Success Rate Of Retail Investors

[Wildreamz]

Indeed, comparison with benchmark (which? why?) with mathematical precision, only useful for professionals (e.g. for regulatory purposes, for comparison across industries etc.). For everyday retail investors, if your brokerage doesn't provide good performance analytics, it's better to be approximately right than precisely wrong, about estimating your performance, as well as managing expectations.

For example, for me and my investment goals: (1) if my absolute returns exceed >7% per year on average, I did well; (2) if any long-term investment might yield me >7% CAGR (risk adjusted) over the next 5-10 years, it's probably a good investment; any investment that can't, isn't.

Time is better spent analyzing companies, industry trends, management quality, portfolio allocation strategies etc. than to worry about if you are going to outperform an arbitrary benchmark(s). 

---

About quant strategies; in general, efficient market hypothesis is hard to violate, long-term. Any strategy simple enough to be written down in a low-fee quant fund prospectus, that obviously worked for a time period, most likely will not work in the next (because everyone will copy them, driving any alpha they might have to zero); any strategy not simple enough to write down in a prospectus (ie black-box) how are you going to evaluate them? If you do find one fund like that, you are more likely lucky than good (in general).

[gzbkel]

Hi gzbkel

Most of my posts will indicate that I am skeptical on simple ratios or quant that doesn't go into details. Track record of Quants have not been spectacular over a cycle except Renaissance Tech's Medallion Fund which is like a black box. So I guess I better declare my bias first

I agree with most of the points VBs raised here but just to add some observations:

1) Averaging down on a broad index makes sense cause it is unlikely for an index, whether Thailand in GFC, Iceland or Greece in GFC or even South American countries' real economy to even halve. However the caveat is the FX adjustments for foreign investors. It makes sense for local investors. To a certain extent if the index goes to zero, maybe investments is not the biggest issue for the locals. It is somewhat similar to rolling a dice on 3, and then 2 and then 1. You might roll 1 next 10 rolls but it is not going to go down anymore, though it will cost you opportunity cost which I will elaborate in 3) .

However when you average down on a style or sector or theme that might not be the case. Nobody expected oil futures to go negative and a lot of ETF uses derivatives. Baltic Dry Index crashed 90% spectacularly in about 6 months. Those bullish on Tech during dot com might not have survived to ride on the past 5 years' bull run, even when they are right long term. Probably Singapore's best Quant Fund Quantedge lost 29% in 2018. If you had been buying a value styled fund, it would have been quite painful past 10 years, unless you are disciplined enough not to follow the Joneses

2) Fees Fees Fess. Yes you can imagine you are paying fees for diversification but so is ETF. So you got to find a good fund manager to be better than market but problem is I don't understand most quant's methodology or sometime like Madoff, they project that mystic about them. On the other hand in theory it is also not impossible to beat the market just using ETF and Asset Allocation, but I have yet to see one personally. The human Greed & Fear is very powerful, all the more when one does not have comfort on the underlying dynamics. That makes all the difference between knowing a company and knowing from a friend's recommendation.

3) I don't think Buffett actually uses a performance evaluator per se etc. Actually value investors are very upside absolute return driven. Hence the mantra "Don't lose money". When he compares to S&P in the Annual Report it is to compare against an Opportunity Cost, in this case you could have bought into a basket of S&P stoocks, or nowadays ETFs. But different people have different opportunity cost. It could be deposit rate, FD rate, WACC, lending rate if you are leveraging, IRR of a business venture etc. All depends on what would you have done instead. That's why Required Rate of Return in cash flow calculation is so fuzzy. To a certain extent it also explains when opportunity costs diminishes during ZIRP nowadays, asset prices goes up despite a recession. Unless you have a deflation like Japan.

In general my guess is to use a 7-10% threhold that has more than enough buffer. Seems to be what Chinese government been using as well to double GDP every 10 years.

Hi specuvestor

Thank you for sharing your views on this. It seems that there is no easy option for the average retail investor.

(A) Active investing - Majority can't beat the market.

(B) Quant ETF - Relatively high fees, poor track record for the past 10 years. If I understand you correctly, you are saying that the opaque methodology results in a lack of conviction to average down during downturns.

© Index investing - Low fees, but as you have mentioned in an earlier post, lack of fundamental research means that the market cap weighted index will just include the biggest companies. Entering euphoric stage?

For the average person, would you say that the last option, index investing, is the least bad option out of the three? Personally, I find it little counter-intuitive after getting influenced into being value-oriented after some years browsing this forum.

[ghchua]

Hi gzbkel,

If you are worried about underperformance, then a combination of your value stock picks and an ETF (not Quant or synthetic types, just your normal direct replication ones like STI ETF) should be quite practical for a typical retail investor here in Singapore. Most benchmark driven funds do this anyway. That is, they buy stocks from the index they are tracking (plus minus some stocks for over and under weights) and add a few stocks outside the index for outperformance bets.

[Corgitator]

Indeed, comparison with benchmark (which? why?) with mathematical precision, only useful for professionals (e.g. for regulatory purposes, for comparison across industries etc.). For everyday retail investors, if your brokerage doesn't provide good performance analytics, it's better to be approximately right than precisely wrong, about estimating your performance, as well as managing expectations.

For example, for me and my investment goals: (1) if my absolute returns exceed >7% per year on average, I did well; (2) if any long-term investment might yield me >7% CAGR (risk adjusted) over the next 5-10 years, it's probably a good investment; any investment that can't, isn't.

Time is better spent analyzing companies, industry trends, management quality, portfolio allocation strategies etc. than to worry about if you are going to outperform an arbitrary benchmark(s). 

---

About quant strategies; in general, efficient market hypothesis is hard to violate, long-term. Any strategy simple enough to be written down in a low-fee quant fund prospectus, that obviously worked for a time period, most likely will not work in the next (because everyone will copy them, driving any alpha they might have to zero); any strategy not simple enough to write down in a prospectus (ie black-box) how are you going to evaluate them? If you do find one fund like that, you are more likely lucky than good (in general).

I, too, don't advocate for mathematical precision (I don't care about Sharpe, Sortino, Maximum DD, Treynor etc). But I think it's important to be benchmark-aware when evaluating whether active stock-picking is even worth the time for an individual. You don't want to be the guy that does 10% per annum for 20 years, thinking that you have the skills/behavior to do stock-picking, despite your benchmark doing 15% per annum during the same period. In that case, it would have been better for that person to just switch over to passive investing.

One can be very complex and quantitative when selecting a benchmark, but keeping it simple is fine for individuals. If you primarily invest in Singapore, STI is your benchmark. If you largely do small caps in Singapore, go look at MSCI Singapore Small Cap Index. If you invest globally, use the MSCI ACWI Index.

And I too agree that one shouldn't spend too much time worrying or thinking about the benchmark, but it is very important to at least spend a few minutes a year looking up the performance of the benchmark, and then evaluating whether all these effort/energy that went into stock-picking was even worthwhile.

[Wildreamz]

Thought experiment:

This is the returns of the STI in the past 10 years:


Assuming a retail investor have beaten the benchmark convincingly, by an average of 1% per year, his 10 year return will be 2.9% annually.

Should he be happy, or hit himself for not putting his money in CPF SA account (4%; risk free!)? Or not heeding Buffett's advise of investing in the S&P 500 instead? 



Or the Dow, or the Nasdaq, or a global Index?

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(1) Here lies my issue with choosing any benchmark to measure performance. Absolute performance in my view, is the most relevant performance metric to the investor. You may not have beaten any arbitrary benchmark for any arbitrary start and end period (which would greatly affect the performance). But in the greater picture, if I did >7% per year on average, over a long period of time. I am fully satisfied. 

(2) If the sole reason of doing active investing, is believing that you can consistently and reliably beat the market going forward; then, most people (statistically) will be solely disappointed. Hence, my Aswath Damodaran quote. But if one could get more out of active investing besides achieving excess return relative to an arbitrary benchmark; then it's win (if you beat it) win (if you don't). Making this endeavor and the risk more worthwhile.

[Corgitator]

Thought experiment:

This is the returns of the STI in the past 10 years:


Assuming a retail investor have beaten the benchmark convincingly, by an average of 1% per year, his 10 year return will be 2.9% annually.

Should he be happy, or hit himself for not putting his money in CPF SA account (4%; risk free!)? Or not heeding Buffett's advise of investing in the S&P 500 instead? 



Or the Dow, or the Nasdaq, or a global Index?

---

(1) Here lies my issue with choosing any benchmark to measure performance. Absolute performance in my view, is the most relevant performance metric to the investor. You may not have beaten any arbitrary benchmark for any arbitrary start and end period (which would greatly affect the performance). But in the greater picture, if I did >7% per year on average, over a long period of time. I am fully satisfied. 

(2) If the sole reason of doing active investing, is believing that you can consistently and reliably beat the market going forward; then, most people (statistically) will be solely disappointed. Hence, my Aswath Damodaran quote. But if one could get more out of active investing besides achieving excess return relative to an arbitrary benchmark; then it's win (if you beat it) win (if you don't). Making this endeavor and the risk more worthwhile.

Let's just agree to disagree, since we have different school of thoughts.

I am not a big fan of absolute returns, because returns will inevitably be driven by the opportunity set (as you pointed out, a SG investor would faced considerably headwinds relative to a US investor over the past 10Y. Although I would like to add that for the previous 10Y before that, it would be the opposite, i.e. the US investor would be crushed by the SG investor).

It's like a student that is happy with 80 marks. Yes, 80 marks might be great when the class's average is 70 marks. But if the exam is simple (i.e. your opportunity set is very attractive, like a value investor between 2001-2004), and the average score is 90 marks, getting 80 marks means I should probably study harder, or give up on studying.

Put differently, I rate a SG investor that outperformed STI by 2% just as highly as I rate the US investor that outperformed SP500 by 2%, even though their absolute returns differ. Absolute returns is important in terms of actually increasing your networth, but it's not as useful in terms of assessing skill. My point has always been that to measure skill, it's important to be benchmark-aware. And by skill, I'm referring to stock-selection skill, not country selection.

[Wildreamz]

We can agree to disagree. 

Just putting a few additional points out there for everyone to ponder.

I believe choosing the market to invest is also an important skill of a competent investor. Should we allocate more in SG for the next 10 years, or more in the US? Or any other markets? Why limit ourselves to SG just because we are born here (https://www.investopedia.com/terms/h/homebias.asp), or stocks for that matter (why not real estates, bonds, funds, cryptocurrencies, angel investments)? Those are all arbitrary limitations/bias/inefficiencies that handicap our performance. A competent investor, by definition should be able to identify that the US market was terrible to invest (assuming your numbers) the previous 20-10 years, but good for the next 10 etc.

End of the day, we are not all fund managers of a themed portfolio.

Fruit for thought.

[specuvestor]

Hi gzbkel

Think ghchua pointed out well the problem with your dilemma: You don't have to be binary thinking. You can do both. We call it a Core and Satellite startegy.

Hi gzbkel,

If you are worried about underperformance, then a combination of your value stock picks and an ETF (not Quant or synthetic types, just your normal direct replication ones like STI ETF) should be quite practical for a typical retail investor here in Singapore. Most benchmark driven funds do this anyway. That is, they buy stocks from the index they are tracking (plus minus some stocks for over and under weights) and add a few stocks outside the index for outperformance bets.

As for the benchmarking / opportunity cost, I think it's back to whether you want to spend effort on it to be grade 8 pianist, becuase I do believe over a cycle, an absolute return focused strategy will outperform opportunity costs. If not keen to learn then ETF would be a good buy and hold idea, unless you want to time the market, which brings in another set of issues.

On the other hand, there is this artistic pursuit of excellence, against all the statistical odds that is also alluring for the ones that honed the craft. As Karlmarx summised: "It is interesting why people bother to do anything when their chances of performing (significantly) better than average is (very) low. I guess it tells us why the history of humans is also a history of progress."

[gzbkel]

Hi ghchua, specuvestor, thank you for the practical advice.
Indeed, moderation may be best for the average man.
I do not see myself pursuing the highest level of investment skill. Knowing enough to avoid getting ripped off is good enough.

[karlmarx]

Good discussion and questions raised. Most of the stuff here have probably been mentioned somewhere in this forum, but we rehash these evergreen topics as our experience grow and opinions change.

Q1) Which is more important, absolute returns or relative returns?

It probably depends on the hat you're wearing. But it also depends on your (primary) objective.

As a serious hobbyist/retail investor, my ideal outcome is to have both high absolute returns and relative returns. But if I had to choose, I will take absolute over relative. Making money is primary, doing better than others is secondary.

If the market is doing -25% but I am doing -10%, I don't feel better even though I beat market, because I lost money and my objective in market participation is to make (large) positive returns. The retail investor cannot 'eat' relative out-performance. At best it makes for good cocktail/coffeeshop talk.

If the market is doing +25% but I am only doing +10%, I may have to accept the painful reality that I'm a terrible active money manager, and should probably buy an index. But lousy as I may be, at least I didn't lose money in my DIY quest. 

For professional managers, losing money may not be so bad, so long as you lost less than everyone else. At the end of the day, most managers still collect fees of 1% or so of AUM. Of course, if as a pro you're under-performing then clients will not be happy paying the 1%. But most clients will be quite happy to do so if you incurred only a nominal loss when everyone bombed (schadenfreude). So I guess you can say that pros can 'eat' relative out-performance.

Q2) So as a retail stock picker, is it okay to be under-performing the market, so long as I am making positive returns?

Positive returns aside, such an individual is still set back by two opportunity costs. First by not earning as much, since the money could have been invested in an index. And next in the time and effort spent to pick stocks. 

The first opportunity cost can be easily measured; it is just how much more money you could have made vis-a-vis an index. The second is harder to discern and potentially larger (especially if you don't succeed), because who knows what you may have achieved with the time you spent on picking stocks. The possibilities are endless. And it is the same dilemma which confront would-be entrepreneurs.

Say there were two retail investors. Both under-performed the market but generated a positive return. To achieve the results, the first spent only an hour a week, while the other spends a few hours a day. So I think an investor who spend more time on stock picking should measure him/herself against the market.

Q3) I am new to the market, should I try to DIY first?

Most beginning stock pickers probably don't fully appreciate the potentially large opportunity cost of time, because they only see their opportunity cost as the starting capital they could lose. If I'm right in my pick, I win. If I'm wrong, I lose. It's like picking numbers on a roulette. And if after 10 spins, I turn out to be a consistently lousy picker, then I'll just abandon this whole thing. No big deal.

But unlike the roulette, investing is a very slow game. It takes time to learn, time to research and add picks to your watchlist, time for the picks in your watchlist to be selling at a price that is acceptable to you, time for your picks to gestate, and time for you to reflect and improve upon on your mistakes. Each iteration of this cycle is measured in years.

The market can also behave 'irrationally' for years (e.g. STI outperform S&P from 2000 to 2010, but underperform from 2010 to 2020) and that may fool you into thinking you're a better/worse investor than you really are. You could have all the right reasoning and facts to support your picks, but the market moves against you. Or you could have made picks on flimsy reasoning and facts, but the market moves in your favour. If you belong to the former, you may need yet more years for your picks to work out. If you belong to the latter, you may think you're a genius, but maybe not so in later years.

So I think it takes a lot of time (7-10 years?) to find out whether DIY is something one might possibly be good at. The stakes may seem high but if you consider the fact that you are gunning for above-average performance -- which is really a lot more than it sounds, since it is achieved by the top percentile of retail/pro practitioners -- it is probably quite acceptable. It takes just about as long to find out if a child may become a concert-level (grade 8) pianist, or a national-level (top 8 finalist) sprinter. So why should it take any less time (or effort) to be a top (market beating) investor? 

Most people have dreams and ambitions other than being a market-beating investor. And so it probably makes more sense for them to focus their time on their dreams and ambitions (top hairstylist, top painter, top chef, top software developer, etc), than on something that they may only be peripherally concerned with, such as trying to beat the market.

===

I think the question about being open to various asset classes and geographies is good food for thought, and I chewed on it for some time.

The kind of out-performance by S&P over STI in the last decade is spectacular. Or if we were to look at the growing price of bitcoin, that is also very spectacular. If Singaporean investors had known this a decade ago, I'm pretty sure all of them would have bought bitcoin and S&P. 

So the question is, how will an investor know which asset class or geography will outperform (or do reasonably well) in the next decade? What kind of knowledge/expertise will that require?

I don't have anything close to an answer for these questions. But if anyone does, I will be very happy to be enlightened.