Since we’re discussing EMH and VTSAX, seems as good a place to add a recent anecdote:
Chatting with someone, investments came up and they asked me where I put mine. I said 100% VTSAX. Why? Because I think the EMH is as true as it needs to be, I don’t understand why markets rise and fall when they do even when I think I’m predicting future events accurately (such as, say, coronavirus), and I don’t think I can beat the stock markets, at least not without investing far more effort than I care to. They said they thought it wasn’t that hard, and had (unlike me) sold all their stocks back in Feb 2020 or so when most everyone was still severely underestimating coronavirus, and beat the market drops. Very impressive, I said, but when had they bought back in? Oh, they hadn’t yet. But… didn’t that mean they missed out on the +20% net returns or so of 2020, and had to pay taxes? (VTSAX returned 21% for 2020, and 9.5% thus far for 2021.) Yes, they had missed out. Oops.
I think you need to follow good practices. Getting out with no plan is not following good practices. I will write up my opinion on best practices soon. Though it is nothing too crazy.
For precisely this reason, I’m fairly certain Bogleheads-style investing has the highest expected value for most people. The core philosophy of the approach seeks to minimize behavioral pitfalls while maintaining satisfactory outcomes. It’s surprising how infrequently it’s discussed here. (Perhaps it’s because we’re more a community of optimizers than satisficers?) On that note, the Bogleheads theory forum is excellent if you’re looking to learn more and develop the ideas further.
You can’t buy the S&P 500, at least not directly. Instead, you can buy funds that try to match the performance of the S&P 500 (while charging a small fee), like VFNIX and VOO.
VTSAX by contrast, doesn’t track the S&P 500, but this isn’t necessarily a bad thing. From the Vanguard website,
Vanguard Total Stock Market Index Fund is designed to provide investors with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks.
In other words, it’s more diversified than an S&P 500 fund.
Yes, right, so to continue this line of thought: since more diversified means less risk, Gwern would want to buy VTSAX if he needs to spend that money in a relatively short time horizon. If this isn’t the reason, though, from what I gathered from a personal finance book I read years ago, funds tracking S&P500 always outperformed funds tracking the entire U.S. equity market over long periods (is this actually true?). So I was curious about why Gwern made such a choice in case the reason I hypothesized (he is investing money he potentially needs shorter-term) was wrong and there are actually good reasons to buy funds tracking the total US equity market even when saving long term.
This discussion is mostly irrelevant in practice, since the two funds track each other extremely well.
Even if it’s true that the S&P500 has beaten the overall market in the past, I doubt it’s statistically significant. Theoretically I can’t imagine a good reason why the optimal investment answer would be “pick roughly the top 500 companies, but not exactly those, but something like that picked by a committee of people you don’t know, in proportion to their market cap.” VTSAX just seems simpler as it tries to approximate “pick every company in proportion to their market cap.” This is also what the one mutual fund theorem in portfolio theory says one should do (if one limits oneself to US stocks only), so it has solid theoretical basis, unlike the S&P500.
I haven’t heard that claim before. My understanding was that such a claim would be improbable or cherrypicking of some sort, as a priori risk-adjusted etc returns should be similar or identical but by deliberately narrowing your index, you do predictably lose the benefits of diversification. So all else equal (such as fees and accessibility of making the investment), you want the broadest possible index.
I think this points to two very important things about investing and trading regardless of EMH.
psychology of the person
We tend to note the loses we avoided (that is the money we kept) much higher than the gains we missed (the money we actually lost by not playing in the game).
Unless someone has a good plan for how to manage and overcome those two aspects of their own mind I suspect they will find it difficult to ever commit to any investing or trading program/strategy. It will not take too much to push them back into the behavior reflected in your comments.
Is there a reason you only invest in the US stock market and not the whole world (VTWAX)? Or is VTSAX good enough and it’s not worth the effort to decide whether you should globally diversify and in what proportion?
I knew someone was going to ask that. Yes, it’s impure indexing, it’s true. The reason is the returns to date on the whole-world indexes have been lower, the expense is a bit higher, and after thinking about it, I decided that I do have a small opinion about the US overperforming (mostly due to tech/AI and a general sense that people persistently underestimate the US economically) and feel pessimistic about the rest of the world. Check back in 20 years to see how that decision worked out...
That’s an interesting argument I hadn’t heard before. It makes sense, although I think this argument can at best be used to rule out stocks of developing nations. That still leaves developed nations. So one might then diversify their stock holdings by adding some, say, Vanguard FTSE Developed Markets ETF (VEA) in addition to their VTSAX/VTI.
One argument is that the US stock market already contains a lot of global exposure as many/most large US firms are internationally diversified themselves. Buying global funds means you’re actually under-investing in the USA relative to the world as 40% of your “US companies” are actually global companies.
I don’t vouch for this argument, it’s just something I’ve heard which sounds somewhat plausible.
I’m not a fan of this argument because even if you have some global coverage, why not get more and reap the benefits of diversification? It’s like saying hey I already own 2 car company stocks, there’s no point in owning all US car company stocks. Sure the stocks might move in tandem most of the time, but diversification allows you to reduce risk.
Hmmm. So I don’t think more global exposure = more diversified. What you should be aiming for is investing in each country/region in proportion to it’s share of the market.
Consider the following situation
The USA is 30% of global markets
A global index fund invests in world equities, putting 30% of it’s money in the US market
The US market is actually also 50% invested abroad
Hence the index fund is really only putting 15% (30/2) in the US and is underweighted towards the US
Since we’re discussing EMH and VTSAX, seems as good a place to add a recent anecdote:
Chatting with someone, investments came up and they asked me where I put mine. I said 100% VTSAX. Why? Because I think the EMH is as true as it needs to be, I don’t understand why markets rise and fall when they do even when I think I’m predicting future events accurately (such as, say, coronavirus), and I don’t think I can beat the stock markets, at least not without investing far more effort than I care to. They said they thought it wasn’t that hard, and had (unlike me) sold all their stocks back in Feb 2020 or so when most everyone was still severely underestimating coronavirus, and beat the market drops. Very impressive, I said, but when had they bought back in? Oh, they hadn’t yet. But… didn’t that mean they missed out on the +20% net returns or so of 2020, and had to pay taxes? (VTSAX returned 21% for 2020, and 9.5% thus far for 2021.) Yes, they had missed out. Oops.
Trading is hard.
I think you need to follow good practices. Getting out with no plan is not following good practices. I will write up my opinion on best practices soon. Though it is nothing too crazy.
For precisely this reason, I’m fairly certain Bogleheads-style investing has the highest expected value for most people. The core philosophy of the approach seeks to minimize behavioral pitfalls while maintaining satisfactory outcomes. It’s surprising how infrequently it’s discussed here. (Perhaps it’s because we’re more a community of optimizers than satisficers?) On that note, the Bogleheads theory forum is excellent if you’re looking to learn more and develop the ideas further.
Why not S&P500?
You can’t buy the S&P 500, at least not directly. Instead, you can buy funds that try to match the performance of the S&P 500 (while charging a small fee), like VFNIX and VOO.
VTSAX by contrast, doesn’t track the S&P 500, but this isn’t necessarily a bad thing. From the Vanguard website,
In other words, it’s more diversified than an S&P 500 fund.
Yes, right, so to continue this line of thought: since more diversified means less risk, Gwern would want to buy VTSAX if he needs to spend that money in a relatively short time horizon. If this isn’t the reason, though, from what I gathered from a personal finance book I read years ago, funds tracking S&P500 always outperformed funds tracking the entire U.S. equity market over long periods (is this actually true?). So I was curious about why Gwern made such a choice in case the reason I hypothesized (he is investing money he potentially needs shorter-term) was wrong and there are actually good reasons to buy funds tracking the total US equity market even when saving long term.
This discussion is mostly irrelevant in practice, since the two funds track each other extremely well.
Even if it’s true that the S&P500 has beaten the overall market in the past, I doubt it’s statistically significant. Theoretically I can’t imagine a good reason why the optimal investment answer would be “pick roughly the top 500 companies, but not exactly those, but something like that picked by a committee of people you don’t know, in proportion to their market cap.” VTSAX just seems simpler as it tries to approximate “pick every company in proportion to their market cap.” This is also what the one mutual fund theorem in portfolio theory says one should do (if one limits oneself to US stocks only), so it has solid theoretical basis, unlike the S&P500.
I didn’t know this, now it makes much more sense, thank you.
I haven’t heard that claim before. My understanding was that such a claim would be improbable or cherrypicking of some sort, as a priori risk-adjusted etc returns should be similar or identical but by deliberately narrowing your index, you do predictably lose the benefits of diversification. So all else equal (such as fees and accessibility of making the investment), you want the broadest possible index.
I think this points to two very important things about investing and trading regardless of EMH.
psychology of the person
We tend to note the loses we avoided (that is the money we kept) much higher than the gains we missed (the money we actually lost by not playing in the game).
Unless someone has a good plan for how to manage and overcome those two aspects of their own mind I suspect they will find it difficult to ever commit to any investing or trading program/strategy. It will not take too much to push them back into the behavior reflected in your comments.
Is there a reason you only invest in the US stock market and not the whole world (VTWAX)? Or is VTSAX good enough and it’s not worth the effort to decide whether you should globally diversify and in what proportion?
I knew someone was going to ask that. Yes, it’s impure indexing, it’s true. The reason is the returns to date on the whole-world indexes have been lower, the expense is a bit higher, and after thinking about it, I decided that I do have a small opinion about the US overperforming (mostly due to tech/AI and a general sense that people persistently underestimate the US economically) and feel pessimistic about the rest of the world. Check back in 20 years to see how that decision worked out...
Thanks. I’m just trying to understand what people’s reasons are. My portfolio is also US-weighted more than market caps would dictate.
EMH requires liquid markets where you can’t cheat. Buying non-US stocks may be putting you on the wrong side of an inefficient market.
That’s an interesting argument I hadn’t heard before. It makes sense, although I think this argument can at best be used to rule out stocks of developing nations. That still leaves developed nations. So one might then diversify their stock holdings by adding some, say, Vanguard FTSE Developed Markets ETF (VEA) in addition to their VTSAX/VTI.
One argument is that the US stock market already contains a lot of global exposure as many/most large US firms are internationally diversified themselves. Buying global funds means you’re actually under-investing in the USA relative to the world as 40% of your “US companies” are actually global companies.
I don’t vouch for this argument, it’s just something I’ve heard which sounds somewhat plausible.
I’m not a fan of this argument because even if you have some global coverage, why not get more and reap the benefits of diversification? It’s like saying hey I already own 2 car company stocks, there’s no point in owning all US car company stocks. Sure the stocks might move in tandem most of the time, but diversification allows you to reduce risk.
Hmmm. So I don’t think more global exposure = more diversified. What you should be aiming for is investing in each country/region in proportion to it’s share of the market.
Consider the following situation
The USA is 30% of global markets
A global index fund invests in world equities, putting 30% of it’s money in the US market
The US market is actually also 50% invested abroad
Hence the index fund is really only putting 15% (30/2) in the US and is underweighted towards the US
Out of curiosity, why a US tracker fund instead of a global one like FTSE all-world?