Graham's Outperformance Benchmark

[Packer16]

How many of you use Graham's outperformance benchmark?  It basically states that security analysis is not worth an investor's time if they cannot outperform an index by 5%.  It can be found on page 15 of the Intelligent Investor.  The funny thing is that very few mutual funds can pass this test.

 

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[WarrenWatsa]

Over the very very long-run (20+ years), I'm thinking less than 5% of investors (retail, institutional, whatever) can beat the index by more than an average of 5% per annum.

[twacowfca]

Over the very very long-run (20+ years), I'm thinking less than 5% of investors (retail, institutional, whatever) can beat the index by more than an average of 5% per annum.

 

The market really is more efficient now than it was in Graham's time -- except when it isn't. 

 

Therefore, great outperformance is very difficult unless investors are patient to wait for those rare opportunities to invest in absolute bargains that can return value to shareholders in sideways or down markets, not relative bargains.

[tombgrt]

Depends on your time horizon imo. 2-3% outperformance is enough as long as your time horizon is 30-40 years. Obviously you shouldn't start with $5,000 if you want to make it worthwhile.  ;D

 

[writser]

An important point Graham doesn't mention: it depends on whether you enjoy investing and if you think your current experiences will be profitable / useful in a later stage of your life. In that case it might be worthwile even if you don't outperform the benchmark by 5%.

[frog03]

2-3% a year LT in a taxable account is not worth the effort in light of the taxes...

[tombgrt]

I always forget about that. Luckily I'm not taxed on it here.  :)

[oddballstocks]

2-3% a year LT in a taxable account is not worth the effort in light of the taxes...

 

This seems a bit strange, are you saying the funds that somehow outperform are taxed differently than how you would normally invest?

 

If you can only invest in index funds in an IRA and you're doing stock picking in a taxable account I can see the argument.  But if you're comparing an index fund in a taxable account vs stock picking in a taxable account I would think 2-3% is pretty significant over the long term.  Especially if you hold for long term capital gains and don't churn the account.

[oddballstocks]

I wanted to dig into this a bit more and show some actual numbers.

 

Starting with $10,000 for 20 years:

 

10% return: $67,274 --> We'll call this our baseline, the market return.

 

12% return: $96,462 --> Gross outperformance, but yes we forgot taxes, assume all capital gains are taxed at 35% yearly = $85,094

 

So even that small bit of outperformance is big, now take it to 30 years an investing lifetime

 

10% 174,494

12% (taxed) 248,230

 

That extra 2% even with high taxes every year adds up to 30% more over the investing lifetime, the difference grows bigger the longer the timeframe is.

 

 

[biaggio]

Oddball, I am thinking that he is talking about the aftertax return in a taxable account if there is significant turnover in the portfolio, which there can be when you re managing own money.

 

But at least here in Canada, have had to pay capital gains tax on mutual fund gains held outside my registered accounts as well.

 

I think the biggest issue is if you enjoy the process.