In reply to Daal: there are some potential extra returns from housing - firstly, it provides yield (or eliminates the need to pay rent) in addition to nominal capital gains. At the moment, places like Las Vegas and Dublin have properties available at 10%+ gross rental yields, far above most conventional assets with similar risk. Second, the ability to borrow large sums at fixed interest rates can give a positive real return from a nominal gain, as inflation erodes the size of the mortgage in real terms (yes this backfires in deflations, but it's a favourable odds play given political incentives to inflate somewhat). Third, using tax write-offs or offset mortgages allows you to enjoy a considerable positive risk-free return e.g. buy a 500k house, with a 400k mortgage, deposit 200k into the offset mortgage account, and you earn the mortgage rate of interest, totally tax free, whilst preserving almost immediate liquidity. So, if you are out of trading ideas, you can reduce some of your interest overhead from (say) 5% to zero, without any tax levied on it. This equates to a risk-free gross return of 6-10% depending on your tax bracket, an amazing free lunch. Or, in the USA, you just write off your mortgage payments against income.
I agree picking an index is still picking to some extent, and carries some risk. But it carries far less risk than picking 5-20 individual stocks year in, year out. Also, I did not say pick one index (e.g. S&P). Proper diversification would require picking several indices e.g. S&P, small/mid-cap, some price-weighted index, along with the foreign portion (which should ideally be split between say G7 big cap, emerging markets, and so on). There is a trade-off between transactions costs + hassle factor versus diversification and simplicity. In any case, it is irrefutable that picking individual stocks is far harder and riskier for most people (including pros) than choosing a few stock index funds with low costs and some diversification and then just rebalancing each year. So, any stockpicking bets should be classed under active speculation/investment and not considered index investing. The homework required to pick the 1-6 best-suited index funds is far far less, and carries far less underperformance risk, than the homework required to pick the best 5-20 stocks year in, year out.
About risk vs return - if you can earn good alpha, then you get 'paid' far more each year for taking risk via high quality trading bets, than taking the same level of risk via passive index investing. E.g. in passive investing, you risk say 10-30% more drawdown to get 1-3% more per year, a ratio of 0.1 (e.g. most stock markets have lost 75-90% at some point in history, few returned >10%). Whereas in profitable trading, how much do you need to risk to earn an extra 1-3% per year? Skilled traders can usually achieve risk/reward ratios of 0.5 at least, implying that 1% extra a year can be earned by risking 2% drawdowns. Why would you then take investment risk for 1% extra, at a cost of 10% extra drawdown? The rational response is to minimise investment risk, and earn your extra return via the far better R/R of profitable trading. If your trading consistently has worse R/R than your passive portfolio, then you have bigger problems and are probably better off moving into a different career.
I agree about mental accounting etc, however there is risk of permanent loss of capital (e.g. in major recessions/depressings, economic breakdown like hyperinflation). Secondly, even temporarily reduced portfolio value reduces how much you can risk and therefore earn on your trading bets (100k portfolio falling to 70k in a bear market means you can only put up 70% of the margin compared to before). Third, if you have come value investing ability, having lower drawdowns means you can deploy more capital in the aftermath of crashes/bear markets, which should boost long term returns. Fourth, life risks can be high and you never know when you might be out of work, hospitalised, face some crisis etc. These are more likely to come during recessions and other socio-economic disruptions. It is rare that people with equity exposure look back in hindsight and say "I took too little risk in my investments", relative to the opposite. This is especially true for someone who can earn 10%+ per annum from trading. Much better to earn 15% per year with 15% drawdowns than 18% per year with 30% drawdowns IMO.
I agree picking an index is still picking to some extent, and carries some risk. But it carries far less risk than picking 5-20 individual stocks year in, year out. Also, I did not say pick one index (e.g. S&P). Proper diversification would require picking several indices e.g. S&P, small/mid-cap, some price-weighted index, along with the foreign portion (which should ideally be split between say G7 big cap, emerging markets, and so on). There is a trade-off between transactions costs + hassle factor versus diversification and simplicity. In any case, it is irrefutable that picking individual stocks is far harder and riskier for most people (including pros) than choosing a few stock index funds with low costs and some diversification and then just rebalancing each year. So, any stockpicking bets should be classed under active speculation/investment and not considered index investing. The homework required to pick the 1-6 best-suited index funds is far far less, and carries far less underperformance risk, than the homework required to pick the best 5-20 stocks year in, year out.
About risk vs return - if you can earn good alpha, then you get 'paid' far more each year for taking risk via high quality trading bets, than taking the same level of risk via passive index investing. E.g. in passive investing, you risk say 10-30% more drawdown to get 1-3% more per year, a ratio of 0.1 (e.g. most stock markets have lost 75-90% at some point in history, few returned >10%). Whereas in profitable trading, how much do you need to risk to earn an extra 1-3% per year? Skilled traders can usually achieve risk/reward ratios of 0.5 at least, implying that 1% extra a year can be earned by risking 2% drawdowns. Why would you then take investment risk for 1% extra, at a cost of 10% extra drawdown? The rational response is to minimise investment risk, and earn your extra return via the far better R/R of profitable trading. If your trading consistently has worse R/R than your passive portfolio, then you have bigger problems and are probably better off moving into a different career.
I agree about mental accounting etc, however there is risk of permanent loss of capital (e.g. in major recessions/depressings, economic breakdown like hyperinflation). Secondly, even temporarily reduced portfolio value reduces how much you can risk and therefore earn on your trading bets (100k portfolio falling to 70k in a bear market means you can only put up 70% of the margin compared to before). Third, if you have come value investing ability, having lower drawdowns means you can deploy more capital in the aftermath of crashes/bear markets, which should boost long term returns. Fourth, life risks can be high and you never know when you might be out of work, hospitalised, face some crisis etc. These are more likely to come during recessions and other socio-economic disruptions. It is rare that people with equity exposure look back in hindsight and say "I took too little risk in my investments", relative to the opposite. This is especially true for someone who can earn 10%+ per annum from trading. Much better to earn 15% per year with 15% drawdowns than 18% per year with 30% drawdowns IMO.
