9 Jan 2021 | By DF
Previously, I opined on the tension between two aspects of indefinite optimism:
I concluded by stating:
It would also be thoroughly irresponsible for me to urge my readers to make long-distance moves, start a company, or generally take huge, unhedged bets. Instead, I offer something less radical: add a twist of definiteness to your life. For example, most retail investors would do well to adhere to index investing and not delude themselves into thinking that they are the next Warren Buffett. However, consider holding holding small but significant positions, whether it be TSLA, BTC, or your crazy uncle’s favorite penny stock. Doing so not only discharges one’s duty to definiteness, it also makes for good conversation fodder at parties. There is much more to life than wealth maximization, after all. I leave it to the reader’s good sense to generalize this to other aspects of life.
While stated as a financial analogy, this prescription—deferring to indefinite optimism but adding a twist of definiteness—is probably good general advice too. Nonetheless, it appears the finance has found a more direct way to operationalize this prescription.
Loosely speaking I would say there are three kinds of investing:In passive investing, you buy all the stocks in the index.In active investing, you buy the stocks you want.In direct indexing, you buy (1) all the stocks in the index, (2) except for the ones you don’t want, (3) plus any other ones that you do want.As a matter of formal logic it is easy to prove that direct indexing is exactly equivalent to active investing: If you start with the index, delete the stocks you don’t want and add the stocks you do want, you end up with a list of stocks that you want, which is where you end up in active investing too. But of course “want” is a vague word. In traditional active investing, you buy stocks where you have an investment thesis, the stocks that you understand and like and can make a case for. The implicit default is not buying; you have to overcome some burden of proof to decide to buy a stock. In direct indexing, you just buy all the stocks (in the index) unless you have a thesis that you shouldn’t. The default is buying everything; there is a burden of proof to delete a stock. […] This strikes me as completely correct! There are thousands of stocks and you only have the time and attention to make, like, five decisions, tops. Also even those probably won’t be particularly good decisions. Choosing five stocks not to buy and then buying the rest will probably get you close to the return of the average investor, which is fine; choosing five stocks to buy and then skipping the rest is pretty much a gamble.In a way this demonstrates the intellectual triumph of the passive indexing revolution even more than actual low-cost index funds do. The message of direct indexing is that, for most investors, active investing should start from the premise of indexing—that you should own the whole market, weighted by market cap—and delete from there, rather than starting from a blank page and adding stocks. Or rather, the message is that the “blank page,” for investors, is owning the market portfolio, that the actual decisions that investors make are choices to deviate from the market portfolio. The default is the index.
This is true for people looking to outperform in life as well. Default to indefinite optimism mostly, make contrarian bets sometimes.