tag:blogger.com,1999:blog-7905515.post4173932117553692042..comments2024-03-14T11:09:32.759-05:00Comments on Falkenblog: Who Gets the Equity Risk Premium?Eric Falkensteinhttp://www.blogger.com/profile/07243687157322033496noreply@blogger.comBlogger14125tag:blogger.com,1999:blog-7905515.post-56326866212401602692012-05-03T18:57:21.730-05:002012-05-03T18:57:21.730-05:00Transaction costs can't possibly be 2%, unless...Transaction costs can't possibly be 2%, unless we are talking really really superdumb money. Run-of-the-mill dumb money is only slightly affected by transaction costs. Bid-ask spreads on SPY are negligible, market impact for SPY is negligible for anyone moving less than $1 million a day in or out, and brokerage commissions are negligible for anyone moving non-trivial sums of money (at least $10,000 per trade) and not moving too often (at most one round-trip per year). <br /><br />2% tax impact is also highly dubious. No one else calculates the ERP relative to munis. Rather the ERP is always relative to taxable bonds (there is much disagreement over whether to use t-bills, 30year t-bonds or 30 year TIPS as the risk-free rate). If you substitute munis, then you increase the ERP pre-tax and reduce it post-tax and it's a wash. I don't care what the study shows. It's obvious without looking at it that the methodology is faulty. Most likely, what they have "discovered" is that the past 30 years has been an unusually favorable one for long bonds, whether taxable or tax-exempt. Under the conditions we can expect looking forwards, regarding taxes, inflation and relatives stock/bond performance, taxation is likely to hit bonds worse than stocks. So the impact to ERP of taxation is not 2% but more like 0% or negative, as the first commentator suggested. <br /><br />Adverse market-timing (buy high, sell low) is where the dumb money loses big. But it isn't insiders who take the other side of those dumb trades. Insiders are capital constrained. Rather, it is smart money. Some of smart money is rich people, but some is not. Doesn't take anyone special to notice that the idiots are finally becoming excited about stocks now that the prices have gone up, or that, conversely, the idiots have once again decided the stock market is too risky now that stocks are on sale again.frhttps://www.blogger.com/profile/14980384436598923074noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-1930635671636047142012-04-28T08:16:55.825-05:002012-04-28T08:16:55.825-05:00Max, First off, munis total returns are not more c...Max, First off, munis total returns are not more correlated with stocks than with treasuries. Only spreads are not total returns (confidently stated as a researcher in the field). Secondly, as a fixed income analyst in a private wealth management group of a broker/dealer, a university educator and voracious reader of risk-related material , I completely agree with all notions cast in this article. I wish I could go to the rooftops and shout to investors everywhere this message. However, this would be perilous to my day-job income. Thus like the rest of the nickle-grubbing financial industry insider-middleman I will keep hush about what is the truth and allow the myths to be perpetuated. I should probably go to hell (if there were such a thing). Besides, if I can't even convince (salesmanshipo aside) my own highly educated and intelligent sister of the follies of the game, how can I convince others that they are being willfully duped into being donators to the inverse Robin Hoods.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-7905515.post-16471002901082420322012-04-26T15:33:32.747-05:002012-04-26T15:33:32.747-05:00Nice post Eric. I've linked to this post on th...Nice post Eric. I've linked to this post on the Society of Actuaries' Investment Section LinkedIn page.Tom Anichinihttps://www.blogger.com/profile/06263159507809271795noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-21062004404672663142012-04-26T09:21:22.803-05:002012-04-26T09:21:22.803-05:00Your views on the ERP caused quite a stir on the B...Your views on the ERP caused quite a stir on the Bogleheads.org forum last year, where you participated in a discussion on your paper. This post seems to me to be in complete agreement with Boglehead thinking, and therefore I added the following post to that thread to inform Bogleheads that you might be on our side after all.<br /><br />http://www.bogleheads.org/forum/viewtopic.php?f=10&t=81865&p=1374430#p1374430Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-7905515.post-50219220602277005912012-04-26T09:01:18.548-05:002012-04-26T09:01:18.548-05:00array just means a set of more than one, where the...array just means a set of more than one, where the returns depend on the strategies and tactics investors choose. So, if you invest passively with consistent amounts each year in index funds, you can acheive index returns. If you invest based on hunches in penny stocks, your average return will probably be around -20%. It's a long list.Eric Falkensteinhttps://www.blogger.com/profile/07243687157322033496noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-5407570601152542022012-04-26T03:39:37.236-05:002012-04-26T03:39:37.236-05:00Eric,
I enjoyed this post. Do you mind clarifying...Eric,<br /><br />I enjoyed this post. Do you mind clarifying what you mean by scalar and array when you refer to the return? Everything else was crystal clear.<br /><br />Cheers,<br />ChuckChuckBnoreply@blogger.comtag:blogger.com,1999:blog-7905515.post-88748706096447546612012-04-25T09:01:36.255-05:002012-04-25T09:01:36.255-05:00Munis aren't a proper "risk free" be...Munis aren't a proper "risk free" benchmark. They are more correlated with stocks than treasuries, due to liquidity risk and credit risk.Maxnoreply@blogger.comtag:blogger.com,1999:blog-7905515.post-22079317726752510912012-04-24T12:59:27.920-05:002012-04-24T12:59:27.920-05:00It is instructive that 2. and 3. are mostly avoida...It is instructive that 2. and 3. are mostly avoidable (don't get in/out, don't trade too much) with simple buy-and-hold, and 1. is avoidable for many of the relevant investors who are tax exempt.<br /><br />Eric's point may be true, but it's based on the voluntary silly actions of investors, not some vast conspiracy.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-7905515.post-35169739843089077482012-04-24T11:21:19.048-05:002012-04-24T11:21:19.048-05:00'This is probably due to simple cognitive diss...'This is probably due to simple cognitive dissonance, as investors are mentally distressed by the conflict between a good self-image and empirical evidence of poor trading tactics. To reduce the discomfort, investors adjust their memory about that evidence and those choices. This is then selectively reinforced by noticing the returns of just their good performing stocks and mutual funds in the portfolio and not the poor ones because ex-post awareness these were mistakes rather than legitimate data.'<br /><br />Nicely put. Anyone who has ever worked with retail investors has seen just this.Patrick R. Sullivanhttp://hisstoryisbunk.blogspot.com/noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-44379579085539521622012-04-24T10:36:14.745-05:002012-04-24T10:36:14.745-05:00JW: the data internationally show a consistent vol...JW: the data internationally show a consistent volatility 'anti-premium', and it isn't correlated withanything obvious (eg, size of country).Eric Falkensteinhttps://www.blogger.com/profile/07243687157322033496noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-14367523744960783392012-04-24T10:27:46.991-05:002012-04-24T10:27:46.991-05:00It is a side issue but so should one favor investi...It is a side issue but so should one favor investing in low volatility stocks that operate in countries where GDP growth is higher relative to equities growth?JWOhttps://www.blogger.com/profile/00004178958481335795noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-91729936591094915612012-04-24T10:22:10.813-05:002012-04-24T10:22:10.813-05:00Of course it is the case that including all fricti...Of course it is the case that including all frictional costs the average investor has a <50% chance of outperforming the S&P 500. Another way to say this (without referencing Lake Wobegon) is: “alpha is everything”. If you can’t identify and make a case for where your equity market alpha is going to come from then it’s probably a good idea to limit your equity exposure to passive, low cost index plays (and make peace with the slight underperformance). Investing is hard and generally stock traders who are smarter, harder working and more disciplined do better than stock traders who aren’t (I consider those who have positioned themselves in the investment business to generate profits independent of actual investment decisions as a separate case). Cheating or milking your clients for fees may be easier than consistently picking outperforming stocks/funds but it’s possible and it happens. It’s just not the best strategy for the vast majority of investors. <br /><br />Regarding the “equity premium”: Boom/bust cycles in some asset classes may be more/less frequent than others (and our short human lives probably further distort the perception of this) but for any one asset class to deliver a perpetual, long-term premium sounds a lot like a free lunch. (are long term returns for all junk bonds –including default losses- really greater than Treasuries?). I do think that some investment processes can deliver consistent, long-term (relative) outperformance, like value investing but this is likely attributable to the fact that most people don’t have the patience (life is short) to realize that premium. Another recognition of this is the various common law prohibitions against perpetuities. <br /><br />But when inflation takes off and capital preservation becomes the new black, the equity “premium” may come roaring back.Mercurynoreply@blogger.comtag:blogger.com,1999:blog-7905515.post-88177088370572127022012-04-24T08:22:59.621-05:002012-04-24T08:22:59.621-05:00Look at Gannon and Blume. They compare to tax-fre...Look at Gannon and Blume. They compare to tax-free munis.Eric Falkensteinhttps://www.blogger.com/profile/07243687157322033496noreply@blogger.comtag:blogger.com,1999:blog-7905515.post-26050945296928831432012-04-24T05:46:02.711-05:002012-04-24T05:46:02.711-05:00Accounting for taxes increases the ERP, not decrea...Accounting for taxes increases the ERP, not decreases it (since stocks are taxed at a lower rate than bonds).Maxnoreply@blogger.com