Does longterm investment in index funds still make sense in a reality of massive algotrading?
What the automation mostly does is make short-term trading that much more difficult. Day trading is a zero-sum game, so if they win more, everyone else wins less.  Long term trading (years to decades) is a positive-sum game; the market as a whole tends to move upward for fairly obvious reasons (at its basis it's still investing, which in turn is based on lending, and as long as folks make fairly rational decisions about how much return they demand for their investment and the companies are mostly producing profits there will be a share of the profit coming back to the investors as dividends or increased share value or both. Day-to-day churn in individual stocks gets averaged out by diversification and time, and by the assumption that if you've waited that long you can wait a bit longer if necessary for jitters to settle out. Time periods between those will partake of some mix of the two. There is a difference between trading which is short term focussed and investing which is longterm focussed. On the long term what drives stock prices is still the overall economy and the performance of the underlying business aspects. I do not think that any trading algorithms will change this. These are more concerned with short term profits regardless of the underlying business economics. Therefore I think that longterm investing using index funds is still a viable strategy for most private investors. Why wouldn't you expect a long-term profit?  Say you buy 100 shares of company X, selling for$1/share today.  You hold it for 20 years, after which it's worth $10/share (in inflation-adjusted dollars).  So you've made a profit, only making two trades (buy & sell).  What the algorithmic traders have done with short-term trades during those 20 years is irrelevant to you. Now expand the idea.  You want some diversification, so instead of one stock, you buy a bit of all the stocks on whatever index interests you, and you just hold them for the same 20 years.  How has what the short-term traders done in the intervening time affected you?
Foreign stocks tend to be more volatile -- higher risk trades off against higher return potential, always. The better reason for having some money in that area is that, as with bonds, it moves out-of-sync with the US markets and once you pick your preferred distribution, maintaining that balance semi-automatically takes advantage of that to improve your return-vs-risk position. I have a few percent of my total investments in an international stock index fund, and a few percent in an international REIT, both being fairly low-fee. (Low fees mean more of the money reaches you, and seems to be one of the better reasons for preferring one fund over another following the same segment of the market.) They're there because the model my investment advisor uses -- and validated with monte-carlo simulation of my specific mix -- shows that keeping them in the mix at this low level is likely to result in a better long-term outcome than if i left them out. No guarantees, but probabilities lean toward this specfic mix doing what i need. I don't pretend to be able to justify that via theory or to explain why these specific ratios work... but I understand enough about the process to trust that they are on (perhaps of many) reasonable solutions to get the best odds given my specific risk tolerance, timeline, and distaste for actively managing my money more than a few times a year. If that. "Don't put money in things that you don't understand. ETFs won't kill you, ignorance will. The leveraged ultra long/short ETFs hold swaps that are essentially bets on the daily performance of the market. There is no guarantee that they will perform as designed at all, and they frequently do not. IIRC, in most cases, you shouldn't even be holding these things overnight. There aren't any hidden fees, but derivative risk can wipe out portions of the portfolio, and since the main ""asset"" in an ultra long/short ETF are swaps, you're also subject to counterparty risk -- if the investment bank the fund made its bet with cannot meet it's obligation, you're  may lost alot of money. You need to read the prospectus carefully. The propectus re: strategy. The Fund seeks daily investment results, before fees and expenses, that correspond to twice the inverse (-2x) of the daily performance of the Index. The Fund does not seek to achieve its stated investment objective over a period of time greater than a single day. The prospectus re: risk. Because of daily rebalancing and the compounding of each day’s return over time, the return of the Fund for periods longer than a single day will be the result of each day’s returns compounded over the period, which will very likely differ from twice the inverse (-2x) of the return of the Index over the same period. A Fund will lose money if the Index performance is flat over time, and it is possible that the Fund will lose money over time even if the Index’s performance decreases, as a result of daily rebalancing, the Index’s volatility and the effects of compounding. See “Principal Risks” If you want to hedge your investments over a longer period of time, you should look at more traditional strategies, like options. If you don't have the money to make an option strategy work, you probably can't afford to speculate with leveraged ETFs either." "Index funds may invest either in index components directly or in other instruments (like ETFs, index options, futures, etc.) which are highly correlated with the index. The specific fund prospectus or description on any decent financial site should contain these details.  Index funds are not actively managed, but that does not mean they aren't managed at all - if index changes and the fund includes specific stock, they would adjust the fund content. Of course, the downside of it is that selling off large amounts of certain stock (on its low point, since it's being excluded presumably because of its decline) and buying large amount of different stock (on its raising point) may have certain costs, which would cause the fund lag behind the index. Usually the difference is not overly large, but it exists.  Investing in the index contents directly involves more transactions - which the fund distributes between members, so it doesn't usually buy individually for each member but manages the portfolio in big chunks, which saves costs. Of course, the downside is that it can lag behind the index if it's volatile. Also, in order to buy specific shares, you will have to shell out for a number of whole share prices - which for a big index may be a substantial sum and won't allow you much flexibility (like ""I want to withdraw half of my investment in S&P 500"") since you can't usually own 1/10 of a share. With index funds, the entry price is usually quite low and increments in which you can add or withdraw funds are low too." That is such a vague statement, I highly recommend disregarding it entirely, as it is impossible to know what they meant. Their goal is to convince you that index funds are the way to go, but depending on what they consider an 'active trader', they may be supporting their claim with irrelevant data Their definition of 'active trader' could mean any one or more of the following: 1) retail investor 2) day trader 3) mutual fund 4) professional investor 5) fund continuously changing its position 6) hedge fund. I will go through all of these. 1) Most retail traders lose money. There are many reasons for this. Some rely on technical strategies that are largely unproven. Some buy rumors on penny stocks in hopes of making a quick buck. Some follow scammers on twitter who sell newsletters full of bogus stock tips. Some cant get around the psychology of trading, and thus close out losing positions late and winning positions early (or never at all) [I myself use to do this!!]. I am certain 99% of retail traders cant beat the market, because most of them, to be frank, put less effort into deciding what to trade than in deciding what to have for lunch. Even though your pension funds presentation is correct with respect to retail traders, it is largely irrelevant as professionals managing your money should not fall into any of these traps. 2) I call day traders active traders, but its likely not what your pension fund was referring to. Day trading is an entirely different animal to long or medium term investing, and thus I also think the typical performance is irrelevant, as they are not going to manage your money like a day trader anyway. 3,4,5) So the important question becomes, do active funds lose 99% of the time compared to index funds. NO! No no no. According to the WSJ, actively managed funds outperformed passive funds in 2007, 2009, 2013, 2015. 2010 was basically a tie. So 5 out of 9 years. I dont have a calculator on me but I believe that is less than 99%!   Whats interesting is that this false belief that index funds are always better has become so pervasive that you can see active funds have huge outflows and passive have huge inflows. It is becoming a crowded trade. I will spare you the proverb about large crowds and small doors. Also, index funds are so heavily weighted towards a handful of stocks, that you end up becoming a stockpicker anyway. The S&P is almost indistinguishable from AAPL. Earlier this year, only 6 stocks were responsible for over 100% of gains in the NASDAQ index. Dont think FB has a good long term business model, or that Gilead and AMZN are a cheap buy? Well too bad if you bought QQQ, because those 3 stocks are your workhorses now. See here 6) That graphic is for mutual funds but your pension fund may have also been including hedge funds in their 99% figure. While many dont beat their own benchmark, its less than 99%. And there are reasons for it. Many have investors that are impatient. Fortress just had to close one of its funds, whose bets may actually pay off years from now, but too many people wanted their money out. Some hedge funds also have rules, eg long only, which can really limit your performance. While important to be aware of this, that placing your money with a hedge fund may not beat a benchmark, that does not automatically mean you should go with an index fund. So when are index funds useful? When you dont want to do any thinking. When you dont want to follow market news, at all. Then they are appropriate. Obviously, these numbers can never be absolute simply because not all the information is public. Any statistic will most likely be biased. I can tell you the following from my own experience that might get you closer in your answer: Hence, even though I cannot give you exact numbers, I fully agree that traders cannot beat the index long term. If you add the invested time and effort that is necessary to follow an active strategy, then the equation looks even worse.  Mind you, active trading and active asset allocation (AAA) are two very different things. AAA can have a significant impact on your portfolio performance. "'Buy and Hold' Is Still a Winner: An investor who used index funds and stayed the course could have earned satisfactory returns even during the first decade of the 21st century. by By Burton G. Malkiel in The Wall Street Journal on November 18, 2010: ""The other useful technique is ""rebalancing,"" keeping the portfolio asset allocation consistent with the investor's risk tolerance. For example, suppose an investor was most comfortable choosing an initial allocation of 60% equities, 40% bonds. As stock and bond prices change, these proportions will change as well. Rebalancing involves selling some of the asset class whose share is above the desired allocation and putting the money into the other asset class. From 1996 through 1999, annually rebalancing such a portfolio improved its return by 1 and 1/3 percentage points per year versus a strategy of making no changes."" Mr. Malkiel is a professor of economics at Princeton University. This op-ed was adapted from the upcoming 10th edition of his book ""A Random Walk Down Wall Street,"" out in December by W.W. Norton. http://online.wsj.com/article/SB10001424052748703848204575608623469465624.html" "What do I mean by infrastructure? Well, if you're doing algorithmic trading, you have to have something monitoring data and making decisions on its own, presumably. How do you set that up? There are many ways, and some are better than others.  First is a problem of scale. If you're a newbie starting out with some small set of equity tick data, perhaps just trades for instance, you can whip together something that can handle that pretty easily. Check out http://www.marketdatapeaks.com/ though. That's your messaging rates you have to deal with once you go full data feeds direct from all the exchanges. 6.65 million messages/events per second. That's a lot. And if you fall behind, you lose your lunch.  Building a robust system that allows you to easily backtest and deploy strategies is crucial as well. The speed at which you're able to conduct the backtest matters a lot. Doing that rapidly, and accurately is not easy. For a broad market-data handling algo design (and now, clearly, for very specific things you can design one that'll handle stuff better for that one corner case, but this is for general algo trading), optimally you have some sort of setup where you have a:  [feed handlers] -&gt; [tickerplant] -&gt; [mkt data subscribers/CEP] -&gt; [order management system] -&gt; [broker]   in this setup you have feed handlers that are taking the raw exchange feeds and pushing them to a consolidated tickerplant, where CEP subscribers can come through and sub to the data they want (perhaps I just want ES futures on one, and only want to arb CMCSA and CMCSK on another -- you dont want each CEP subscriber getting your full feed for all tickers all the time, its a waste). so more or less, each independent strategy is its own subscriber to the tickerplant, taking whatever data it wants and only that data (could be ""give me all the trades and quotes for all nasdaq stocks, but not book depth"" for instance).  your CEP does whatever maths it has to do to figure out trading decisions, and when it does, it sends it to your order management system which does your risk checks, etc (""do you have enough money to place this trade?"" ""do you already have a position in this?"" ""are you trading against yourself?"" ... million other things). your OMS knows how to talk to your broker/directly to the exchange depending on your setup. Assuming all your risk checks pass, off the order goes to the exchange, and it deals with the fill msgs, etc.  Now, as far as speed is concerned - try to do all of this at 6.5 million events/second. It's hard. Some strats/cep subscribers will run faster than others, some are slower, some need to keep a full book to work while some work on just trades. Your OMS depending on if youre using only market data sources may need to keep its own book to place orders on behalf of your subscribers if they lack information about various markets (think all the twitter trading bots these days for instance), etc.  If you look back at the above setup as well, you'll notice some interesting things. [tickerplant] -&gt; [cep subscriber] portion can stay the same for live trading or backtesting. This is huge. The only thing that changes here for backtesting is that if you're trying to backtest, you can take historical data (query it out of your hopefully column-store database) and push it into your tickerplant rather than having it come from a live feed through the feed handler. Your tickerplant and cep subscriber will never know the difference, so you can use the same exact code for backtesting as you can for live. On the other end, you obviously cant send historical orders to your live broker, so you need to code a simulated OMS that does the backtest simulation (another huge piece of software to code that is hard to do well). But, for backtesting, your setup is staying largely the same except those two end pieces. This means that testing/deving/deploying strats can be pretty rapid, and uses the same code base for live and historical, which helps you eliminate bugs and have to code everything twice.  Backtesting design: [historical mkt data db] -&gt; [tickerplant] -&gt; [mkt data subscribers/CEP] -&gt; [order management system simulator/backtester]  These are just a few of the many problems that you hit when trying to dev good infra. There are like a million more. Point was simply, it's complicated. And C++ is a good lang. I use a wide variety of languages depending on exactly whats going on and how fast the code needs to be. With a proper tickerplant design, youre using some ipc protocol so a subscriber can be coded in any language. Check out http://www.zeromq.org/ -- thats an excellent piece of software to use to make a tickerplant out of, think they even have a design for one in the docs if I recall. With that, your CEP subscribers can be in any language - perhaps pure C if you need the speed, perhaps .NET or Java if you dont (check out http://esper.codehaus.org/ for a Java implement of a CEP subscriber, nEsper for the C# port of that I believe). But I use C, C++, C#, python, R, x86 asm for a few very minor things, and a lang or two I can't mention here." "Being long the S&P Index ETF you can expect to make money. The index itself will never ""crash"" because the individual stocks in it are simply removed when they begin performing badly. This is not to say that the S&P Index won't lose 80% of its value in an instant (or over a few trading sessions if circuit breakers are considered), but even in the 2008 correction, the S&P still traded far above book value. With this in mind, you have to realize, that despite common sentiment, the indexes are hardly representative of ""the market"". They are just a derivative, and as you might be aware, derivatives can enable financial tricks far removed from reality. Regarding index funds, if a small group of people decide that 401k's are performing badly, then they will simply rebalance the components of the indexes with companies that are doing well. The headline will be ""S&P makes ANOTHER record high today"" So although panic selling can disrupt the order book, especially during periods of illiquidity, with the current structure ""the stock market"" being based off of three composite indexes, can never crash, because there will always exist a company that is not exposed to broad market fluctuations and will be performing better by fundamentals and share price. Similarly, you collect dividends from the index ETFs. You can also sell covered calls on your holdings. The CBOE has a chart through the 2008 crisis showing your theoretical profit and loss if you sold calls 2 standard deviations out of the money, at every monthly interval. If you are going to be holding an index ETF for a long time, then you shouldn't be concerned about its share price at all, since the returns would be pretty abysmal either way, but it should suffice for hedging inflation." "I think, the top three answers by Joe, Anthony and Bigh are giving you all the detail that you need on a technical sense. Although I would like to add a simple picture that underlines, that you can not really compare day trading to long-term trading and that the addictive and psychologic aspect that you mentioned can not be taken out of consideration. The long term investor is like someone buying a house for investment. You carefully look at all offers on the market. You choose by many factors, price, location, quality, environment, neighborhood and extras. After a long research, you pick your favorites and give them a closer look until you finally choose the object of desire, which will pay off in 10 years and will be a wise investment in your future. Now this sounds like a careful but smart person, who knows what he wants and has enough patience to have his earnings in the future. The short term investor is like someone running into the casino for a game of black-jack, roulette or poker. He is a person that thinks he has found the one and only formula, the philosopher's stone, the money-press and is seeking immense profits in just one night. And if it does not work, he is sure, that this was just bad coincidence and that his ""formula"" is correct and will work the next night. This person is a pure gambler and running the risk of becoming addicted. He is seeking quick and massive profits and does not give up, even though he knows, that the chances of becoming a millionaire in a casino are quite unrealistic and not better than playing in a lottery. So if you are a gamer, and the profit is less important than the ""fun"", then short term is the thing for you. If you are not necessarily seeking tons of millions, but just want to keep your risk of loss to a minimum, then long term is your way to go. So it is a question of personality, expectations and priorities. The answer why losses are bigger on high frequency signals is answered elsewhere. But I am convinced in reality it is a question of what you want and therefore very subjective. I have worked for both. I have worked for a portfolio company that has gone through periods of ups and downs, but on the long term has made a very tempting profit, which made me regret, that I did not ask for shares instead of money as payment. These people are very calm and intelligent people. They spend all their time investigating and searching for interesting objects for their portfolio and replace losers with winners. They are working for your money and investors just relax and wait. This has a very serious taste to it and I for my part would always prefer this form of investment. I have worked for an investment broker selling futures. I programmed the account management for their customers and in all those years I have only seen one customer that made the million. But tons of customers that had made huge losses. And this company was very emotional, harsh, unpersonal - employees changing day by day, top sellers coming in corvettes. All the people working there where gamblers, just like their customers. Well, it ended one day, when the police came and confiscated all computers from them, because customers have complained about their huge losses. I am glad, that I worked as a remote developer for them and got paid in money and not in options. So both worlds are so different from each other. The chances for bigger profits are higher on day trading, but so are the chances for bigger losses - so it is pure gambling. If you like gambling, split your investment: half in long term and other half in short term, that is fun and wise in one. But one thing is for sure: in over ten years, I have seen many customers loosing loads of money in options in the future markets or currencies. But I have never seen anyone making a loss in long term portfolio investment. There have been hard years, where the value dropped almost 30%, but that was caught up by the following years, so that the only risk was minimizing the profit." ChrisW's comment may appear flippant, but it illustrates (albeit too briefly) an important fact - there are aspects of investing that begin to look exactly like gambling. In fact, there are expressions which overlap - Game Theory, often used to describe investing behavior, Monte Carlo Simulation, a way of convincing ourselves we can produce a set of possible outcomes for future returns, etc.  You should first invest time. 100 hours reading is a good start. 1000 pounds, Euros, or dollars is a small sum to invest in individual stocks. A round lot is considered 100 shares, so you'd either need to find a stock trading less than 10 pounds, or buy fewer shares. There are a number of reasons a new investor should be steered toward index funds, in the States, ETFs (exchange traded funds) reflect the value of an entire index of stocks. If you feel compelled to get into the market this is the way to go, whether a market near you of a foreign fund, US, or other. if you bought gold in late '79, it would have taken 30 years to break even. Of all this time it was two brief periods the returns were great, but long term, not so much. Look at the ETF GLD if you wish to buy gold, and avoid most of the buy/sell spread issues.  Edit - I suggest looking at Compound Annual Growth Rate and decide whether long term gold actually makes sense for you as an investor. It's sold with the same enthusiasm as snake oil was in the 1800's, and the suggestion that it's a storehouse of value seems nonsensical to me. There are a few flaws in your reasoning: I know my portfolio will always keep going up, No, it won't.  You'll have periods of losses.  You are starting your investing in a bull market.  Do NOT be fooled into believing that your successes now will continue indefinitely. The more risky your portfolio, the bigger the losses.  The upside of a risky portfolio is that the gains generally outweigh the losses, but there will be periods of losses. I honestly don't believe that it's possible for me to end up losing in the long term, regardless of risk. I think you vastly underestimate the risk of your strategy and/or the consequences of that risk.   There's nothing wrong with investing in risky assets, since over time you'll get higher-than-average returns, but unless you diversify you are exposing yourself to catastrophic losses as well. "The stock market may not grow ""forever"". There will be growth in the stock market, though. The stock market is a positive-sum game, since it is driven in large part by the profits earned by the companies. This doesn't mean that any individual stock will go up forever, it doesn't mean that any given index will go up forever, and it doesn't mean there won't be periods when the market as a whole drops. But it is reasonable to expect that long-term investing in the market as a whole will continue to return profits that reflect the success of companies invested in. Historically, that return has averaged about 8%; future results may be different and exact results will depend on exactly when and how you invest. Re ""what about Japan, which has been flat over 30 years"": Market being flat doesn't mean individual companies may not be growing strongly. Picking stocks may become more important, and we might need to relearn to focus on dividends rather than being so monomaniacal about growth (dividends are not reflected in the indices, please note), but there will be money to be made. How much, and how much effort is required to get it, and whether the market offers the best available bets, deponent sayeth not. Past results are no guarantee of future returns, and your results may be better or worse than average. You should be diversified into bonds and such anyway, rather than only in the stock market." If the ship is sinking, switching cabins with your neighbor isn't necessarily a good survival strategy. Index funds have sucked, because frankly just about everything has sucked lately. I still think it is a viable long term strategy as long as you are doing some dollar cost averaging.  You can't think about long term investing as a steady climb up a hill, markets are erratic, but over long periods of time trend upwards. Now is your chance to get in near the ground floor.  I can completely empathize that it is painful right now, but I am a believer in market efficiency and that over the long haul smart money is just more expensive (in terms of fees) than set-it-and-forget it diversified investments or target funds. "From http://blog.ometer.com/2008/03/27/index-funds/ , Lots of sensible advisers will tell you to buy index funds, but   importantly, the advice is not simply ""buy index funds.""   There are at least two other critical details: 1) asset allocation   across multiple well-chosen indexes, maintained through regular   rebalancing, and 2) dollar cost averaging (or,   much-more-complex-but-probably-slightly-better, value averaging). The   advice is not to take your single lump sum and buy and hold a   cap-weighted index forever. The advice is an investment   discipline which involves action over time, and an initial   choice among indexes. An index-fund-based   strategy is not completely passive, it involves some active risk   control through rebalancing and averaging. If you'd held a balanced portfolio over the last ten years and rebalanced, and even better if you'd dollar cost averaged, you'd have done fine. Your reaction to the last 10 years incidentally is why I don't believe an almost-all-stocks allocation makes sense for most people even if they're pretty young. More detail in this answer: How would bonds fare if interest rates rose? I think some index fund advocacy and books do people a disservice by focusing too much on the extra cost of active management and why index funds are a good deal.  That point is true, but for most investors, asset allocation, rebalancing, and ""autopilotness"" of their setup are more important to outcome than the expense ratio."