Investing

You Don't Need Alpha

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You Don't Need Alpha

https://ofdollarsanddata.com/you-dont-need-alpha/

I don't always agree with what this blogger (Nick Maggiulli) says, but like to read what he writes:

What I found interesting was the following discussion about the impact of consistently squeezing out small amounts of extra returns on your investments:
More importantly, how much will that alpha change your financial life even if you do happen to acquire it? For a little bit of annual alpha, the answer is very little.

For example, let’s assume that the market will return 4% a year (after-inflation) going forward and you can earn 1% above this (net of fees) over the next 10 years. How much more money would you have 10 years from now? About 10% more:

After 20 years, you’d have about 20% more and after 30 years, you would have a little over 30% more.

Of course, having 10%, 20%, or 30% more is great, but it’s not going to transform your retirement. You won’t go from living in a low-cost city in the U.S. to living off the beach in Monaco. You just won’t.


This certainly is how I think about investing because once I have a reasonable, middle class income, I don't see myself being significantly happier with more money. For me, it is far more important to stay out of poverty. I do get a certain satisfaction out of making a good investment decision, but it is a transient feeling, like watching my favorite sports team win a game.
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To each their own. Apha is certainly important to me, as it allows me to achieve financial independence and not worry about having to work to produce income. If one can only achieve a 1% alpha over the years, maybe the effort is not justified. For me, it certainly is, as my alpha is more than double the market for my growth investing (started in 2012), and my income growth from my dividends is also higher than the market (7% income growth for the last 20 years).

To have significant alpha, you need to address the pitfalls of indexing. That includes buying at a fair valuation (instead of paying market price for everything), buying companies that will keep growing earnings (instead of buying in the mix companies with signs of distress) and reducing or eliminating MER.

The advantage of holding individual stocks is that the better performing stocks can be harvested (sell high) rather than having to sell a piece of everything (selling low) - besides buying them with a higher margin of safety.

The financial theory is just part of the puzzle. Discipline to stick with the plan and separating emotions is the other part that is hard to implement, and it's more of a soft skill (temperament) than hard skill. Many also mix up trading techniques (market timing, price movement) with investing techniques, which should be geared towards the business and its valuation.

Also, keep in mind that beating the market is not everyone's goal, not everyone will do it, and many times that's by design. Every individual investor does not have the same investment goals, needs or investment objectives. Some investors are concerned with beating the market, others are concerned with maximum safety over the highest return, and others are concerned with maximizing their income and the growth thereof.



Rod
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rodbarc wrote: To each their own. Apha is certainly important to me, as it allows me to achieve financial independence and not worry about having to work to produce income.
To each their own, but the point of the article is that this can be achieved by a typical retail investor without Alpha. What is far more important in this case (as touched on by the author), is to live below your means starting at and early age and investing your savings.
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My article:

"You don't need index funds"

For perfect security and not thinking about future growth, one doesn't need equity, bond, or index funds. Just buy GICs and deposit in HISA. Concentrate on saving and increasing your pay income. If you can save enough, you don't need any growth. Zero downside risk, and even with loss to inflation, the money is securely there. The more income you make, the more you can save.

For example, let’s assume that an index fund will return 4% a year (after-inflation) going forward and it earns 2% above GICs over the next 10 years. How much more money would you have 10 years from now? About 20% more:

After 20 years, you’d have about 40% more and after 30 years, you would have a little over 60% more.

Of course, having 20%, 40%, or 60% more is great, but it’s not going to transform your retirement. You won’t go from living in a low-cost city in the U.S. to living off the beach in Monaco. You just won’t. Besides equity markets could crash right before you're set to retire and your savings wont have such risk.
-—----------
There is somethIng called being content with what you do. You can look at anything and take it a different way. I'm not going to begin to point the flawed premise of the article, (other than assuming 1% above average is the standard alpha calculation, but I digress before I become "uncivil" to you). People make different choices based on their needs (and doing my own investments is certainly not based on 1% more return). So I guess I will say I'm happy you are content with your investments(?).
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It really depends how much we are talking about, the level of effort needed, and goals. So "need" becomes a personal question. Some people would definitely be better off ignoring the urge to beat the market because they will take unneeded risks and end up losing the "alpha" - but an average of an extra 1% per year? Sign me up.

1% extra when you are investing 5k per year? 16.4k extra (3 "bonus" years of making contributions)

Starting with 100k -> extra 46k after 20 years at 5% vs 4% (46% of the original value! - )

Starting with 100k and adding 5k per year -> ~62.5k more after 20 years.

Portfolio of 250-500k: 1% matters even more - which is the whole point of trying to get the lowest fee for an "indexer". The drag of paying an 'advisor' fee of 1-2% vs 0.25% for an ETF makes a big difference in the end even if it is not seen/negligible at the start)
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While I agree with authors overall sentiment in terms of being content and not make risky bets, the rest of it makes little sense. 1% is a big deal over the long term as we all know what an extra 1% fee does to returns over a long period.
Questrade* estimates that a 1% decrease in fees over a typical 30-year investing horizon could result in 27% to 29% more money in one’s retirement
If it makes a difference when it comes to fees, it must make a difference when it comes to alpha. Now, consistently generating 1-2% alpha over 30 years, that's a separate issue :)
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xgbsSS wrote: My article:

"You don't need index funds"

For perfect security and not thinking about future growth, one doesn't need equity, bond, or index funds. Just buy GICs and deposit in HISA. Concentrate on saving and increasing your pay income. If you can save enough, you don't need any growth. Zero downside risk, and even with loss to inflation, the money is securely there. The more income you make, the more you can save.

For example, let’s assume that an index fund will return 4% a year (after-inflation) going forward and it earns 2% above GICs over the next 10 years. How much more money would you have 10 years from now? About 20% more:

After 20 years, you’d have about 40% more and after 30 years, you would have a little over 60% more.

Of course, having 20%, 40%, or 60% more is great, but it’s not going to transform your retirement. You won’t go from living in a low-cost city in the U.S. to living off the beach in Monaco. You just won’t. Besides equity markets could crash right before you're set to retire and your savings wont have such risk.
-—----------
There is somethIng called being content with what you do. You can look at anything and take it a different way. I'm not going to begin to point the flawed premise of the article, (other than assuming 1% above average is the standard alpha calculation, but I digress before I become "uncivil" to you). People make different choices based on their needs (and doing my own investments is certainly not based on 1% more return). So I guess I will say I'm happy you are content with your investments(?).
There is a bit of a Strawman Fallacy here: most people would agree that if someone needs a fixed sum of money in the short term (e.g. saving up a downpayment to buy a house in the next 2-3 years), they should choose to put their savings into a GIC or HISA because the downside risk is almost (but not completely) zero. But clearly what Maggiulli is referring to in the article is a retail investor saving in the long term for their retirement. In this situation, most people would agree that a better choice in this situation would be a portfolio primarily of equity investments based on historical performance of equity. If you accept this premise, then generally two options for the retail investor are: 1) a couch potato portfolio 2) stock picking. What Maggiulli is arguing is that the couch potato gets beta with very little additional time/effort on their part. If the stock picker wants alpha, this requires considerably more time/effort, continually over the long term, and the rewards for same for a retail investor are uncertain. Yes, this is a matter of judgement and depends on the person, but he (and I) feel that for most retail investors, the couch potato option is the better choice.
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CheapScotch wrote: If you accept this premise, then generally two options for the retail investor are: 1) a couch potato portfolio 2) stock picking. What Maggiulli is arguing is that the couch potato gets beta with very little additional time/effort on their part. If the stock picker wants alpha, this requires considerably more time/effort, continually over the long term, and the rewards for same for a retail investor are uncertain. Yes, this is a matter of judgement and depends on the person, but he (and I) feel that for most retail investors, the couch potato option is the better choice.
I think too we are blurring the lines between personal finance and investing. From a personal finance point of view, saving and capturing beta leads to success of the long term.

From an investing point of view, although not required, it makes sense that an investor would want to chase alpha, as it's a challenge and that's the name of the game.

I would be careful extrapolating your personal feelings to the masses - many investors enjoy chasing alpha if nothing else as a hobby.
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CheapScotch wrote:
There is a bit of a Strawman Fallacy here: most people would agree that if someone needs a fixed sum of money in the short term (e.g. saving up a downpayment to buy a house in the next 2-3 years), they should choose to put their savings into a GIC or HISA because the downside risk is almost (but not completely) zero. But clearly what Maggiulli is referring to in the article is a retail investor saving in the long term for their retirement. In this situation, most people would agree that a better choice in this situation would be a portfolio primarily of equity investments based on historical performance of equity. If you accept this premise, then generally two options for the retail investor are: 1) a couch potato portfolio 2) stock picking. What Maggiulli is arguing is that the couch potato gets beta with very little additional time/effort on their part. If the stock picker wants alpha, this requires considerably more time/effort, continually over the long term, and the rewards for same for a retail investor are uncertain. Yes, this is a matter of judgement and depends on the person, but he (and I) feel that for most retail investors, the couch potato option is the better choice.
This isn't strawman fallacy at all (you really need to relearn argumental fallacies as you continuously misuse it and weaken your argument). All my post did was merely highlight the point Maggiulli's argument made: You don't have to chase anything as long as it allows you to do what you need (ie. retire). So my GIC/HISA argument (a joke keep in mind)'s premise is the same. If you can save enough money, does any gain really matter? That is the same logic in the article.

But the main weakness in what you are presenting is that

1) Obtaining alpha is a mere incremental change in performance that is set at 1%
eg. if I am investing for the chance of making 100% return, but if I fail, lose 10%, is that a reasonable choice to make? 100% immediate gain can significantly change my life, but a 10% loss doesn't decimate my situation.


2) That obtaining alpha has to involve a significant amount of effort to obtain.
-as you mention, dependent on who you ask. In other words, you probably shouldnt decide for someone.

3) Your audience being that you are not the author

I could even rewrite my article (this was a joke keep in mind but it is still true) to say bank mutual funds. That 0.5-2% extra management fee can be argued in a similar vein as the article represented. The premise is the same: if that allows you to meet your goals, why should I care? Sure that person could save on fees, but if it is easier for them, and they don't care, then you leave it at that.

At least Maggiuli has a point to his article. His blog has a specific target audience: that being an investor that is starting out and/or generally saving and investing. You extrapolated that intention to suggest everyone should follow said advice despite the fact that many people are here are past that stage or are here to learn about other investment strategies. Basic investing is also more than covered. I generally post or suggest index funds for most beginners here inquiring as it is a great way to start out. You can't decide for people what they need out of their investments.

The author has a blog with a specific audience, you have an investing forum where you start new posts with the same rehash which you present as something new and absolute. Again I will ask, what exactly are you trying to discuss here? Because I've come to think that all you are looking for is some kind Of validation what you are doing is fine. You probably are, so good job. Now can we discuss about other things
Last edited by xgbsSS on Jul 31st, 2020 2:39 pm, edited 1 time in total.
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xgbsSS wrote: <edited:>Again I will ask, what exactly are you trying to discuss here? Because I've come to think that all you are looking for is some kind Of validation what you are doing is fine. You probably are, so good job. Now can we discuss about other things
That's ok. Give this to him, because whenever the repetitive comment gets made in the future in another thread, the mods can always refer back to this thread. Hopefully we will NEVER have to see the same index droning in another thread again.
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MrMom wrote: That's ok. Give this to him, because whenever the repetitive comment gets made in the future in another thread, the mods can always refer back to this thread. Hopefully we will NEVER have to see the same index droning in another thread again.
Aww... didn't realize you were so sensitive. I'll stop posting about index investing, will that help, Mom?
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Sounds like this guy has been losing money for quite some time now :p
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Deepwater wrote: I tried reading the article but never made it past using your oven to make ultra-crispy French fries. Smiling Face With Sunglasses
A lot people who write blogs like to get a bit whimsical to make what they are writing more interesting. In this particular case, its a lead-in an amateur cook who has a following on Youtube (timely, given the Covid-19 pandemic).

I agree with the overall thrust of Maggiulli's point in the article, but I would not myself compare cooking skills to investing skills. In terms of performance between an amateur vs. a professional, cooking is not the same as investing.
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bend3r wrote: Sounds like this guy has been losing money for quite some time now :p
He is an American; assuming he has been investing in low cost US ETFs over the last decade, I would say it is very likely he has done pretty well for himself.
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treva84 wrote: I think too we are blurring the lines between personal finance and investing. From a personal finance point of view, saving and capturing beta leads to success of the long term.

From an investing point of view, although not required, it makes sense that an investor would want to chase alpha, as it's a challenge and that's the name of the game.
I am not sure I get your point. I would not say there is any kind of "line" between personal finance and investing. There are many components to personal finance; investing is an important component of personal finance, but not the only one - there is also insurance, estate planning, spending habits, etc.
treva84 wrote: I would be careful extrapolating your personal feelings to the masses - many investors enjoy chasing alpha if nothing else as a hobby.
If someone enjoys stock picking as a hobby, or a challenge to be overcome, and they going into the game with their eyes wide open, by all means, go for it.
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Yes you need alpha.

-Picking a low cost ETF over mutual funds is 2% immediate alpha already

-Making your portfolio tax efficient (USA dividend ETF into RRSP and non dividend growth stocks into TFSA) is another 0.5% alpha

-What if you went more aggressive portfolio like 90% stocks instead of 50% stocks? That's another 3% alpha.

Add them all up and a low cost stock heavy tax efficient ETF has 5.5% alpha over the bond heavy mutual fund that is tax inefficient.


Do that math over 30 years.

Guy A saves $10,000 per year earning 4% returns

Guy B saves $10,000 per year earning 9.5% returns

Guy A ends up with $500K. Guy B ends up with $1.5 million.
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garmium wrote: Yes you need alpha.

-Picking a low cost ETF over mutual funds is 2% immediate alpha already

-Making your portfolio tax efficient (USA dividend ETF into RRSP and non dividend growth stocks into TFSA) is another 0.5% alpha

-What if you went more aggressive portfolio like 90% stocks instead of 50% stocks? That's another 3% alpha.

Add them all up and a low cost stock heavy tax efficient ETF has 5.5% alpha over the bond heavy mutual fund that is tax inefficient.
I generally agree with the strategies which you suggest above. Far better to go with a low cost ETF over a mutual fund. Making your portfolio tax efficient is a good idea too - but not sure if you will squeeze out another 0.5% from this. Better to have a higher proportion of stocks vs. bonds for long term investing, but this depends a lot on how close you are to retirement and possibly other personal circumstances. But I see all of these straegies as the low hanging fruit that any retail investor should pick. The 'Alpha' the article refers to is comparing an investor who follows all these strategies vs. one who tries to do better over the long term picking stocks. How likely is such an investor to beat the market by 5.5% over 30 years?
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garmium wrote: Yes you need alpha.

-Picking a low cost ETF over mutual funds is 2% immediate alpha already

-Making your portfolio tax efficient (USA dividend ETF into RRSP and non dividend growth stocks into TFSA) is another 0.5% alpha

-What if you went more aggressive portfolio like 90% stocks instead of 50% stocks? That's another 3% alpha.

Add them all up and a low cost stock heavy tax efficient ETF has 5.5% alpha over the bond heavy mutual fund that is tax inefficient.
None of those are alpha. Alpha refers to portfolio return above or below the market or a relevant benchmark.

https://www.investopedia.com/terms/a/alpha.asp
The excess return of an investment relative to the return of a benchmark index is the investment’s alpha. Alpha may be positive or negative and is the result of active investing. Beta, on the other hand, can be earned through passive index investing.

That's not to say that low cost, tax efficiency and asset allocation are not important. They are fundamental principles of good portfolio management . But they are not alpha.
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.

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