How big of a deal is this when compared to a traditional index fund? The maximally risky portfolio that wealth front recommended to me underperformed the US stock index over the last 20 years, for example.
Wealthfront holds indexes for both the US and foreign developed markets. These probably have about the same expected return going forward (we have no reason to believe that the US will have better economic growth than Europe or Japan), but holding both reduces risk. Even if you’re close to risk-neutral, you should reduce risk if you can do it for free.
Wealthfront holds an emerging market index fund. Emerging markets will likely outperform the US in the long run, even if they haven’t over the last 20 years. (Emerging markets are doing particularly badly right now and the US is doing particularly well so this may just be a short/​medium-term trend.)
Emerging markets are riskier because they are more likely to collapse, so a priori we should expect them to have higher returns. It’s commonly accepted that they do have higher returns, although a quick search couldn’t find much (this source claims they outperformed the US market by 2 percentage points from 1985-2005 but this isn’t a very long period). Wealthfront assumes that emerging markets will have a 5.4% return versus 4.3% for the US market.
Of course, if you wanted to invest on your own instead of using Wealthfront and buy something like 25% US /​ 25% developed markets /​ 50% emerging markets, that would have a higher expected return. It might not be a bad idea to do something like this if you’re willing to put in the time.
These probably have about the same expected return going forward (we have no reason to believe that the US will have better economic growth than Europe or Japan)
I was largely going off the conventional wisdom and the a priori belief that we can’t make good predictions about countries’ future economic growth. There’s more to it than that but I don’t have any good sources off hand.
To be clear, the efficient-market hypothesis says nothing about economic growth: as I understand it the demographics of the US relative to Japan in particular are a good reason to expect higher growth in the US over the long term. What it says is that facts such as that (which are widely known and understood) should already be accounted for in stock prices, and so you shouldn’t be able to get an ‘easy win’ by betting on such trends.
The efficient-market hypothesis should still predict that we will see equal risk-adjusted returns from any country. If the US and Japan have equal risk (which they probably don’t but let’s say they do), and most people expect the US to see more economic growth, then the US market should be more highly valued than Japan’s to the point where the expected market returns from each are the same. Otherwise you could get an easy win by buying US stocks instead of Japanese stocks.
How big of a deal is this when compared to a traditional index fund? The maximally risky portfolio that wealth front recommended to me underperformed the US stock index over the last 20 years, for example.
A couple of points:
Wealthfront holds indexes for both the US and foreign developed markets. These probably have about the same expected return going forward (we have no reason to believe that the US will have better economic growth than Europe or Japan), but holding both reduces risk. Even if you’re close to risk-neutral, you should reduce risk if you can do it for free.
Wealthfront holds an emerging market index fund. Emerging markets will likely outperform the US in the long run, even if they haven’t over the last 20 years. (Emerging markets are doing particularly badly right now and the US is doing particularly well so this may just be a short/​medium-term trend.)
Emerging markets are riskier because they are more likely to collapse, so a priori we should expect them to have higher returns. It’s commonly accepted that they do have higher returns, although a quick search couldn’t find much (this source claims they outperformed the US market by 2 percentage points from 1985-2005 but this isn’t a very long period). Wealthfront assumes that emerging markets will have a 5.4% return versus 4.3% for the US market.
Of course, if you wanted to invest on your own instead of using Wealthfront and buy something like 25% US /​ 25% developed markets /​ 50% emerging markets, that would have a higher expected return. It might not be a bad idea to do something like this if you’re willing to put in the time.
Any pointers to sources on this?
I was largely going off the conventional wisdom and the a priori belief that we can’t make good predictions about countries’ future economic growth. There’s more to it than that but I don’t have any good sources off hand.
You could appeal to the efficient market hypothesis to justify yourself here i reckon. https://​​en.wikipedia.org/​​wiki/​​Efficient-market_hypothesis
To be clear, the efficient-market hypothesis says nothing about economic growth: as I understand it the demographics of the US relative to Japan in particular are a good reason to expect higher growth in the US over the long term. What it says is that facts such as that (which are widely known and understood) should already be accounted for in stock prices, and so you shouldn’t be able to get an ‘easy win’ by betting on such trends.
The efficient-market hypothesis should still predict that we will see equal risk-adjusted returns from any country. If the US and Japan have equal risk (which they probably don’t but let’s say they do), and most people expect the US to see more economic growth, then the US market should be more highly valued than Japan’s to the point where the expected market returns from each are the same. Otherwise you could get an easy win by buying US stocks instead of Japanese stocks.