Active traders tend to lose money relative to the “rest of us” passive index investors.

This is something that will not work forever. If 100% of investors were passive, they would get fleeced.

Passive investing works thanks to active investing. Funny huh?

I think passive investing works, on average, because, on average, companies generate profits and increase in value over time. Active investing loses because transactions have costs in terms of management fees, commission and spread and is how stockbrokers make their money.

If 100% of the stocks were passive invested, then the game for banks would be to list companies as fast as possible, with as high capitalization possible. Who cares if its overvalued? nobody is looking. As soon as a stock is publicly listed it gets bought.

IT would not work. Not poorly, it just wouldn't work at all. This tells me that there is a balance on how much active/passive investment can there be, and at some point they will be balance by some criteria.

I agree that passive investing works, but the real story, I think, is that the economy is guaranteed to grow on average if the population keeps increasing and innovation keeps happening.

If the population grows 3%, we have to produce roughly 3% more, so revenues go up roughly 3%, number of employed goes up roughly 3%, so the economy grows 3%.

If I invent a steel manufacturing process that makes steel 3% cheaper, expenses go down 3%, profits go up, supply goes up, prices go down, the economy grows.

If all you do is passively invest, then over large periods of time you should on average see returns of, roughly, population growth + innovation. Even if everyone is passively investing, it's the same thing. If you actively invest, but still invest in the whole market (as any diversified investor does), you get the same thing, minus ~1% towards. If everyone was actively investing before, and the market grew ~8% per year, and now they passively invested, why would the market not gain the same?

No it wouldn't. Everybody could be a passive investor and the economy and your portfolio would just continue to exist.

Passive funds are priced based on the activity of active investors trading underlying securities.

I don't think he's implying that literally everybody trades passively, of course Zuckerberg is going to actively trade his Facebook shares, I'm going to actively trade my stock options at Public Company X, the guy down the street will still rent his house out instead of selling it and investing passively.

Plus, it's not like passive investing causes securities to never be traded, when I buy into a mutual fund I'm buying stock from someone. That someone is probably retiring and selling their securities.

Lastly, most "active traders" just buy a bunch of Blackrock/Vanguard/SPDR index funds anyway and call it a diversified portfolio that only they could deliver.

There would be a price without the constant underlying activity as well. This is basic financial economies.

I get the sense that that relationship will reverse itself as soon as the market turns down. Bear in mind that a day trader can cash out in a second; you and I will will have to wait two business days.

Indexing as a strategy implies staying invested through downturns and not trying to time the market. Selling during downturns and buying during boom times is as wrong as an investment algorithm can possibly be.

And the market might recover in 2 days and that day trader would lose money for nothing.

In reality, trying to time the market rarely works out, and when it does it can often be attributed to luck. In general, just investing every month is the best strategy.

> a day trader can cash out in a second; you and I will will have to wait two business days

Why the delay?

You can log on to your 401k account and move your position over to treasury bonds or something that looks safer, but they will wait two business days to process the transaction. I know from personal experience; don't see much information online about the phenomenon. My guess is that they are legally allowed to do this, probably because they wrote the law.

> they will wait two business days to process the transaction

This was a decision your 401(k) provider made. The proper person to gripe to is whomever in HR chose a cheap provider. (They make up for reduced administrative costs by (a) being less efficient and (b) capturing float.)

Ah, here it is in the FAQ:

"When selling a mutual fund to purchase a fund in a different family, you are selling the mutual fund you own and using the proceeds to purchase another fund in a different fund family. Since you are performing a cross family trade, the settlement date for the sale will differ from the settlement date for the purchase. Typically, cross family trades execute over two business days."

The funny thing is, even though they say "up to 2 business days", the trade was executed at 3:59:59 PM on the dot, on the 2nd business day after I made the request. I'm certain they waited until that moment to execute the trade because legally, they can.

Fidelity is a cheap provider?

> Fidelity is a cheap provider?

No, but they have different tiers of service. In my account, for example, I can sell and purchase intraday. They do what they do for my personal account, which is credit the cash intraday. TL; DR This is not a legal, but contractual, requirement.

It's a legal requirement to some extent unless you have a margin account. Funds take two days to settle. If you sell, buy, and sell again within two days, your account can be suspended for violating SEC rules.

https://www.ally.com/do-it-right/investing/what-are-unsettle...

I see! Good to know. Still, I'm inclined to believe that more people are in my tier of service than are in yours.

Unless they are a market making financial institution, yeah.

Yes, but:

1. Market makers don't make investment decisions or hold positions. They facilitate trading as counterparties to investing parties, but do not drive prices themselves.

2. Market makers would make a terribly poor shadowy cabal, because the amount of capital they collectively manage is in the high single to low double digit billions. Mutual funds, hedge funds and private equity account for trillions.

Is this based on research or just that theoretical model that passives do better while actives churn fees in a zero sum game?

Actively managed mutual funds don't tend to outperform the S&P 500 over the long term, when you account for selection biases (i.e. if you look at a set of mutual funds from a given brokerage, most of them will appear to outperform the index because they've cancelled the ones that didn't; if you actually choose some of those funds, however, they're going to eventually underperform and get cancelled and replaced with a new set of funds).

This selection bias works somewhat like the old sports betting scam:

1. You get 16,000 email addresses from people who want to receive your expert tips to predict NFL games. You send each of them your pick for the Monday Night Football game. You tell 8,000 of them that the home team beats the spread and the other 8,000 that the away team beats the spread. Be sure and include complicated rationales that will seem prophetic after the fact.

2. Of the 8,000 who received the "correct" tip, you send 4,000 of them one pick for Thursday Night Football and 4,000 of them the opposite.

3. Repeat for the Sunday Night game.

4. You now have 2,000 people who think that you can accurately predict who's going to win a football game, because you've done so for three nationally broadcast games in a row, and the odds of that are astronomical! (I mean, they're 1 in 8, but the kind of people who sign up for spammy sports betting tip newsletters aren't necessarily that sharp). Con 10% of them into paying you $50 for your expert tips for the next Monday Night Football game and you've made $10,000 out of 16,000 email addresses and a week's worth of making up shit about football.

(the exception being, with mutual funds, it's the funds themselves that are dropped instead of the poor saps who invested in them).

...

On the one hand, when it comes to active vs. passive investing, you have the Bogleheads and the hardcore efficient-market-hypothesis types who will tell you that every possible rationale you could ever have for ever making an active investment decision is already priced into the market. On the other hand, Warren Buffett spent virtually his entire life overperforming the market. How to reconcile this?

Actually, I think it's entirely possible for active investment to beat the market, but with a LOT of caveats:

1. The market isn't 100% efficient, which is logically equivalent to saying that it's possible for active investment to beat the market. This seems pretty obvious when you put it this way--100% efficiency is fucking magical, it's not a realistic expectation to have of the world--but how efficient is it? 95%? At that point, you're spending a ton of time and effort finding a market opportunity where you can realize a return of $100 instead of $95. That's a lot of work, and if you're smart and diligent enough to make your marginal $5 that way, you're probably smart and diligent enough to make $10 doing real work instead.

2. So let's say you follow your passions, and active investing is it. You work long and hard to find $5 opportunity after $5 opportunity, and nothing else matters to you other than your loved ones, your weekly bridge match, and advocating for tax reform because you think it's ridiculous how low your taxes are. See where I'm going with this? If active investing is hard enough, and lucrative enough, you're not going to go around asking bored salary drones to let you invest their retirement money in exchange for commissions and fees. That's ridiculous. If you know how to beat the market, beat it yourself and keep all the money. In other words, active investing only works if you, personally, are the active investor. It's not a justification for buying mutual funds.

3. So let's imagine that you are literally the single most successful person in the world at active investing. You're a household name, a genius, an "Oracle", you go to the White House and play bridge with Bill Gates and you're in the top ten billionaire list...

...wait, did I say "Bill Gates"? Take another look at that list, while you're at it. If you're really smart, and diligent, and ambitious, and want to get really really rich by working really really hard at it, it turns out actually creating new businesses works out a lot more often than investing in existing ones. Active investing is exactly the kind of field where you would expect massively outsized returns, and yet, once you eliminate out the heirs, heiresses, and developing country oligarchs who ended up with a controlling stake in newly privatized industries through Totally Not Corrupt Processes™, you're a lot more likely to make a huge fortune by getting 2 billion people to use your ad-supported website, selling cheap flat-pack furniture, selling database software to large companies, selling running shoes, or literally doing any other kind of real work.

So, yeah. Active investing can work out for you, but there's no free lunch, and if you have the money to spare and you're willing to put in the work, you might be better off doing something like buying and flipping houses. Sure, you'll spend frightening amounts of spare time covered with sawdust and choking on mold spores, but at least you'll expect that going in.