

  40. To John in 36:

    Okay, I see what you mean now. Yes, I agree that having some bonds in your overall portfolio is a good idea.

  41. My portfolio currently has 25% invested in fixed income. Fixed income CEFs are good investments that few people use.

  42. Hi Ramit, I recently read “How I made 2 Million in the stock market” by Nicolas Darvas who made that much money in only 18 months in the 1950. This book is fabolous and you can read it for free at http://www.nicolasdarvas.org/.

    There is so much to learn about investing in stock by reading this book. You’ve got to read to it! After investing some time Darvas concluded that trading like Wall Street is like gambling. Darvas also wrote another book called “Wall Street: The other Las Vegas”.

  43. Great Review. Thanks a lot.
    Cheers,
    FIREFinance

  44. I have considered buying this book and after this review and the others it has moved to the top of my ‘buy’ list.

    Thanks.

  45. I’ve been thinking a lot about market timing lately myself. I’m a young guy (22) so an extra 1-2% annually over 40 years would make a big difference. But after all is said and done, I think I’ll stick with the “average” indexing. And I’ll tell you why.

    I study money in my spare time, as a hobby. I’ve read around 20 or 30 personal finance and investing books. I’m not a full time active fund manager, responsible for A LOT of money. It makes sense that these fund managers will spend a lot more time researching than I have. I’ve read 30 books, they’ve probably read 300 or more. Despite all their research, the market average still beats the majority of them.

    It’s interesting to me that sites like validea.com claim to have made a 173% return over the past three years with their strategy (on sale for $30/month). If this information is so easily available (for a monthly fee, of course) then why aren’t these fund managers at least staying a few points above the index? Something is fishy there.

    So for now, I’ll stick with simple Vanguard index funds. In the future I think I’ll set aside a little money to play with these market timing strategies, just out of curiosity. There do seem to be some that may work a little better, such as staying out of the market during the worst four months of the past 50 years (June-September), but I’m not sure yet.

  46. Excellent post. Many of the Bogleheads posts just give a brief description of what the chapter was about. Good job!

    I also covered Bogleheads and Market Timing

  47. While I agree that most mutual funds are a scam, keep in mind that John Bogle is trying to sell something as well. His Vanguard Mutual Funds.

    There are many opportunities to make money, and fairly consistently, with lower risk then the overall market. Volatility trading, arbitrage, mirco/small cap investing, high-frequency trading, etc. etc.

    So keep open to investment ideas, try to differentiate between leveraged beta & alpha. If you can’t do it, find someone who can or diversify across non-correlated assets for long term investing.