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
16.68%20.64%53.50%
Return required for
Mean Scenario
6.28%7.12%10.48%

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
52.72%22.15%24.12%
Return required for
Mean Scenario
13.63%7.81%1.69%

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