Wednesday, 29 June 2016

Why Chase Alpha

Why do people try to beat the market?

Barry Ritholtz interviews Burton Malkiel in this podcast. I'm a big fan of both, but felt uneasy when they seemed to chuckle at investors who seek consistent market-beating returns despite decades of evidence that such a feat is incredibly rare.

I don't subscribe to the idea that the markets are wise while investors are dummies. Knowledge of the returns you can expect is only a Google away. People wouldn't swing for the fences if they could live with hitting a few grounders.

Could average market returns then provide for the man on the street? More specifically, would it enable him a decent retirement?

Assumptions (US):
The aim is to hit retirement with net wealth - excluding the family home - large enough to replace 75% of income with drawdowns at the safe withdrawal rate.

SCF 201335-44 y.o.45-5455-64
Median Income (USD '000)57.765.459
Mean Income60.960.955.1
Median Wealth46.7105.3165.9
Mean Wealth347.2530.1798.4
Years to Retirement25155
Return required for
Median scenario
Return required for
Mean Scenario

Let's throw Australia into the mix. Truth be told, I'm more familiar with the Australian data and retirement regime. I can adjust for things like home value and household size across different age ranges.

Assumptions (AU):
  • Comfortable Retirement: $640K (Couple)
  • Savings Rate: 8.1% of net disposable income
  • Superannuation contributions: 9.5%
Households35-44 y.o.45-5455-64
Median Income (AUD)199221071557
Mean Income250326502151
Median Wealth (AUD '000)343.9603.1786.8
Mean Wealth573.3944.91239.7
Years to Retirement25155
Return required for
Median scenario
Return required for
Mean Scenario

While the median household would have to achieve eye-popping returns of 24%-53%, doubling their net wealth every 3 years to 18 months, things look pretty good for the mean (average) household. The median S&P500 nominal return of 13% will do them just fine.

But average is the minority. Assuming uniform distribution across age ranges, you have to be in the top 25% of income and net wealth to be 'average'. Everyone else chases alpha perhaps not out of delusion or avarice, but because they have to.

Note: our beloved companion, friend, family member, and dog of 9 years died recently. So if you get a sense of hobbled limping on despite hopelessness from this post, well, that's where I am right now.

No comments:

Post a Comment