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Recently my pension fund gave a presentation at the place where I work. They explained that they invest by following the index of several stock exchanges. They reason that since 99% of the active traders are unable to outperform the index they cannot outperform it either.

Basically they claimed that 99% of the active traders would be better off doing absolutely nothing most of the time. This seems like a highly controversial statement to me. On the other hand an entity as big as a pension fun will probably have researched this thorougly.

After searching around on the web their claim seems to be supported by both 'amateur researchers' 1 and academics 2, though not universally (see the comments on those articles). This search might also be extremely biased due to the key words I used. Since I do not know a lot about stock trading I find it hard to judge the quality of the sources I found.

My question is: Is it true that 99% of active traders cannot beat the index in the long term?

A supplemental questions if this is true: On what kinds of terms is this claim true? Some sites claim 10 years or less, but pension funds usually operate on the very long term (30+ years).

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    Think carefully what "Active Trader" means to you and how it is different from "Retail investors of Active Funds". Then modify your question. – base64 Oct 22 '15 at 12:48
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    80% of all statistics are made up ;) Will be interesting to see what answers get posted. – Ross Oct 22 '15 at 12:56
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    IMHO -- Once more MY OPINION: I believe that it's plausable. The majority of "Active Traders" are likely average folks. These average citizens not only are subjected to delayed charts but are also constantly fee'd out the butt for every trade and then pay taxes on top of it because they want to be day traders but don't have the education on how to be one. So yeah, I'd imagine the majority of "Active Traders" aka day trader wannabe's do not beat the index. Buy and hold is a much better option from what I have seen when it comes to every day people. – Anthony Russell Oct 22 '15 at 13:04
  • @base64 though I'd be interested in the performance of retail investors I believe the pension fund was talking about active funds. – Roy T. Oct 22 '15 at 14:26
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    @Ross similar to the 80℅ you made up ;) – Dheer Oct 22 '15 at 16:21
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What decision are you trying to make? Are you interested day trading stocks to make it rich? Or are you looking at your investment options and trying to decide between an actively managed mutual fund and an ETF?

If the former, then precise statistics are hard to come by, but I believe that 99% of day traders would do better investing in an ETF.

If the latter, then there are lots of studies that show that most actively managed funds do worse than index funds, so with most actively managed funds you are paying higher fees for worse performance. Here is a quote from the Bogleheads Guide to Investing:

Index funds outperform approximately 80 percent of all actively managed funds over long periods of time. They do so for one simple reason: rock-bottom costs. In a random market, we don't know what future returns will be. However, we do know that an investor who keeps his or her costs low will earn a higher return than one who does not. That's the indexer's edge.

Many people believe that your best option for investing is a diverse portfolio of ETFs, like this. This is what I do.

  • Doing something with my savings is in the back of my mind, since the rent I get on the bank is currently so low (<0.9%). But with this question I was more interested in how large companies, such as pension funds, think about money. Day trading would definitely not be something for me :). – Roy T. Oct 22 '15 at 14:29
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    I suggest Googling for news about Calpers. That is the org that runs pensions for California. They have recently made big changes because they were not getting good performance despite paying high fees. – gaefan Oct 22 '15 at 14:37
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Obviously, these numbers can never be absolute simply because not all the information is public. Any statistic will most likely be biased.

I can tell you the following from my own experience that might get you closer in your answer:

  • Taking investors who call themselves professional traders, I rarely met one who consistently outperformed their own benchmark. If they did, then they just took a lot more risk and got lucky. By far most of them heavily underperformed.
  • Some active fund managers actually do outperform their benchmark, i.e. an index, but they usually do so by overweighting certain positions, which in the end just means that the overall risk is higher (even if by a relatively small margin). So it really becomes questionable if the benchmark is still appropriate.

Hence, even though I cannot give you exact numbers, I fully agree that traders cannot beat the index long term. If you add the invested time and effort that is necessary to follow an active strategy, then the equation looks even worse.

Mind you, active trading and active asset allocation (AAA) are two very different things. AAA can have a significant impact on your portfolio performance.

  • True. I believe it all boils down to the efficiency of markets. In the long run, it is extremely difficult to beat the average. One missed quarter will destroy 20 years of good performance. – Jack Swayze Sr Oct 22 '15 at 19:06
  • Plenty of big UK Investment trusts have beaten the market over 10/15 years I have several in my portfolio. – Pepone Oct 22 '15 at 22:03
  • @Pepone That statement is just too general. If you're referring to an asset allocation fund, by definition it is difficult to define what "the market" is. But even in the case of a single asset class fund, the question always boils down to which index the fund chose as benchmark and in what ways it deviates from the index. The outperformance is usually due to an increase in risk (most notably bulk risk). – vic Oct 22 '15 at 22:19
  • @vic They bench mark against various index's one of my PE IT (Electra) has beaten the average PE fund by a lot over the last 10 years its quite possible to beat the average if you take a contrarian stance and invest for the long term – Pepone Oct 22 '15 at 22:22
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That is such a vague statement, I highly recommend disregarding it entirely, as it is impossible to know what they meant. Their goal is to convince you that index funds are the way to go, but depending on what they consider an 'active trader', they may be supporting their claim with irrelevant data

Their definition of 'active trader' could mean any one or more of the following: 1) retail investor 2) day trader 3) mutual fund 4) professional investor 5) fund continuously changing its position 6) hedge fund. I will go through all of these.

1) Most retail traders lose money. There are many reasons for this. Some rely on technical strategies that are largely unproven. Some buy rumors on penny stocks in hopes of making a quick buck. Some follow scammers on twitter who sell newsletters full of bogus stock tips. Some cant get around the psychology of trading, and thus close out losing positions late and winning positions early (or never at all) [I myself use to do this!!]. I am certain 99% of retail traders cant beat the market, because most of them, to be frank, put less effort into deciding what to trade than in deciding what to have for lunch. Even though your pension funds presentation is correct with respect to retail traders, it is largely irrelevant as professionals managing your money should not fall into any of these traps.

2) I call day traders active traders, but its likely not what your pension fund was referring to. Day trading is an entirely different animal to long or medium term investing, and thus I also think the typical performance is irrelevant, as they are not going to manage your money like a day trader anyway.

3,4,5) So the important question becomes, do active funds lose 99% of the time compared to index funds. NO! No no no. According to the WSJ, actively managed funds outperformed passive funds in 2007, 2009, 2013, 2015. 2010 was basically a tie. So 5 out of 9 years. I dont have a calculator on me but I believe that is less than 99%!

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Whats interesting is that this false belief that index funds are always better has become so pervasive that you can see active funds have huge outflows and passive have huge inflows. It is becoming a crowded trade. I will spare you the proverb about large crowds and small doors.

Also, index funds are so heavily weighted towards a handful of stocks, that you end up becoming a stockpicker anyway. The S&P is almost indistinguishable from AAPL. Earlier this year, only 6 stocks were responsible for over 100% of gains in the NASDAQ index. Dont think FB has a good long term business model, or that Gilead and AMZN are a cheap buy? Well too bad if you bought QQQ, because those 3 stocks are your workhorses now. See here

6) That graphic is for mutual funds but your pension fund may have also been including hedge funds in their 99% figure. While many dont beat their own benchmark, its less than 99%. And there are reasons for it. Many have investors that are impatient. Fortress just had to close one of its funds, whose bets may actually pay off years from now, but too many people wanted their money out. Some hedge funds also have rules, eg long only, which can really limit your performance. While important to be aware of this, that placing your money with a hedge fund may not beat a benchmark, that does not automatically mean you should go with an index fund.

So when are index funds useful? When you dont want to do any thinking. When you dont want to follow market news, at all. Then they are appropriate.

  • Thanks for the explanation, great answer! But If I look at your graph active traders won 5 out of 9 years. However, the difference if you look at the totals for the full 9 years seems very small. So I'm not sure if your '5 out of 9' argument means that active traders can reliably outperform the index over longer periods of time. – Roy T. Oct 23 '15 at 7:02
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    This analysis is very misleading. In the first place, they don't tell you if the results are net of fees. Active funds need to not just beat their benchmark, but beat it by enough to recoup the fees. More importantly, looking at the average of actively managed funds is meaningless because you don't invest in the average; you invest in a fund. In a year like '09, some funds overperform, and some underperform. In a year like '13, the same, but there is no reason to expect that the funds that overperform in '13 are the same ones that overperformed in '09. In general they won't be. – Nobody May 29 '18 at 21:51

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