The Stupidest Thing You Can Do With Your Money (Rebroadcast)

Podcast Summary

• The Costly Illusion of Active Investing: Everyday investors lose billions through active investing, a negative sum game where investors unwittingly fund each other's losses. Low-cost index investing offers a potential solution by reducing fees and aligning investor interests with market returns.

  Everyday investors are unwittingly throwing away billions of dollars through active investing, which is a negative sum game where for every winner, there must be a loser. This phenomenon is often overlooked due to the delusion that one can outsmart the market through cleverness and the misinterpretation of portfolio returns due to overconfidence and weak feedback. Investment firms make money by charging a percentage of assets under management, creating an incentive to grow assets and perform well, but also contributing to the cycle of active investing and its associated costs. The revolution in low-cost index investing offers a potential solution to this problem by reducing fees and aligning investor interests with market returns.

• The Shift from Active to Passive Investing: Despite the popularity of active management, a study found that only top performers cover their costs, leading to a shift towards passive investment vehicles with lower fees and wider market exposure.

  The debate between active and passive investment management has been a topic of much discussion in the financial world. Active management involves hiring professionals to select the best investments for your needs, while paying for their expertise and the associated fees. However, a study by Ken French and Eugene Fama in 2010 revealed that only the top 2-3% of fund managers had enough skill to cover their costs, leaving the rest of the managers underperforming. This has led to a shift in investor preferences towards passive investment vehicles like index funds and ETFs, which have lower fees and allow investors to own a piece of the entire stock market. Jack Bogle, the founder of Vanguard and the world's first index fund, is considered a pioneer in this area and has significantly contributed to making investing accessible and affordable for the average investor. With Vanguard now managing $4 trillion in assets, the impact of passive investing is undeniable.

• The Impact of Jack Bogle and Index Funds: Jack Bogle's creation of Vanguard and the rise of index fund investing have collectively amassed significant wealth, transforming industries and educating millions, while Bogle himself has remained humble and focused on keeping costs low.

  Jack Bogle's creation of Vanguard and the rise of index fund investing has collectively amassed an unprecedented amount of wealth, enough to fund major industries and educate millions. This revolution, which began as an alternative to high-fee expert-driven investing, continues to reshape the financial industry. Bogle, the man behind it all, remains humble and content with his modest lifestyle despite his pivotal role. He started Vanguard after being fired from Wellington Management in 1974 and initially continued with traditional actively managed funds. However, inspired by economist Paul Samuelson's paper, Bogle began questioning the wisdom of picking stocks and eventually led the industry towards index funds. Despite his financial success in leading this revolution, Bogle has remained focused on keeping costs low and has not amassed a personal fortune as large as one might expect.

• Jack Bogle's Unpopular Idea of Index Funds: Despite initial resistance, Jack Bogle's index fund idea gained popularity due to its cost savings and potential for better performance compared to actively managed funds. Most actively managed funds underperformed their respective index funds over time.

  Jack Bogle's introduction of the index fund was met with significant resistance due to the cultural belief that Americans aim to be above average and that active management was necessary to achieve superior returns. However, Bogle's contrarian perspective challenged this notion, arguing that most stock pickers underperformed the market and that investors would benefit from a low-cost index fund that simply tracked the broader market. Initially, the reception was harsh, with the fund being labeled as heresy and even a "Wall Street nightmare." Despite this, Bogle remained confident in his belief and the fund, initially underperforming with a disappointing $11 million in underwriting, eventually gained traction as more investors recognized the cost savings and potential for better performance compared to actively managed funds. Over time, data showed that the vast majority of actively managed funds failed to beat their respective index funds, making index funds an increasingly popular choice for investors.

• The odds of beating the market through individual stock picking are slim: Investing in index funds with lower costs and diversification is a more predictable and reliable approach than actively managed funds, leading to substantial differences in returns over the long term.

  The odds of beating the market through individual stock picking are slim, and the costs associated with actively managed funds can significantly reduce returns over time. The perception that everyone can get rich through active trading is a myth. Instead, investing in index funds, which offer diversification and lower costs, is a more predictable and reliable approach. The difference in returns between actively managed funds and index funds may not seem significant in the short term, but the compounding effect over longer periods can lead to substantial differences. For example, a dollar invested in a 7% market growing at 5% with a 2% cost for an actively managed fund would result in around $10 after 50 years, while the same dollar invested in an index fund with a 0.04% cost would grow to around $32. It's essential to understand that the investor bears all the risk but only gets a fraction of the return in the case of actively managed funds. Therefore, it's crucial to consider the long-term implications of costs and the benefits of diversification when making investment decisions.

• The Neutral Fund Actively Managed Business: Pay Less, Get More: Jack Bogle's advocacy for indexing, Eugene Fama's Nobel Prize for efficient market hypothesis, and the shift towards index funds and ETFs challenge the traditional active management approach.

  The Neutral Fund Actively Managed Business, where you don't get what you pay for, but rather what you don't pay for, has been a game-changer in the world of finance. Jack Bogle, a pioneer in this field, advocates for indexing despite criticisms. The revolution towards index funds and ETFs has been a long time coming, and it was only in 2013 that Eugene Fama, a finance professor at the University of Chicago, was awarded the Nobel Prize in economics for his work on the efficient market hypothesis. This hypothesis suggests that prices reflect all available information, making it difficult, if not impossible, to beat the market. Despite controversy, the efficient market hypothesis has significantly influenced the finance industry and continues to shape investment strategies today.

• Challenges of Beating the Markets with Active Investing: Despite market efficiency, consistently outperforming it through active investing is difficult. Active managers must take risks and accept higher costs, making the decision a personal preference.

  While the markets can be efficient, they are not perfectly so, and consistently beating them through active investing is a challenging proposition. Eugene Fama's research in the late 1960s identified this concept, but it took time for it to be widely accepted. The financial services industry, which stood to lose from this line of research, may have contributed to the resistance. Today, we're witnessing a shift towards passive investing, but active management still has its place, especially for those willing to accept higher risks and costs. Active managers must make bets to differentiate themselves, leading to significant dispersion of outcomes that can be indistinguishable from luck. Therefore, the decision to pay for active management boils down to a personal preference for higher risk and costs versus the market.

• High fees for active management may be a waste: Despite high fees, active management may not guarantee better returns, leading investors to consider cost-effective passive indexing as an alternative

  The high fees paid to investment professionals for active management, whether for individual investors or large institutions like Harvard Endowment, may not necessarily lead to better returns. The data shows that a significant amount of money spent on active management is essentially wasted. This is not just a problem for "stupid people who think they're smart," but for even the most accomplished and intelligent individuals who may be prone to cognitive errors and groupthink. The financial services industry profits from this phenomenon, and it's important for investors to be aware of their biases and consider passive indexing as a cost-effective alternative.

• High fees on some S&P 500 index funds irk experts: Experts criticize high-fee S&P 500 index funds, citing skepticism towards Wall Street and potential loss of market insights with widespread passive investing

  Despite the growing popularity of index funds and exchange-traded funds (ETFs), there is still a significant number of S&P 500 index funds with high fees, which some experts view as a tax on unsophisticated investors. This trend, which has been ongoing for decades but has gained momentum in recent years, can be attributed to the aftermath of the financial crisis, during which investors became more skeptical of Wall Street and the fees and services they provide. While passive investing, such as indexing, has its merits, critics argue that it could lead to a loss of price discovery and valuable market insights if everyone invests in the same way. Additionally, only about 30% of mutual and exchange-traded funds are currently passively managed, leaving plenty of room for active management and diverse investment strategies. Ultimately, the debate between passive and active investing continues, with each approach offering unique advantages and challenges for investors.

• Argues against limiting investment choices, could eliminate up to 70,000 jobs: Scaramucci opposes new rule limiting investment choices, fears potential loss of 70,000 jobs in financial services sector

  Scaramucci argues that it limits investment choices for individuals, leading to overloading of ETFs and indexes, and potentially eliminating up to 70,000 financial services jobs. He also believes the rule undervalues the full economic worth of financial advisors, who provide not only financial returns but also psychological support and coaching. The industry, according to Scaramucci, is unlikely to self-reform, and the rule needs to be repealed. This trend towards concentration in index funds and ETFs could result in significant job losses in the financial services sector.

• Essential Rules for Personal Finance Management: The financial industry undergoes frequent disruptions, but personal finance management remains crucial. Freakonomics Radio will discuss essential rules for managing personal finances in the next episode.

  The financial services industry may undergo significant changes due to innovations and trends, but the shift towards low-cost indexing and being financially responsible is a trend that is here to stay. The speaker emphasized that the financial industry has become too large and overcompensated, and every few years, it goes through major innovations that disrupt the status quo. However, personal finance management remains a crucial aspect of being a fiscally sane and responsible adult, and many people lack knowledge in this area. Therefore, the next episode of Freakonomics Radio will focus on the essential rules for managing personal finances.

• Exploring the Power of Music and Community in Podcasting: Through music, accessibility, and community, Freakonomics Radio enhances the podcast listening experience. We can easily access content on multiple platforms, read transcripts, and engage with research. Connecting with others through social media and email fosters a rich and vibrant podcast community.

  Another key takeaway is the ease with which we can access and engage with the podcast content through various platforms such as Apple Podcasts, Stitcher, and Freakonomics.com, where we can not only listen but also read transcripts and explore underlying research. Connecting further, the availability of these resources encourages deeper learning and fosters a more informed and engaged audience. Lastly, the various ways to connect with Freakonomics Radio, including social media and email, highlights the importance of community and communication in fostering a rich and vibrant podcast experience. Overall, this episode underscores the value of music, accessibility, and community in enhancing our podcast listening experience.