Why Can't Active Funds Beat the S&P? The Source of Return

Quick answer: they go flat or short. Either strategy is a loser. Why? The return of the S&P (and nearly ALL broad-based indexes) comes from a miniscule number of trading days that are very scattered and very unpredictable. The plot below shows the continuously compounded daily returns of SPY from its 1/29/1993 start date to 5/22/2024.

SPDR S&P 500 ETF Trust (SPY) closing price since 1/29/1993 adjusted for splits, dividends and capital gains distributions. Source: https://finance.yahoo.com/quote/SPY/

SPY has traded 7884 trading days or 31.28 years since inception. Here are the numbers:

CCROR = Continuously compounded rate of return (ln(day 2/day 1).

CAGR = Compound annual growth rate = sum of daily returns.

These are the returns from nonstop buy and hold for SPY from inception to 5/22/2024. These returns outperform 70% to 90% of all active managers, consistently, across nearly any time frame. See S&P's passive/active website here: 

https://www.spglobal.com/spdji/en/research-insights/spiva/about-spiva/

The total return of SPY (and QQQ and IWM, for that matter) is extremely sensitive to the top 10, 20, 100, etc. individual trading days. How sensitive is it? Here are the numbers:

The "Top" table shows how the SPY return changes when an active manager misses the top 10 SPY days. Just missing those specific 10 days reduces your return by 200 basis points (9.79% to 7.26%). Missing the top 20 days cuts you further and missing the 100 top days results in a sub TBill return!

Here are the top 10 and worst 10 days since inception for SPY:

Well what are the odds of that? Probably the chance of missing (or picking) the top 10 or 20 or any fixed number of top days is probably random but every day an active manager is OUT of the market, or worse yet, short the market, is another chance to miss a top day. Note that when tested for just random days, missing say 10 or 100 or 2000 random days (a much more likely scenario), there is much less effect on return.

Missing the "top 20 and worst 20" or any number of  like days also has a smaller effect on return. Returns only go up if you can miss the worst days and not miss the top days-a task as unlikely as any other. 

In sum, THE ONLY WAY TO GUARANTEE THAT YOU DON'T MISS TOP DAYS IS TO BUY AND HOLD.

If you can do it, more power to you, but public audited managers can't. 

How to Invest

 

How to Invest

An investment guide for everyone.

 

Investments are a form of spending but spending on SAVINGS. Savings for yourself, your future, your car, home, retirement, your family, your child or children’s future. 

 

Smart investing involves knowing your needs and goals, researching and MAKING good choices.

 

Needs and Goals

 

We are all unique. But while we all have some things in common: we each answer needs in our own way. Investment needs depend upon your stage of life. Needs and goals include your education, car, home, family, children’s education and retirement and a slew of goals specific to each. 

• For students, your job is school. Max out your education. Challenge yourself and take school seriously; your life will depend upon it. 

Take advantage of every wise opportunity but most importantly, avoid bad choices. NO “for-profit” schools or schools that advertise with promises. Go to community college if you must, use school counseling, government and agency programs/grants for low/no income students. Don’t sign student loan applications.

• 20s? Not a Student? Try and do what you love and whatever you make, SPEND LESS than you make. Take advantage of every opportunity, especially low/no income programs. Your library is your friend. MAX OUT your retirement plan at work and you’ll have thousands saved by your 30s. No work retirement plan? Change jobs or open your own IRA (Individual Retirement Account) at Vanguard or T Rowe Price² and MAX THAT OUT. Save for down payments on a car and home. Put your college and retirement funds into an S&P 500 index fund. Put your down payment savings into a money market account³. 

• For all adults-SPEND LESS THAN YOU EARN. Begin planning now, MAX OUT your retirement plan at work. Don’t neglect your basic needs to complete your education, avoid unwise debt and buy a home-a 30-year mortgage is your friend! No work retirement plan? Open your own IRA and MAX THAT OUT. If needed, still save for down payments. 

Buying a home may be the best INVESTMENT you can make. You not only INVEST your money but you LIVE in it and, as you pay down your mortgage, your home equity grows too! Mortgage payment is a form of forced saving and may be one of the best ways to accumulate wealth.

• For parents of newborns, get your child’s SSN right away and open a children’s account. Work with Vanguard or T Rowe Price to make the right choice for you. Investing in a S&P 500 stock index fund these first 3 or 4 years can triple your child’s assets! 

• For middle aged adults with children-kid’s college is looming and then retirement, no time to slouch now, you must juggle spending AND saving. With or without children, live your best life, make your best choices.  

• Near retirement? -You can be retired for 30 years or more, you need growth. Forget income, all income comes from principal or growth. Income funds UNDERPERFORM, buy and hold an S&P 500 Index fund (or Nasdaq 100 index funds, if you can stand it. 

Index fund declines are a COST! A price you pay for superior FUTURE returns. 

NEVER pay fees for a financial planner or broker commissions. Forget buying stocks, commodities, options and ESPECIALLY CRYPTO. These are all gambling. Don’t gamble until you have substantial income and can AFFORD gambling losses.

When it comes to insurance, buy only car and home insurance, and when you have dependents buy ONLY straight life insurance. Insurance has huge commissions and is NOT an investment.

Research 

Your library is your friend. Local, state and federal programs, agencies and non-profit organizations can be lifelines. Learn and know your choices, especially, what to avoid! 

 

WHO you invest with is as important as WHAT you invest in. Almost ALL financial professionals offer products you don’t need, with unnecessary complexity and with exorbitant, explicit or hidden fees. Throughout your financial life do not be lured BY and avoid almost ALL full service advisors, insurance salesmen (except when you NEED to insure your home, life or car) and stockbrokers. 

 

Good advice IS available but sadly without a good MBA one may not know what good advice looks like. In my opinion, for those NOT in the know, only a few investment firms truly exist to serve their customers: Vanguard and T Rowe Price are the major companies that I recommend. Call them, tell them your situation and they will give you excellent unembellished advice (no promises, no misrepresentations).

 

BEWARE ALL GET RICH QUICK SCHEMES. You already know this. As for bitcoin, the stock market, house flipping, etc. etc. these are all forms of gambling and totally depend upon your financial weight class. Choose wisely. 

 

Investment Choices

 

Just like spending, you have choices. Different investments have different risks. Time is your friend. Below is a table of investments ranked by risk, Risk is always a subjective measure-subject to your personality and financial weight class. Time is your friend and reduces your risk for retirement investments. Here’s one standard way to rank investments by risk:

 

Investment	Historical and  Estimated Rates of Return	Risk
Bank Savings	0.1% to 3%, 1%	Very low, FDIC insured
Money Market Funds	-1% to +2%, +3% on average	Very low
Bond Funds	-3% to +5%, +5% on average	Low
Home Ownership	-10% to +10%, +8% on average	Market risk
Stock Market	-20% to +20%, +8% on average	Market risk
Technology Stocks	-40% to +40%, 12% on average	Above Market
Bitcoin	-50% to +50%, no average	Very high

 

Stock indexes have risen over time and this is the major reason honest professionals recommend stock index investments for retirement and long term investors. There is no guarantee this will continue! But, for the last 200+ years, it has.

 

Stock indexes are NOT favored by investment professionals due to their very low fees. Some will lure you with no fees but offer to share in your profits. Again, at Vanguard or TRP, you won’t have to give up very low fees. 

 

Your investment life is just one part of your money life, social and family life. Make the most of what you have with your best possible choices. 

 

Why Vanguard or T. Rowe Price? I don’t work for them but in my experience, they are as good as it gets for investors of all weight classes.. I suggest you call them and once you get your bearings, then you can explore their websites. Their contact information is: 

 

Investor.vanguard.com 877-662-7447

troweprice.com 1-888-285-2612

Money markets have very low risk and are appropriate for short term investments where you can’t afford losses such as for a car or down payments.

 

Volatility is a fancy way of measuring how much an investment has fallen in the past. It does not predict how prices will move in the future.

Medallion Fund? Red Flags

May 10 the Wall Street Journal, when reporting the obituary of James Simons, called Simons "one of the most successful investors in modern financial history".  To be fair, MANY other sources make the same claim. How does anyone know this?

The Journal continues to claim: 

"Between 1988 and 2018, Renaissance’s flagship Medallion Fund produced gains of more than $100 billion and average annual returns of 66% before the firm’s unusually hefty investor fees. The annual gains were 39% after those fees ... Medallion years ago became a fund only open to Simons and his colleagues."

These claims and almost ALL claims made about the Medallian Fund come from ONE source, The Man Who Solved the Market, by Gregory Zuckerman (2019) which has an appendix claiming to show a summary of Medallion's performance data. Zuckerman and every other claimant tell stories of the epic security and closely guarded secrets including "ironclad non disclosure agreements" of Medallian and its owner Renaissance Capital. 

This table, as presented in a paper by Cornell Capital Group is far from the standard disclosure required of a publicly offered futures account or mutual fund. This table would be rejected as insufficient and misleading. The requirements for a valid disclosure document are found here. 

The red flags here are too numerous to list. The major red flags are:

• opaque trading methodology
• no public track record
• too consistent extraordinarily high up years
• NO down years
• fund only open to insiders
• public funds offerred by parent firm Renaissance Technologies: the Renaissance Institutional Equities Fund and Renaissance Institutional Diversified Alpha funds were both subpar performers and no longer listed by my broker. 

The WSJ claim of  "a performance that topped those of Buffett, Soros, Peter Lynch and other investors" is laughable! These are true investor giants with public, audited track records and funds that made their investors millions!. There is NO SUCH PUBLIC TRACK RECORD with the Medallion fund. Pro-tip: Bogle may have the greatest record and legacy of all, permitting average investors to earn superior returns!

The only other performance tidbit from the Cornell Cap paper is the claim 

"According to Robert Mercer, one of Medallion’s key investment managers, Medallion was right on only about 50.75% of its trades.". 

How odd is that? Not very. According to Microsoft's stockhistory function, as of today (5/13/2024) the S&P 500 ETF, SPY, was up 4,204 days out of its 7,877 day trading history or a win percentage of 53.37%. 

While Madoff falsely tried to show his methodology, he TRIED. Perhaps Simon DID make these returns - to his credit, as far as I know, he never made public claims - but the inability to replicate these numbers in his public funds should give all of us pause. There's no fear of missing out with a story like this.