Hi! Does anyone have any thoughts about how to figure out when you're saving enough? You can keep "living under your means" as your means grow, but there must come a point where you're contributing enough to savings, and you can start spending more. How do you come up with that "putting enough into savings monthly" number?

Have you heard of a monte-carlo simulation before?

Not since my statistics class in undergrad :)

Curious what other people think, but interestingly enough, this is the single biggest question we answer with clients at Frum.Finance. The method we do is basically taking all known future big goals (house, yeshiva tuition, chasuna, etc), and put it into a big ol’ monte carlo simulation against the entire history of the stock market, run 5000 simulations, and tell people (given a confidence interval) how much they need to put aside a month. Here is a free tool if you’d like to do it yourself https://www.portfoliovisualizer.com/financial-goals

I've only heard 25x in connection to retirement/FI. How do I apply it if my expenses will change dramatically over the next 20 years iyH (tuition, weddings, helping kids out? Then mortgage gets paid off?) But I'm also willing to work as long as I can because I like my job

so that is why you need the statistical model bc the 25x rule doesn’t work well for frum people for that very reason. Right now I would either recommend that tool I sent. I meet with families one on one to calculate what you are asking bc doing it yourself can be hard. I’m also working on writing a frum dedicated software to calculate EXACTLY what you are asking bc its the #1 question BY FAR.

Amazing, iyH I hope to play with it later tonight

👍 if you need a hand with it, I am happy to help.

Fascinating. I'd love to try out such a tool. My current retirement planning is maxing the matched contributions I'm offered, having Google sheets FV the annuity at 8% annualized return, looking at the value for when I turn 70 and saying that it looks good 😂

Haha so you will definitely get a lot more value from this! It's incredible how this tool has changed people's lives finally knowing what they need to put away to meet all their goals.

@bored-jewelry-48369 Any projection or simulation is almost certainly going to be probabilistic. But your point is worth being stated explicitly in case someone isn't familiar with simulations. @mysterious-tomato-10057 is correct in the sense that barring a black swan event, the market as a whole should continue to climb, as it is a proxy for the US economy as a whole. As my thinking goes, if the S&P 500 crashes, I probably have far more serious problems than my financial future to worry about.

Agreed @nutritious-raincoat-28876 . I think you can make the case even stronger if you use a total stock market index fund instead of an s&p fund. If every US company goes to zero, we have a lot more to worry about than our investments.

Fair point, although being that the S&P 500 is defined as the top 500 companies, if any of those drop, they will be replaced by #501, etc.

True, but you can also say that then if you had a fund that tracked the top 1 company... So intellectually, id rather every company than some arbitrary cutoff. Especially bc the next big thing is not in the top 500.

Interesting. Not having looked at the data, which of these has performed better historically? Two counterarguments come to mind at the moment. The NBT may already be big by the time it's publicly traded, since private companies are obviously excluded from a market fund. Also, the very small percentage of NBTs may be far outweighed by lousy companies.

Another fund to look at while you look deeper into this is VXF. It’s the complement of VOO. So VOO + VXF = VTI. So let’s say you like what I am saying, but want to control the ratio yourself instead of the natural split of s&p and non s&p funds. VXF is everything NOT IN the S&P. So you can make your own portfolio of VOO/VXF with your own proportions, like 70/30 or 90/10 if you want more or less small/mid cap exposure. So let’s say you think the next 15 years things are changing to be more small cap focused, you could do 25% VXF with 75% VOO instead of relying on the natural order of the world with VTI.

@nutritious-raincoat-28876 @mysterious-tomato-10057 1) There is no correlation between economic growth and stock market returns. If anything, the correlation is negative (see attached chart). Example: China has been growing much faster than the U.S. yet its stock market returns have been disappointing comparatively. 2) If you think that there is a link between economic growth and stock market returns, why not invest in much faster growing emerging economies rather than the U.S.? 3) Making investment decisions based on historical returns is like driving by looking in the rear view mirror rather than the windshield and can lead investors to buy high and selling low, chasing the good returns. All knowledgeable investors know that the U.S. has had a great run over the past 10 years. That doesn't mean it will outperform the rest the world markets in the future.

I agree with everything you said @bored-jewelry-48369 but I fail to see the relationship between that and what is being discussed. Are you arguing that one should use a world index fund instead like 'VT' so we don't over index on the USA?

@mysterious-tomato-10057 I was getting at multiple points so I will try to clarify. I’ll give a scenario of how using historical data for a Monte Carlo can be misleading: Lets say the stock market goes up 50% in one year. If the Monte Carlo was using historical data, it would assume that future returns should be presumed to be higher in future years going forward because the 50% return from the past year brings up the average return. However, in most cases, a 50% one year return leads to the stock market being overvalued, depressing future returns, the opposite of the Monte Carlo assumption. The reverse is true for a big stock market drop.Using historical data also presumes that the U.S. will continue to outperform international, and I don’t think there is evidence to back up that assumption. Bottom line is a key part of investing, if the goal is to outperform, is to buy assets when they are undervalued. Presuming that past rates of return will continue indefinitely does not lead to that outcome.

I agree with everything you’re saying 🙂 Key difference is I am not trying to help people outperform the market. Vast majority of frum people are underperforming the market because either they are not investing in funds at all or paying an investment manager to just be in an index fund for them and get charged a compounding 2%. Halevai one day we can all start talking about outperforming the market. My dream is frum yidden all just capturing the market gains 😂 But you make a strong case to pick

VT

instead of

VTI

I strongly believe (not my shita, and this is backed up by data, e.g. see Kahneman's works) that holding risk constant, almost no one can consistently "outperform" the market. Given that many people will try, some will appear to succeed, and some will fail miserably, just as if many people rolled a die 100 times trying to get as many 6s as possible. The fact that someone did in the past does not mean they will continue to do so in the future. So yes, the goal would be to earn a market return at minimal cost. I definitely hear the global diversification argument, but sticking with the US market fits my risk/reward preference. Last point for now is that the stock market is random walk (with drift), so 50% return in one year says nothing about the following year (neither up nor down). I invest in the market purely for the drift component.

You are conflating market outperformance with mean variance optimization

Jump on in and join us Pinchas! Explain what we are missing 🙂

Too much here to respond to but lots of problems

You can't leave us hanging like that😂

You have to say #shameless self promotion if you're going to send us articles from your own website 😂 😂

You are conflating market outperformance with mean variance optimization

Perhaps I misunderstood what @bored-jewelry-48369 meant by outperform. I interpret that word to mean increasing expected returns (mean) holding risk (variance) constant. Given the risk premium demanded by risk-averse investors, increasing expected returns by holding a riskier portfolio is not "outperformance" in my books. Or maybe I'm misunderstanding your comment 😂

Why write stuff again when it already exists

No I agree with the approach, just wanted to make it transparent that it’s you 🙂

:)

@nutritious-raincoat-28876 Mean variance optimization is plagued by the same issues I was discussing earlier. To use this approach, you must presume a 1) expected return 2) a variance (which you are equating with risk, but I don't agree with this presumption) and 3) a correlation between the assets. These models are often based on the presumption that what has happened in the past will continue in the future, which may or may not hold true. Increasing expected returns does not always mean increasing variance, because variance does not equate to risk. I think it is fair to say that if the market is underpricing an asset, there is at least a perception amongst investors that there is an increased level of risk that must be compensated for.

Agreed. CAPM doesn't "work" in the real world. But how does one measure risk? Would you say volatility is at least correlated with risk?

@nutritious-raincoat-28876 @mysterious-tomato-10057 "how does one measure risk?" is the million dollar question. Investing is not an exact science and the future cannot be put accurately into a statistical model or algorithm. Future price changes will be heavily influenced by future events, and the future is unknowable. Being diversified broadly can make sense for many people to manage risk, even if all of the risks are not known by the investor. I think that volatility is one form of risk (market beta), but it is just one of many different things to look at before investing. In the chart attached, you will see that investing in high beta stocks for 30 years did not significantly add to returns, as one would expect according to the CAPM.

You continue to suggest that these models are simply designed to regurgitate historical occurrences when in reality they are based on Nobel prize winning research. Are you familiar with the Fama French 3-Factor model? Also, why would you question the definition of volatility with respect to mean variance optimization when the whole purpose is to reduce standard deviation?

@eager-smartphone-39564 when you said "you" earlier and now, you were referring to @bored-jewelry-48369? Thought you were talking to me the first time lol Just in case, yes, I'm familiar with FF3 along with Carhart's 4th factor

@eager-smartphone-39564 The Fama French 3-Factor model was a first attempt to explain why the CAPM was not accurate in the real world. Fama and French observed that value and small stocks outperformed what would normally be expected based on their volatility. Since the 3 factor model, several other factors have since been discovered. Fama & French were DISPROVING the CAPM, not supporting it. No one knows what the value and small factor premiums will be in the future, but factor investors believe they will be positive. Just because a portfolio would have had a reduced standard deviation in the past does not mean that will hold true in the future.

The point I am making is that estimating future returns is not simply a regurgitation of historical events. The concept of beta and other factors remain contemporary both respect to stock valuation models and performance evaluation. So the idea the the inputs to a Monte Carlo analysis are undefinable is flat out inaccurate. Regarding mean variance optimization, I still don’t understand how your comment about defining risk is relevant to the conversation at all. What part of it are you disputing?

@eager-smartphone-39564 Market Beta is not a reliable indicator of future returns: “Between January 1991 and June 2021, Low Volatility outperformed the S&P 500 with lower risk, while High Beta underperformed with higher risk… Low Volatility outperformed the benchmark by 0.90% annually, despite its lower volatility. Academics have cited this surprising combination of lower relative risk with higher relative return as perhaps “the greatest anomaly in finance.” Source: SP Global, See link below. As an aside, SP Global is in the business of doing factor research. Please cite evidence if you believe the above is incorrect. If you believe that factor premiums can be accurately inputted into into a Monte Carlo model, please inform us what the future value premium will be over the next 10 years. How did you come to that conclusion? If it’s an average of the past, that’s not reliable, because the value factor has been shown to underperform for decades at a time. If outperforming the market were as easy as overweighting value, every portfolio manager would do it. Factor investing requires a very long time horizon and patience, and the results are not guaranteed.https://www.spglobal.com/spdji/en/documents/research/research-low-volatility-and-high-beta-a-study-in-backtest-integrity.pdf

Beta alone may not be reliable, but it remains a primary factor per the CAPMs more modern adaptations. If beta has no significance, why is alpha used as the most contemporary performance evaluation metric?Why do equity research firms use it in their valuation models? Why does every single major publication on strategic asset allocation assume higher rates of return for higher beta asset classes? Showing that it cannot predict returns alone does not suggest that it doesn’t play a major role. I’ll take my chances with Nobel-prize winning research. As far as coming up with reasonable inputs, you simply need to define the timeframe for your analysis and ensure that it is similar to the period over which you observe certain premiums. The notion that the lack of scientifically defined metrics can somehow justify making random allocation or lifestyle choices is the kind of poor logic that helps drive annuity sales.

@eager-smartphone-39564 if you thought I was saying you should allocate randomly I think you misunderstood me. As an aside, there is nothing wrong with allocating a portion of a portfolio to a low cost annuity in retirement to manage longevity risk. Delaying social security is another way to have more guaranteed lifetime income which in that case is protected from inflation as well. I think Monte Carlo is a useful tool for coming up with a reasonable rate of withdrawal in retirement, for example. This is best done using sophisticated financial planning software to map out income and liabilities over a lifetime. However, the results of Monte Carlo are a mere projection and should be taken with a healthy dose of skepticism. Monte Carlo is misused when an investor thinks that a mathematical formula is going to tell them what areas of the market they should invest in. That requires a high level knowledge that most retail investors do not have. I’m not sure which publications you are referring to that use beta as a proxy for future returns, but “Morningstar calculates the fair value estimate of a company based on how much cash we think the company will generate in the future.” (See link) I think this is a more reasonable approach than presuming high beta means high returns. Just because alpha is used to market investment products does not mean that it is a reliable indicator of future performance. At no point did I contradict factor research. In previous post, I actually cited factor research to show that low volatility has earned its stripes a factor, alongside value, size, quality, and others. Two things can be true at once: factors can be real, and capturing factor premiums can be difficult. https://www.morningstar.com/articles/735361/the-morningstar-fair-value-estimate-for-stocks?offercode&utm_source=google&utm_medium=cpc&utm_campaign=MORNP_General_Bob_Search_Branded_Broad_Longtail_National%20Morningstar_Gen_Bob_Broad_Investments&utm_content=engine%3Agoogle%7Ccampaignid%3A18729375552%7Cadid%3A634310749564%7Cgclid%3ACjwKCAiAkfucBhBBEiwAFjbkrzlr29vRb1YyfdAlnE36T0BO0vyFEB_Ev66Emp3EW3Cqlmgw1peqVhoC8D8QAvD_BwE&utm_term=morningstar%20investing&gclid=CjwKCAiAkfucBhBBEiwAFjbkrzlr29vRb1YyfdAlnE36T0BO0vyFEB_Ev66Emp3EW3Cqlmgw1peqVhoC8D8QAvD_BwE

No one is talking about using Monte Varlo analysis to outperform the market. We are talking about using it to ascertain risk capacity. I was referring to annuity with guaranteed return elements - not income annuities. Morningstar is not an investing institution. It’s an online resource. Google “long-term capital market assumptions” and you will see what I am talking about. Furthermore, the idea that forecasting future cash flows as a means of valuation is somehow mutually exclusive with using beta suggests 1) that you are not familiar with the concept of discounted cash flow which incorporates both or 2) you do not believe that markets are mostly efficient as research suggests it is

• @eager-smartphone-39564 You have referred several times to market efficiency as "Nobel-prize winning research" as if to suggest that anyone who disagrees with the doctrine of market efficiency is somehow out of step with the academic community. Take a look at this article published to the Harvard Business Review around the time that Fama won 1/3 of the prize in 2013. I say 1/3 because he actually split the prize with Robert Shiller of Yale (and another economist, Lars Peter Hansen). Shiller called the Efficient Market Hypothesis “one of the most remarkable errors in the history of economic thought” and wrote a book called "Irrational Exuberance" because he believes that the market is prone to speculative bubbles. Those who reject market efficiency are also on solid ground with their own "Nobel-prize winning research." • Your presumption that all discounted cash flow models rely on market beta is incorrect. According to Morningstar, "In deciding the rate to discount future cash flows, we ignore stock-price volatility (which drives most estimates of beta) because we welcome volatility if it offers opportunities to buy a stock at a discount to fair value. Instead, we focus on the fundamental risks facing a company's business. Ideally, we'd like our discount rates to reflect the risk of permanent capital loss to the investor." • Morningstar is a market leader in investment information products/services with over 8500 employees and covering over 620,000 investments. I think their approach to investing is at least worth contemplating. • I don't think what I said about Monte Carlo is controversial. The main points I was making is that Monte Carlo is a useful tool, but the result is merely a forecast, its outputs are only as good as its inputs, and the optimum inputs are unknown, because the future is unknown. If you disagree with any of that, we will have to leave it there; we disagree. "On the downside, the simulation is limited in that it can't account for bear markets, recessions, or any other kind of financial crisis that might impact potential results." - Kushal Agarwal • To believe Monte Carlo accurately gauges risk capacity, one must believe that all risk is accounted for in volatility. If markets are efficient as you claimed, and all risk is accounted for in volatility, then high beta stocks should significantly outperform low beta stocks, which as I outlined in my previous post, the opposite has been the case, at least over the long run. • Before you reply, please understand I am not saying that the stock market is easy to beat with active management. What I am saying is volatility is not a proxy for portfolio risk. • Understanding the true value of stock requires a deep understanding of a company's future profits, competitive advantages, leverage, cyclicality, cost of capital, ESG risks, country risk, etc, and few retail investors can do that type of fundamental analysis on a level that is competitive with professional analysts that specialize in a given economic sector.

I am not sure how to interpret your “out of step” comment, but I will state that my Nobel-prize comment was in direct response to your comment of “_Making investment decisions based on historical returns is like driving by looking in the rear view mirror rather than the windshield”_ which suggests that studying historical returns is not only a waste of time, but a tremendous hazard – the former of which is in conflict with Nobel research and the latter of which is extremely misleading. Furthermore, I referred to this research in the context of CAPM and Fama French – not market efficiency as you have suggested. Once again I will ask, if beta is obsolete why is alpha used as the most contemporary performance evaluation metric? Why do equity research firms use it in their valuation models? Why does every single major publication on strategic asset allocation assume higher rates of return for higher beta asset classes? I do not know what to make of your commentary of its outputs are only as good as its inputs, and the optimum inputs are unknown, because the future is unknown. You seem to 1) draw a connection between an unknown future and the inability to derive reasonable inputs to a Monte Carlo simulation when the inputs themselves acknowledge that uncertainty through a defined standard deviation and 2) imply that the lack of perfect inputs somehow undermines the prudence of using Monte Carlo analysis when the alternative would seemingly be to arbitrarily determine an investor’s risk capacity. It suggests that being vaguely right is worse than being precisely wrong – an adage that I would not advise anyone to follow. Your quote of On the downside, the simulation is limited in that it can't account for bear markets, recessions, or any other kind of financial crisis that might impact potential results, cannot be talking about conventional Monte Carlo portfolio simulations which yield results that are fairly normally distributed around their means and thus have downsides that are just as if not more pronounced than their upsides. As far as market efficiency goes, I don’t think I’m following your point. No one believes in the strong form of the efficient market hypothesis. What many people have recognized is that it is efficient enough to render spending time or money trying to outperform it an economically inefficient proposition. Lastly, I am really struggling to grasp your point about defining risk for the purposes of Monte Carlo. Can you please share what measure of risk would be relevant to me as an investor to discern my risk capacity other than upside and downside?

Why is a standard deviation not a great way to measure risk?

@eager-smartphone-39564 @fierce-megabyte-69582 @mysterious-tomato-10057 • While I didn't fully explain the analogy, I used driving a car to make my point for a reason. When investing, it is important to look forward, but of course you need to have awareness of your present surroundings, including what is behind you (the past), just like driving. Backward-looking indicators like standard deviation play a role but are only one piece of the puzzle. When an investor relies on pricing data solely to make long-term investments, this can become dangerous. Stock ownership is ownership in a company (or group of companies in the case of an ETF). Wouldn't it make sense to know something about what you are investing in besides how the share prices have moved in the past? Investors who believe that volatility = risk may be mislead to say, "why bother?" • Fama did not win a Nobel prize for the CAPM, which has been around since the 1960s, long before he was on the scene; he won the prize for finding an alternative way of explaining the CAPM (through factors), because the original theory does not hold up in real life. Factors do not prove the CAPM, they provide an alternative explanation for the CAPM that is still plausible. Fama & French's research identified factor premiums in hindsight, which might not help someone investing now. While there is a basis in market history for the belief that the value factor will outperform growth, for example, there is no certainty that that is the case over any particular time horizon. Shiller completely rejects the CAPM and also won the Nobel. • I am not going to respond to every part of your comments regarding Monte Carlo because we have made several exchanges on that and I want to move on. I think it is a useful tool as long as the user acknowledges its limitations. There is one thing I can't help not to mention: you (accurately) brought up that the typical Monte Carlo analysis produces a normal distribution, which is yet another flaw of the model. Stock returns differ from a normal distribution due to skewness, and kurtosis (extreme outcomes are more likely then would be expected). Monte Carlo does not account for this typically. • Alpha is useful as a way for active managers to keep score. With a positive alpha, an active manager can say, "you were better off investing with me then in the index I track." For this reason, alpha isn't going anywhere anytime soon. • I don't doubt your claim that there are many "equity research firms" that rely solely on pricing data to calculate expected returns. A few reasons might be because there are plenty of retail investors who believe that type of analysis is valuable and are willing to pay for it, and it is much cheaper to produce then doing actual fundamental analysis. The existence of something (particularly in finance) doesn't mean that the thing is correct. Why are there so many high priced mutual funds? Because enough people are still willing to pay for them. • I think it will be productive for me to provide some more evidence and context for what I am saying about volatility not being equal to risk because that is the most important point of this conversation in my view. If you take anything away from this, I hope it is that. Please watch these relatively short videos; you seem to have a keen interest in investing so I this will be worth your time. Here goes: Warren Buffett explaining why volatility does not equal risk Buffett & Munger explaining why finance professors wanted the CAPM to be true, although it was incorrect Richard Coffin of the Plain Bagel giving a nice overview of this topic, titled "Volatility is Not Risk" and provides an alternative definition of risk Ben Felix on why investors often end up overpaying for high beta stocks. I found the part about Jensen's Inequality to be both fascinating and enlightening. Ben is an adherent of Fama's philosophy so you may like his work in general. I don't have an alternative formula to offer you that will quantify risk. I think doing security analysis correctly is extremely challenging, and not everything is quantifiable. Most investors are best served by being well diversified and managing cost and tax. Your risk capacity is unique to your personal circumstances. I hope some the above helps.

Thank you so much @bored-jewelry-48369!

The answer to your question is no. First – an important point of clarification. Let’s be careful not to conflate the concept of risk premiums - which is driven by regression analysis and rational economic arguments – with the practice of technical analysis – which seeks to extract alpha using charts and pricing patterns with no fundamental basis for its outputs. Your reference to “pricing data” sounds a lot like the latter. Given the high efficiency of the market as evidenced by the inability of active managers to stand the test of time, long-run returns for a given investment must be driven by its risk. If the market has already incorporated cash flow expectations into today’s price, there is absolutely no reason for me to spend time doing due diligence on a company or hiring someone else to do so. In fact, it actually makes more sense not to get involved given the associated trading, tax, and management fees. Once again, the 3-factor model does not prove or disprove the CAPM. It simply adds two variables to the original regression model to achieve the desired r squared. This would explain the prominence of alpha as a performance measure and beta as a key element in contemporary discounted cash flow analysis despite its inability to explain returns in isolation. People can reject the CAPM all they want, but until they come up with a more compelling case for what drives returns the investment community will continue to evaluate managers and value companies on the basis of systematic risk. With respect to your Monte Carlo comment, once again I must correct you. eMoney advisor is just one example of financial planning software that uses a left-skewed, lognormal distribution in its Monte Carlo engine. I never said that equity research companies rely solely on risk premiums. I merely stated that they incorporate them to derive a discount factor. I asked you to explain the significance of alternative definitions of risk to ascertain risk capacity, but I don’t believe you have. Finally, I watched that video from Buffet and all I can say is that this looks like a classic case of a successful practitioner throwing shade at academia. I put much more weight on debates than I do interviews.

@eager-smartphone-39564 maybe I am misunderstanding your position so let me ask you point blank: Stock A has a beta of 1.2 Stock B has a beta of 0.8 Do you expect stock A will outperform stock B? If you need more information to answer, what information would you need?

First I think it would appropriate for you to address each of my points above before you start asking further questions. Then I would be happy to answer yours.

@eager-smartphone-39564 I don’t think we are making forward progress in this discussion. I will pass on addressing your points. If your process is working for you I am glad and I wish you well with your investments and financial plan.

I’ll answer @bored-jewelry-48369 s question Over the very long term on average stock A should outperform This assumes efficient markets

Beta represents the relationship between an individual stock's return and the market return. It's the estimated coefficient, calculated by regressing historic stock returns on historic market returns. Assuming the relationship continues to hold, if the market return is r the expected value of the stock return should be beta * r

@orange-pager-65838 @nutritious-raincoat-28876 thanks for engaging on this. I don't require a theoretical explanation as to why high beta= high returns; I get the hypothesis. I am wondering how adherents to high beta = high returns approach explain why high beta has not delivered the long-term performance over the past 50 years that would be expected by the hypothesis (see link).To try and answer my own question, from a financial planner who believes in efficient markets explaining that low beta has exposure to the profitability and conservative investment risk factors. Why are highly profitable companies and those that invest conservatively MORE risky? That just seems like sound management to me. I like the concept of factors but not all factors are intuitive as risks. Momentum is also hard to grasp to me.

I tried to be very careful with my explanation. I had no intention of implying higher return to high beta stocks. Market return can be negative, in which case high beta stocks should be more negative. Beta can better be interpreted as a measure of a stock's systematic risk.

@nutritious-raincoat-28876 I reread your explanation and qualifiers to your answer. I’m still confused by how this metric is helpful to long-term investors, not to say you claimed it was; I’m not trying to debate you. The U.S. stock has had an incredible run over the past 50 years. If there was ever a time that taking on more systematic market risk should have paid off it should have been in the US over the past 50 years.

Where did you get the idea that "highly profitable companies and those that invest conservatively MORE risky"?

@bored-jewelry-48369 I don't believe the market beta helps long-term investors. I strongly believe people should pick a low-expense index fund and leave their money alone until they are approaching retirement.

Those concepts are not mutually exclusive

Meaning, don't get scared when the market drops.

@orange-pager-65838 I’m not saying I believe investing in more profitable companies is more risky. I’m saying that many factor proponents believe in highly efficient markets so if more profitable companies have higher expected returns, there must be some additional embedded risk, no? Otherwise it would just be an anomaly and undermine the hypothesis of efficient markets.

If a company was more profitable without any additional risk the market would immediately bid up the price. So you’re no longer expected to make higher returns

@orange-pager-65838 in theory you are correct. My question is about the well documented profitability factor. Profitable companies have outperformed what would be expected based on their volatility in an efficient market model in real life not in theory. See link for description of the 5 Fama French Factors.

I'm not sure I'm following. What do you mean by "profitable companies"? As apposed to what? Is your point that market Beta isn't the only factor?

@orange-pager-65838 sorry I should have said highly profitable companies have outperformed, earning profitability a place in factor research.

What’s the anomaly?

The outperformance highly profitable (quality) stocks relative to their systematic risk.

What’s their risk and how are you measuring quality?

@orange-pager-65838 I did not make up the quality factor so I don’t feel the need to defend the methodology. If you are interested in this topic here is an article https://alphaarchitect.com/2021/01/the-quality-factor-what-exactly-is-it-2/

I wasn’t questioning it I simply do not understand your question

I never said quality is the only factor; it’s part of a 5 factor model I sent a link to earlier. It’s just the factor I was asking for thoughts on. I don’t believe that historical returns are a reliable way to calculate future factor premiums; I can’t give you a number. However MSCI observed a 1.98% excess return over the 20+ years they studied the past data on the quality factor. https://www.msci.com/documents/1296102/8473352/Quality-brochure.pdf

Quality isn’t clearly defined So I’m not sure how scientific that study is

I love how far away we are from @steep-dog-55906s original question 😂

@orange-pager-65838 I don’t disagree with any of your points. Only thing I would add is just because something isn’t clearly defined doesn’t mean it’s not real.

The burden of proof is to show that it is real Up until that point I don’t care if it’s real or not

@orange-pager-65838 if you hold this position you would need to discard much of factor research. Do you hold that the momentum factor is irrelevant and should be ignored?There is a huge body of evidence demonstrating its effects across markets and time periods. That doesn’t mean it is easily defined or explained. The ability to explain a phenomenon has nothing to do with the truth of its existence. A bet against momentum is a bet against market history.

@mysterious-tomato-10057 Definitely qualifies as a broken telephone

If there's no real risk then the second word gets out people will bid up the price and you can no longer make money off of it. So if it has any value for the future then it either there's a real risk, hence a premium. Otherwise the phenomena itself isn't real and it's just a matter of looking at data long enough till patterns appear in the random flux.

Vanguard's aum is 7 trillion plus DFAs is 540 Billion

@orange-pager-65838 your explanation about cost is one of the explanations of the momentum factor. However, that doesn’t mean that knowledge of the factor is useless. DFA for example does consider recent momentum when deciding when to time a trade that they want to make. This approach is consistent with factor research.

I don’t know if it is or isn’t I’m just saying I don’t believe in free lunches So either there’s additional cost or additional risk

@orange-pager-65838 I agree that’s generally a good starting assumption. However if someone chooses to overweight quality and underweight junk I would not fault them just because they couldn’t articulate an explanation of the strategy that fits in with the efficient view of markets. There is good reason it’s called the Efficient Market HYPOTHESIS; it’s never been proven or disproven.

You first need to assume you know something the market does not While not impossible it’s improbable And it’s not perfectly efficient Congress can game it There’s a cost to trading and hedging I don’t blame them for choosing any strategy it’s a free market Everyone has their own goals their own risk tolerance Some people don’t want the risk doesn’t mean it’s not worth it It’s just not for them Like different flavors I’d ice cream

@orange-pager-65838 information asymmetry is not the only possible cause for market inefficiency. The vast majority of trades these days are done by professional managers. An anomaly like value or quality may be of little use to a fund manager because the premiums are not reliable over short periods and their bonus structures are typically year to year not decade to decade. A professional manager once told me that retail investors generally will not tolerate underperformance for multiple years so a fund manager trying to keep their job will typically not rely on strategies that could take a decade or more to play out. Incentives influence decisions and few are incentivized to optimize for a 30 year time horizon.

@bored-jewelry-48369 dfa value premium is a great example of this. It has been absent for awhile and recently showed up

@fierce-megabyte-69582 yes! Value was trailing for decades and made up a lot of lost ground this year. Also to my point, many active value fund managers had been buying growth stocks to to try to mask value’s underperformance and then got caught holding growth when the bottom feel out. It takes a lot of discipline to execute a value strategy well. Investors really need to gauge how much underperformance they can take and for how long before betting too big on the value factor.

@bored-jewelry-48369 couldn't agree more! Now DFA can't collect quick enough! It appears that through the cycles some want to be up all the time, which can't be.

@fierce-megabyte-69582 I also agree with what you are saying about investments and insurance being different tools that serve different purposes and a financial plan requires consistency. I know it’s in vogue to dunk on insurance products and some of that is deserved by the industry, but investing in stocks is not the answer for everyone; volatility is really hard for some people to deal with emotionally. If your financial plan is literally keeping you up at night, is that really the right plan for you?

Yep. It's similar to nusach and minhagim... If people are striving towards the same goal... About criticism some of it is deserved and some isn't. E.g. criticism of lubavitch communism is sometimes well deserved.

@bored-jewelry-48369 that's a good point you mention about emotions. Emotions and money are a horrible mix, but sometimes unavoidable.

@nutritious-raincoat-28876 absolutely When the market goes on sale people run. This is part of the 3% value add of vanguard famous study as I. Sure you know

A calendar year seems so arbitrary...

What is your suggested timeframe?

10-year rolling windows perhaps. Didn't give much thought to it.

What percentage of assets in the market are held for that long?

My advice is always a 10 year rolling window. Strongly believe in it. If you need it in 9 years, no equities for you.

Just to be clear, I was not referring to investment time horizons. I simple meant that using calendar-year returns as a metric seems arbitrary.

Since most income taxes go in yearly cycles I don’t believe it’s arbitrary at all

all the presents people buy in December… I think its big santa influencing the stock market for better year end results

Tax is based on realized returns. Who buys on 1/1 and sells on 12/31?

Companies

I'm not following. Suppose in the first half of 2022 markets do well and in the second half they drop back to what they were on 1/1. So 2022 returns are 0%. What information does that convey? 2020 would be a great example. Pre-covid and post-covid are different worlds. Why would I care to lump the beginning of 2020 with the rest to get one number for 2020? That's what I mean by arbitrary.

You’re arguing against it’s usefulness which has nothing to do with arbitrariness Arbitrary definition “based on random choice or personal whim, rather than any reason or system.” Nothing is arbitrary about choosing a year

Ah, I see what you mean, but I meant arbitrary with respect to returns windows. Sorry for the confusion, but glad we worked it out 😃

These simulations are useful to the extent that they let us capture our goals and how close we are. However, they do rely no a number of assumptions. Returns may be lower than they were in the past. If someone retires at the beginning of a serious bear market, that's not good. Another risk is change in income. If someone loses their job a few years before retirement, it can be hard to find a new job with the same income. Medical or other emergencies can be expensive and limit ones ability to work. Insurance helps with these, but we also need some caution about these model predictions.

Agree strongly. You should never blindly follow a model. You use it to inform your decisions.

The thread is mostly questioning the accuracy of predictions, but at the heart of this question is first knowing what your desired result is, i.e. figuring out your cost of living over time and future foreseeable expenses. How do young people in the frum world make that calculation? In the secular world, where you plan how many children you will have, you can plan based on that. In the frum world, or at least in my circles, we don't know the size of our family until very late in the game. Every child dramatically changes your cost of living and expenses you need to plan for. So to me, before I care about the accuracy of models, how does one decide what their desired result is?

Have you looked at the frum.finance flowchart already? Are you familiar with FI numbers? I did also answer that question towards the top of this thread. Essentially the question you are asking is why I started the non profit in the first place, to help families answer that specific question.

I saw the flowchart, but will look at it again and try to find the answer 🙂

so the flow chart doesn’t directly answer your question, but does so tangentially, I did answer the question here and in following messages but let me know if you have quesitons ! https://frumfinance.slack.com/archives/C04FE40CYU8/p1670854855732449?thread_ts=1670854624.607919&cid=C04FE40CYU8

Is it basically that you only plan for foreseeable expenses, that being based on the number of children you currently have?

Yes, i redo every families numbers after they have each kid

Most young couples expect to have more children over time. So, I think it makes sense to try to increase their income - through improving their skills, promotions, growing their business, investments, or some other vehicle. It is hard to predict and it may not fit nicely in the spreadsheet, but I think increasing ones income may be more important than managing expenses for most young families.

I completely agree! I do a lot of technical mentorship for that exact reason getting people into software engineering or other higher paying fields goes a lot farther than managing expenses. But a lot of families want that both spouses are teachers and it puts me in a tough spot

I agree. Many of my friends in Chicago teach. It's tough.