View Full Version : do you believe you can beat index funds?

12-07-2001, 01:12 AM
do you believe you can beat index funds?

whatever type of stocks you trade, do you believe that as a customer you can beat the index funds of that category in the long term?

for example, if you typically have a portfolio of 20 stocks, all big nasdaq stocks...do you really think this portfolio, after your trading transactions, value of time (explained below), expenses, etc., over 5/10 years, will beat the Nasdaq 100 Index, which you can simply buy by purchasing QQQ and sitting on it for the same length of time?

I am not here to criticize anyone, just asking some of the posters here (Zee, Haley, Kim Lee, elroy, paul, etc.) if you believe you are winning by trading as a customer.

Value of time (my definition) : if you can make more money doing something else with the time you spend watching, analysing stocks, then this is an economic negative....however, one must factor in the fun factor of trading, watching, sweating, analysing stocks ... this is a positive for a lot of people....so factor this in...i know some who are perfectly happy knowing they are losing 1% against the market averages when they trade actively, because it is fun for them, and that's perfectly fine, becuase the fun part of it is worth the 1% differential in the long run.

12-07-2001, 10:28 AM
You can make money trading, but it takes an ENORMOUS amount of labor. So it helps to scale it with a lot of capital and equipment.

But trading, for the most part, involves using the news and the ticker to predict what levels of buyers and sellers will show up nearby. A longer form of trading focuses on larger trends in the supply of and demand for investments of specific durations, without that much regard to their relative utility compared to competing investments of alternative durations, meaning without regard to the value of stocks.

So if we reduce your question to can someone, in the long run, do enough better than his competitors at predicting the actual business prospects of companies to make money, screening out all those other factors, I would say "Yes." I know I can do it in at least a limited subset of companies with businesses that I understand better than anybody else.

Problem is, 99% of businesses nobody really understands, so they can trade at crazy prices seemingly forever. Take Enron - nobody could have had any idea what was going on, and I wasn't even paying attention. If somebody knew, he apparently didn't have too much credibility or a following, and probably sold a 100-lot. But then again, somebody had to be selling on the way down.

Analyst earnings estimates are only accurate so long as earnings exhibit strong serial correlation, a slight trend, and a lot of positive steering from management. Every time earnings collapse, analysts are behind the curve by precisely the magnitude of the sequential collapse.

But if you are like a freak biophysicist, for example, you may be able to predict the prospects for pipeline drugs better than enybody else. Or if you run a children's day-care center in Harlem, you may command a good statistical sample for determining the prospects of certain video game manufacturers or clothing trends. Or if you run a cash register at a monster grocery store in the Midwest...


12-07-2001, 11:02 AM
The biggest mistake I made was assuming that somebody else had his hands on the wheel.

By the time I even got around to visiting VerticalNet's web site, the stock had already gone from like 150 to 12. But I'm thinking how is this stock not worth zero? What does somebody know that I don't? I was shocked, the emperor had NO clothes.

Same thing with, like JWEB and Net-Zero. Steve Jurveston thought they were great business ideas. But I used these services, and it was pretty plain to me as a customer that they were getting broker by the day at an alarming rate, and scaling back their ambitions even at the same time as putting on a good face for the public.

You can feel it, as a customer, when each additional customer is costing a business money, when they're forced to add customers to keep Wall St. happy, but at the same time they're trying to minimize their per-customer loss so they can eat. It's like Knight Trading was already saying how they were considering charging to execute Nasdaq orders - saying out loud they couldn't afford your business, wanted less of it - and yet people were still paying over 20 for NITE.

I also used to do temp work in Silicon Valley in the early 90's. I debugged microncontrollers at C-Cube, so I knew how many orders and interest they were getting for chip-sets for the Asian DVD market. The analysts heard about it a few weeks later, and the stock went from, like, 20 to 40.

I separated bad die from the RayChem substrate in the Intel prototype-tooling lab, so I got the runs straight from the new Texas plant, and "knew" the yields from their latest sub-micron process probably better than any single of the other 5 billion people on Earth.

I built cardboard boxes at the 3COM shipping plant right before the hey-day and washout (remember Ascend and Cascade?) and it seemed pretty clear capacity was lagging demand in both directions. I worked at Sun, Raychem, interviewed for logistics for AMD's new plant, I coordinated the major hub for the purchase and sale of used/refurbished Hewlett test equipment in the Valley, I sold the new Dot-Coms all the free juice and snacks for their break rooms which gave me a perfect index of the rise and fall of throwaway money - as well as of the day-to-day orders of Kozmo, WebVan, etc. - oh, I remember a good one, this loser VP from Oracle, Umang Gupta (GPTA?), started his own database company, and there was no doubt in my mind the place was doomed from the first day I worked there.

So the point is not that I had the sense to make a billion dollars while temping for $16.00/hr. The point is that people are dumb, and the truth can stare them right in the face and yet nobody sees it.


12-07-2001, 11:18 AM
"So if we reduce your question to can someone, in the long run, do enough better than his competitors at predicting the actual business prospects of companies to make money, screening out all those other factors, I would say "Yes." I know I can do it in at least a limited subset of companies with businesses that I understand better than anybody else. "

let's also add : but beat it enough to overcome the vig at the same time

12-07-2001, 11:37 AM
You know, I don't like your original assumption that, as part of the free money we can get in this world for the good fortune of having been born, if you buy and hold an index you will make money.

As I said in another post, if you had bought at the 1930 low and held through today, you would hve made money. But the reason why the 1930 low was so low was specifically because nobody had the money to buy. At least not on this planet. maybe if you were from Mars, you could have had money on Earth when no one else did.

This goes along with what people call "international diversification." The theory is that if you spread your investments across two countries, the returns won't be correlated, so you can filter out country-specific risk and make free money. But the reality is THE ONLY REASON THEY AREN'T CORRELATED IS BECAUSE OF THE COSTS AND FRICTIONS ASSOCIATED WITH INVESTING IN FOREIGN COUNTRIES. If there is no geographic friction stopping the free flow of money and infromation between countries, their stock markets become PERFECTLY correlated. (Which of course brings up asymmetric friction, which is what I was talking about with stocks, where a Wall-St. analyst can't afford to build carboard boxes all day at 3Com but you can.)

In theory, the stock market should always rise to the level where people expect NO return over their investment time horizon. Why? Because people have no opportunity cost! If they have extra money now, and need mony for retirement, there is NONE of the opportunity cost which economists normally associate with "investment."

Somebody might have enough money now that he would rather have 1 apple in 10 years than 2 additional apples today. Meaning, the required return to get him to invest is NEGATIVE 50%. The more excess wages people have, the further into the future they are willing to accept a negative return, so the further against future expectations they discount the immediate stock price. If you have the money at the same time as everyone else, you will have to accept a negative rate of return at the same time as everyone else - while dot-com slackers fresh out of college drink free apple juice in the break room!


The "vig" is different for everyone, and it really isn't very big, compared to other factors.


12-07-2001, 12:02 PM
as for messing with the big stocks its pretty clear you should buy a bunch and hold or do the index funds. both methods should return close rewards over a long time.

with small stocks you can certainly beat the market if you can identify things missed or not known by others. rmember that smaller stocks may not be covered by analyists and so little is really known to the general public. and as ive seen over the years most insiders dont know much themselves. except when there is alot of big insider selling on some stocks you can confidently bail out and then short them.

12-07-2001, 12:12 PM
"You know, I don't like your original assumption that, as part of the free money we can get in this world for the good fortune of having been born, if you buy and hold an index you will make money. "

I don't think I ever stated that I had this assumption. I'm asking if individual investing can beat index funds. Whether index funds are up or down, this question still applies. If the NDX is down 10% over 5 years time, can an individual investor, however much the investor trades, beat that mark given he is paying more vig than the index fund?

12-07-2001, 12:18 PM
I gather by your statements that you do believe you can beat an index like the Russell 1000 index (small cap stock index) or possibly you mean even smaller stocks than that - I think there is another index that does measuer that, but I'm not sure.

Does the edge of these snipbits of info beat the higher vig you pay on smaller stocks? I don't know, what do you think?

Also, I am slighly wary of this info not known to the general public but still public info. I've known several very smart doctors lose money on small medical stocks because they thought they had knowledge not applied in the market. I believe it is true that if one is bright and smart, and knows how to apply information to the marketplace, one may be able to beat the market indices in small stocks...but what I am saying is that even if you are a brain surgeon, it doesn't necessarily translate to applying your brain with the info to beat the market even with some insider information (again, we're talking public info that the general public may not know or use). But of course, a brain surgeon and an accomplished professional gambler are two very different brains...I would put my money on the professional gambler understanding how to apply the info he may have over the brain surgeon.

12-07-2001, 12:18 PM

12-07-2001, 12:20 PM
yes, you can also beat a loser by doing nothing, but can you predict that the market will be a loser in the next 5 years?

if you can't, then you shouldn't be doing nothing.

12-07-2001, 12:20 PM

12-07-2001, 12:22 PM

12-07-2001, 12:35 PM
You asked about your performance relative to an index.

If you are assuming the index is perfectly random, isn't that the same as asking about your expected performance in absolute terms, meaning relative to zero?

Why even include the index in the equation, why not substitute 0?

Some people simply adjust the risk-free rate by expected volatility to get expected return - although I've never seen one of them in the Forbes 400.

So what am I missing?


12-07-2001, 01:02 PM
the reason to measure against an index is to see how much one is gaining or losing by picking 10/20 stocks out of 500.

12-07-2001, 01:26 PM
But ther're more than 500 stocks in the world. And not all "investments" are listed on exchanges.

So how and why do you pick which 500 stocks you want to do better than?


12-07-2001, 07:28 PM
I've had some excellent runs buying individual stocks but I have changed my mind based on a lot of reading and prefer using QQQ and SPY. If I want to acheive superior returns (beat the averages) I'll try and time the market and/or use leverage.

12-07-2001, 07:35 PM
The S&P 500 is a cap weighted average and thus amounts to disproportionate weighting in market capitalization and not stock price. Therefore the overall valuation of US companies is reflected in this average. This probably would not hold true if you selected 500 stocks at random.

12-07-2001, 08:03 PM
I simply meant you are indifferent to what your investment is correlated to, so long as it has a positive expectation, and especially if you have no opinion on the instrument to which it is correlated.

I assumed "beating" was not limited to positive correlation over a specific period, but could include perfect inverse correlation with a positive random deviation.

The question implied a super-choice - already made - to invest in either an index or some subset of compenents, and the sub-decision was whether to invest in the index or the subset of componenets.

The question could perhaps have been simplified to saying we have stock X and stock Y, with similar deviation from expectation, do you think you can tell me which has a higher expectation?

Or something...


12-07-2001, 08:50 PM
sure i think you can dig and find some stocks that will beat the averages. not many though but they are out there. you need to know something about the stock and its business and do some legwork.

usually local stocks can be followed and you can get a good read on whats going on with the company before the general public. i remember in the 60's when i told my parents to buy into that mcdonalds company as their 19 cent hamberger was good. they laughed. then i went to colledge and ate at paleys fried chicken in florida. it had a picture of a white haired guy on the sign. and something about kentucky fried. it had to make a go of it. i was too young to know about investing in those days.

now i find companies that have owners(managers) with a substantial interest in the company and something looks like its changing with their business. then i short or go long depending on the direction.

12-09-2001, 03:54 AM
You manage against a benchmark (depending solely on your time horizon) because efficient markets don't allow one benchmark to significantly outperform others for long periods of time. Thus, your goal in managing vs. a benchmark is to do better than an efficient market. If you can't do it..then buy the index.

It's as simple as that. 90+% of money managers and active mutual funds don't beat market returns in the long run. It's hard to do. And they have a lot more resources than you do.

12-09-2001, 11:16 AM

12-09-2001, 11:34 AM
As an aside, of course it is very difficult for managers, on average, to beat the average performance of representative stocks which they are buying a subset of.

You don't need decades of research, and heated debate, to demonstrate how it is also impossible for more than half of people to enjoy "above-average intelligence" - even if they believe they do.

In fact, the more tightly managers hug the benchmark - by intention - the proportionally larger effect the higher costs of active management vs. indexing will push more than half of active managers below indexing.

But if one day I rub my eyes and realize the childish mathematical reality that most people will have below-average incomes (skewness), am I going to put everything I have in t-notes and go on welfare?

The amusing thing about the stock market as compared to, for instance, brain surgery, is that you don't find a lot of investors who also fancy themselves as knowing the first thing about brain surgery.


12-10-2001, 10:52 PM
Like an alcoholic, I had to finally admit that I was powerless when it came to investing in individual common stock issues. There was always someone, or usually many someones, who knew a lot more about a company than I did, and it was already reflected in the stock price. Then I'd have to get over the market-maker's outrageous bid-asked spread on some little name that traded about 3000 shares a day. I hit some small stuff for some big percentage gains but after expenses, yadayadayada I couldn't beat the S&P600 or Wilshire4500 or Russell2000 or whatever index tracked the size stocks I played with.

I found out that there are index funds that track almost all portions of almost every market: debt, equity, junk, emerging market, value, growth, Korean small cap, whatever. The funds are cheap (free) to buy and cheap (low expense ratios) to own. You can take on as much risk as you want, like owning small value stocks, without adding the type of risk that goes along with only owning a couple of names.

As a small-business owner and professional, I have become intensely aware of the worth of my time to the people who hire me to get things done, so while I might waste time throwing investment pearls of wisdom before y'all, I don't spend ten minutes a day thinking about whether I'm selling IBM puts tomorrow.

I am also intensely aware of how easily I could get broke. As a small-business owner and professional, I am taking on large, concentrated risks that revolve around my health, mental competence, the health of my dependents and parents, my ability to attract and keep clients, and on and on. I am no longer willing to take on the risks that I can easily and cheaply buy my way out of using index funds.

I am also intensely aware of the effect of taxes on my drop. Maximizing tax-deferred contributions is much more important than any trading strategy ever devised. And tax-loss harvesting in taxable accounts might cheer you up these days, but I'd rather have to worry about how to shelter gains than count losses.

I'm with dr, I believe, when I say that in the long run and after expenses, very few of this forum's readers will beat "the market" (name the index) over any five or ten year period while actively trading in stocks that comprise that "market". Of course it will happen to a lucky few, but we must remember that in 95 cases out of 100 it was luck, not trading skill, that led to the result.

If you're rich and like to play the market, play away; it's the reason the market's efficient. If you like to set aside 5% as mad money, trade away. If you really want to provide for yourself and yours in the future, you've got to find cheap, diversified, risk-suitable investment vehicles (index funds being the best example) and keep your fingers crossed. I know it sounds simple, but markets that are efficient where it counts, markets that reward risk, are simple and cheap to own and shouldn't be passed up. Good luck.