[Editor's Note: This is a guest post from Dr. Cory S. Fawcett, who has guest posted here before. He blogs at CorySFawcett.com and is the author of The Doctor's Guide to Starting Your Practice Right and The Doctor's Guide to Eliminating Debt. We have no financial relationship.]
Steady plodding brings prosperity; hasty speculation brings poverty–Proverbs 21:5
We often hear the following advice; make investing simple, invest only in what you know, and you don’t need to get fancy. Buying only index funds is one example of this philosophy. But how often do we get to experience proof of the concept?
Whooping the Market
When I was younger, I thought I was smart enough to beat the market. I didn’t want to invest in those boring index funds, I wanted to make a killing instead. Why should I settle for an 8% return if I could get 30%? I figured since I was a doctor, I was probably smarter than average. If I was smarter than average, I should be able to study what others are saying about the financial market and beat it by picking winners. So I subscribed to several investment magazines and newsletters and did my research. I bought the things that seemed to be ripe for the picking and sold when I thought they had hit the top. I was investing several hours a week on my research and stock trading to speed up the arrival of my financial independence.
Dr. Cory S. Fawcett
One day I decided to calculate just how good I was doing, to prove the time I invested was well worth it. My wife and I each had an IRA account with thousands of options to invest in and that is where I was doing all the trading. This also meant my stellar profits were not being taxed with each trade. I also had a 403(b) account that only offered about eight mutual fund choices to invest in. Because the choices were so limited in that account, I just picked two mutual funds and I never paid any attention to it. That account made for a good control group to contrast with my stellar stock picking results.
Much to my dismay, after some intense number crunching, those two accounts had about the same return. The 403(b) account just sat there minding its own business, very simple, very boring and making money without much fanfare or any time allotted to its care. The IRA account made about the same return on investment but required an input of several hours a week of my time, a commodity I didn’t have much of as a busy surgeon.
We have heard time and again that only about 20% of professional investors, and I was not one of them, can actually beat the market in any given year. The next year it will be a different 20% of them who can beat the market. If the professionals can’t beat the market consistently, what makes me think I can?
Well, I can’t. After I finally realized this, I stopped being an active investor/trader and became a more passive one. Yes, I became a more boring investor. Now, I invest my money in mutual funds with good track records and let it ride, seldom making any trades in the account. I no longer invest those many hours a week reading the latest newsletters, watching the market and trying to beat it by timing its unpredictable ups and downs. It’s time in the market that counts, not timing the market. I don’t know who first said this but it holds true and it has been confirmed many times by many people and yet I had to prove it to myself. Oh if I could only learn my lessons from others and not have to make the mistakes myself.
The Student Becomes the Master
Father doesn't always know best
A few years later, I was trying to teach my son, Brian, who was about 7 years old at the time, how investing in the stock market really works. We each got $10,000 of play money to invest in the stock market. The rules were to invest in anything we could buy on the exchange or any mutual fund and divide the money into 8 different investments to learn about diversification. He picked his stocks based on what he was familiar with, like Disney, Honda, Ethan Allen, Gold, Nike and others that he could recognize when he heard the name. I, on the other hand, was more sophisticated and bought stocks that I thought were especially poised for a big profit. He was steady plodding with investments he knew. I was speculating with what I thought would be the best money makers in the next few years. This sounds remarkably like the story of the tortoise and the hare when I look back on it, and we all know how that ended.
His portfolio blew the socks off of mine. We both made profit, but his profit after a couple of years was about 10 times mine. I was teaching the concepts to a 7 year old and he used the principles I taught to blow me out of the water as I strayed from the formula and tried to get fancy. He bought those boring bread and butter stocks. I bought the exciting wishful thinking stocks. It doesn’t help to know better, if you don’t use that knowledge to do better. So I’ve now learned that lesson twice. Seems I can’t learn from myself any better than I learn from others.
Plod Steadily
Don’t get fancy. Make sound, conservative investments that you understand. Make them every year. Make as many of them as your budget can handle. Keep as much as possible in tax advantaged investments and you will eventually become wealthy. It is not a hard formula to follow if we can avoid getting sidetracked. Yet many of us will still try and beat the system to get there faster. After all, we are doctors and we are smarter than average. But are we smarter than a second grader?
This is not a new or novel concept, it’s been around for a long time. About 3000 years ago, King Solomon stated the same idea in Proverbs 21 when he said, “Steady plodding brings prosperity, hasty speculation brings poverty.” This simple truth holds the same power today as it did 3000 years ago. Steady plodding brings prosperity. You don’t need to get risky or fancy, you don’t need to try and make investing seem more exciting. Sometimes the solution is so simple, it’s hard to believe it will work. Just work the plan, and the plan will work.
What do you think? Are you a “steady plodder?” Why or why not? Were you ever a stock-picker? How did you do? Comment below!
Pure gold: “It doesn’t help to know better, if you don’t use that knowledge to do better.”
Thanks for sharing your great article.
Your welcome Toby. Thanks for taking the time to make a comment.
I totally agree. Find a portfolio that fulfills your goals, and stay the course.
Great article, Cory. Warren Buffett put it well in his recent annual letter to shareholders. His standard advice to invest in the S&P 500 is usually taken by his friends of meager means. It is almost never taken by his wealthy friends, who believe they are the best and deserve the best of everything in life, including financial advice. Therefore, they are sold by a high-fee manager’s sales pitch and get inferior returns to the regular guy who follows Buffett’s advice to invest in the S&P 500.
Thanks Wall Street Physician. I like that reference you used. Why do we always think we have a way to beat the system.
I’m a “steady plodder.” Funny that your 7-year old won, and that he recognized the name “Ethan Allen.” I’m more familiar with the Stanford running back than the name brand furniture.
Back in 9th grade social studies, we learned about the stock market by each choosing individual stocks and following them in the newspaper daily. All that taught us was the excitement of “making money” some days. I don’t remember learning anything about mutual funds, but I do recall Briggs & Stratton performing well for me. Not a great lesson to learn at age 15.
I enjoyed your Guide to Eliminating Debt, Dr. Fawcett. Look for a review soon.
Cheers!
-PoF
Thanks PoF. I’m looking forward to hearing what you have to say in your review on “The Doctors Guide to Eliminating Debt.”
I also did that in the 7th or 8th grade. I remember the guy who won, Kevin Camp. He picked a penny stock that he bought for 1.8 cents a share. A very small increase, a few cents, made a huge profit for him. My Disney stock didn’t do as well (I think I paid $38 a share for it.)
My group totally rocked the stock market game senior year in 1999-2000 during the dot com bubble. The rules were that you bought and sold stocks at the closing price yesterday. They expected that we would be looking at the prices in the news paper, but instead we watched CNBC at noon and watched the ticker. Any stock that had gone up double digits since the close the day before, we bought a ton of it and hoped it didn’t go down in the few hours before the closing bell. We started with $50,000 and ended 10 weeks later with almost 3 million! Mr. Francini had no idea how we were doing it, he thought we were just financial geniuses! I learned nothing but had a ton of fun, especially when teachers and librarians tried hitting us up for stock tips.
Great article. Very true. One difficult lesson I’m learning in my 50s (a little late…) is the hit I have been taking with regards to expenses in actively managed mutual funds. Wish I knew earlier. Currently correcting, but I have been victimized by high expenses for over 2 decades 🙁
Better to learn the lesson now, Ron, than in another 10 years.
When it comes to investing, I’m definitely into making things simpler. Traders try to make a living from buying and selling in the short-term, but an investor focuses on long-term gains and stability instead of short-term wins. I’m all for investing in index funds to build reliable net worth.
Mrs. Picky Pincher your comment reminded me of the old joke: How do you make a million dollars in the stock market? First you start with 2 million dollars……
7 is a good age to start. I tried to teach my 2 year old yesterday about spending money and he just laughed at me…
Slow and steady works not just for boring investments, but in debt pay down, savings, and any of the other fun financial fields. Thanks for sharing the story! I am bummed he did not have Nintendo on his list. In my day that would have been the number one pick for a 7 year old boy!
When my kids were young and we went to Disneyland, we told then they could have $20 to buy souvenirs and so they didn’t need to ask us for any. One of them asked “If we don’t buy any, can we keep the money?” He quickly discovered how to get free souvenirs and keep the money. Now the fancy plastic cup his drink came in was a good enough souvenir and he no longer wanted the 4 foot tall stuffed Winnie the pooh. They both went on to be great money savers.
Last night, my 5 year old told me he wanted bunk beds….because his best friend at preschool has bunk beds. We have just started teaching him about money recently. He has a wallet and gets paid tiny amounts for chores/work that he does along with birthday money from the grandparents. So far it is good for him to learn how much toys cost and save for what toys he wants to buy.
Last night, when he told me he wanted bunk beds (he already has a nice bed), I told him he could buy bunk beds with his money. He asked how much they cost. I told him about 500 dollars (off the top of my head I have no idea what a bunk bed actually cost….but I knew what he had in his wallet). Then I asked him how much he had saved up in his wallet. He told me 3 dollars. Dejected, he said, wow bunk beds are expensive. I was so happy but had to hold it in since he had tears coming. Then I had to give him the life isn’t fair speech and tell him how lucky he is to have a bed and a house. So he was sad, but I was ecstatic! This morning he had forgotten about it, although I’m sure he will ask his mother tonight.
The sooner you learn that you can’t have everything, the better.
I think you should give him a bunk bed and a younger sibling sleeping above him.
Ha. That’d be a different lesson, careful what you wish for.
A younger sibling might teach the kid, but definitely decreases the parents’ net worth.
Actually, they may get this in the future….But we are keeping the 2 year old in the crib as long as physically possible!
I have mentioned before that I am about 50% ETFs and 50% my own picks. When I checked 6mos ago or so, my picks were winning. So then I thought I was smart and picked a real doozy. Now, they are about even and you’re right, the time sunk is a cost, too. So back to just ETFs for a while. I’m sure that little itch will come back though.
ChrisCD I’m glad to have the time back I used to spend on learning what was hot in the stock market. I can think of a lot more fun things to do now.
I invested all of the money I made back in college in Apple right when the iPod came out. Only about 4k at the time but I now have an above average Roth IRA and taxable account from gains in Apple. I thought I was a genius in investing until 2015 when it underperformed by a wide margin. It’s now picking back up. Too much stress, not enough diversification. All new money since that has gone into index funds but Apple stock in my taxable account at least will likely stay due to tax consequences of selling with a lot of capital gains, but should become less and less of my portfolio as I accumulate more funds.
Good example of decisions based on recent results. If we hit a winner, we feel like we have a greater chance of doing it again. So we try again. But they won’t all be winners.
Yup, slow and steady wins the race.
Some of us still like to trade and think we can beat the market. If you can’t give that up cold-turkey at least limited that “play money” to 10% or less (and less is better). Compare the results at the end of the year and the plain boring index funds will almost always prevail.
Good advice for those needing to wean off an unproductive habit. Thanks WealthDoc for your good comment.
How can I teach my wife the ropes? She is clueless with NO INTEREST
Kenny, if she reads your comment, you will not be having any MUTUAL FUND tonight.
Kenny,
If you haven’t already, you might want to read this thread in the forums. It might be a lost cause
“Best Personal Finance Book for Your SO?”
https://www.whitecoatinvestor.com/forums/topic/best-personal-finance-book-for-your-so/
Kenny, I started the thread NOTADOC is referring to. I ended up sitting down with my wife and telling her that it was very important to me that she read at least one financial book and told her the reasons why I felt so strongly (mainly, inner peace knowing that if I were to die suddenly, she’d have to base financial knowledge to be ok). Like me, I’m guessing you don’t say to your wife “this is really important to me” often, so when I said it my wife was more than willing to humor me.
And in case you care, I’m having my wife read “The One-Page Financial Plan” by Carl Richards.
Gas Doc & Kenny, it is a great idea to have your spouse involved in the finances, even if they don’t like to. They may be forced to one day. When I do one-on-one coaching on personal finances, I insist on both spouses being involved. If one spouse won’t participate, I won’t accept the client. It’s so important for spouses to be on the same page financially as about 70 % of divorces state finances as a contributing cause. Kenny, I hope you find a way to get her to have some interest. Even if it is just to go over together what you spent each month. Best of luck.
While I appreciate the sentiment you are trying to convey with the example of your 7 year-old son (don’t day-trade), I fear that some may take it the wrong way. Your son was better than you in that he was willing to make his picks and stick with them, though I’d argue that you both took unnecessary risk without any increased expected return by picking individual stocks rather than broadly diversifying with index funds.
“Picking stocks that you know” has the potential to be a death trap, especially if you are picking stocks related to your field of work (there’s the potential to have your stock picks go down as well as lose your job if that particular sector is hit hard). To the author, I’m curious if you advocate picking individual stocks if you are willing to hold them for the long term? Because if you are, I’d argue that this practice only increases your portfolio’s risk without increasing it’s expected return.
Gas Doc, no I don’t advocate picking individual stocks.
Dr. Fawcett,
I would love to hear more specifics on your process for getting your son involved in investing and being more financially savvy. I’m always looking for ideas to get my kids excited about managing money.
The best way is to be a good example and talk openly about what you are doing and why. They will often mirror your style. Maybe a good topic for one of my future books.
I am a plodder, but I’m afraid that my plodding comes not from a deep place of wisdom but from a deeper place of laziness. I could not be bothered to put in the effort it would take to pick individual stock. It sounds too much like hard work. I have a full time job, a toddler, a dog, a blog. If I have spare time I’m going to use it to curl up with a book and slowly nod off to sleep. I’m not going to use it to try and time the market.
Whatever your reason, just keep plodding.
https://www.youtube.com/watch?v=0Hkn-LSh7es
Even when I was a stock picker I tended to pick a diverse set of dividend paying stocks. I.e. I never was really shooting the moon. These days I just do index funds and the only active part of it is I sometimes tilt towards a specific asset class if I feel it is undervalued. Even within the tilt I try not to adjust it often and then only with new money. I guess I meet your definition of the plodding approach.
Good job. Just keep plodding and you will get there.
It’s true that the least effort in investing is investing in broad based, low fee index funds. You won’t go wrong this way. There’s another way that costs you even less. Create a broad based portfolio of individual stocks, never sell them and reinvest dividends. This is more efficient than a mutual fund or EFT. Selection is not that difficult. You can access Morningstar, Investors business daily, other well accepted ratings methods through your library card.
Choose the number; 20, 25, even 50 individual companies spread across sectors. Once you have the portfolio filled out, stop looking for new investments. Build positions, reinvest dividends, wash, rinse, repeat. Mutual funds with a 1% management fee strip 5-15% of your potential earnings year by year. Some are sold with a front end or back end load. Even the low fee broad based index fund takes money from you every year, whether you gain or lose value in the portfolio. Once you have purchased an individual stock, particularly in your qualified plan or IRA, there are no additional costs until you withdraw for retirement income. Such a portfolio can be managed in a couple of hours 4 times per year. You’re paying yourself when you avoid management fees, loads. Dividend reinvestment is almost always commission-free. Yes, there’s more work than the Vanguard index fund, but one can reduce costs even more, create a rising stream of dividends, create enough diversity that a single company disaster doesn’t prevent the portfolio from performing well.
You can still dispense with the “beat the market” mentality. If you are purchasing an ownership stake in a business, don’t pay more than it’s worth, then accept what it pays you to own it and stop comparing it to “the market”. Think about real money in dollars; dividends and capital appreciation. if you are earning a respectable return, you can forget about indexes.
If the alternative were 1%+ mutual fund ERs with loads, that’s not a bad strategy. Consider an investor in 1970 for example. But when the alternative is 0.05% mutual fund ERs and no uncompensated risk like a 20-50 stock portfolio carries, it’s hard to go for your strategy.
show me a ultra low fee broad market mutual fund with a 3-4% cash dividend return so I can live on cash flow rather than selling shares, and I’ll consider fund investing. There are very few, with short histories. I’m not putting passive investing down, just pointing out a low cost alternative. In a 50 equity portfolio, if one issue melts down completely, you have a 2% loss, countered by the composite performance of the remainder of the portfolio. I have been doing this for a decade, have had 3-4 meltdowns, but overall portfolio performs very well, with rising cash flow from dividends every year, in addition to my contributions.
Part of the rationale for writing this is to address the the individual who takes active interest in investing, but doesn’t want to fall prey to the “market timer”, momentum or swing trader, paid-investment services sharks, etc. This is more the widows and orphans approach. In today’s age of discount brokerages it is ultra-low-cost.
0.05% on $1,000,000 is $500 in yearly fees. My yearly expenses are about 1/3 of that rate.
There is still significant uncompensated risk in a 50 stock portfolio, not to mention the hassle of choosing and purchasing (and rebalancing?) 50 stocks. If funded adequately, it will probably work just fine as you have noticed for the last decade. Is it optimal? I would argue it is not.
The dividend yield argument is a little odd. If you showed me an ultra low fee broad market mutual fund with a 3-4% cash dividend I’d be interested too. The reason it doesn’t exist is that the vast majority of stocks have a yield under 3%. You can’t have broad diversification right now AND a yield over 3%.
NAK-a concentrated stock portfolio has a chance to beat the markets but that is not a gamble I am willing to take. If you want individual stocks just buy Berkshire hathaway
Many investors never realize the real returns in mutual funds because they go in and out.
From my experience and others, THE LESS YOU TRADE THE BETTER YOU WILL DO
as bogle says stay the course
stick to your AA model and REBALANCE YEARLY
You’ll all do well with the Boglehead advice. You WILL need to liquidate assets to retire. It is possible to be well diversified and maintain a composite yield over 3%. I know many individuals who are doing it, as am I, even in this inflated valuation environment. You can’t do it in a minute; there are times when it’s best to sit on your hands. Over time however, the opportunities present themselves and you can set your system to catch them when they do.
I have the same goals you do; broad diversification, ultra-low fees, sleep well at night. What I don’t have is the baggage of another few hundred equities that I wouldn’t choose at all if I examined them closely. Your mutual fund managers, even those who manage an index fund, have different objectives and obligations than you do. They haven’t signed fiduciary agreements. They are driven to reflect the index, not to prune out the laggards. They are so “over-diversified” that you can’t even calculate the additional safety margin after their 50 largest holdings.
Then, there is the potential for “pseudo-diversification” The only way to clearly avoid that is to either buy one single index fund, or buy sector funds that have no overlap. If you dig deep into the holdings of many funds that purport to follow a particular investment objective, you find substantial amounts of overlap. You aren’t as diversified as you thought.
I will say, you can’t be an ostrich and manage a diversified stock portfolio. You have to have more interest and pay some attention, so that precludes anyone who wants to simply dollar cost average into a few funds and trust someone else to do the thinking. I can say honestly that the core of my personal mutual fund does not need close monitoring. It actually mimics the biggest holdings of most large diversified funds. What it doesn’t have is fees, even small ones. Once the position is established (now about $5), no more fees, ever. It’s not a trader’s platform.
If you pay attention to the rate of turnover in many large funds, it’s phenomenal. There’s a reason for that; redemptions. that’s an activity that everyone pays for. Or, a company gets listed or delisted from an index; every index fund is now obligated to adjust to that event.
I’m not typing to attempt to convince the converted that my way is better than your way. I’m offering the opinion that there is an alternative that meets similar objectives for the investor who has issues with how funds are managed. I am informed in my approach by my view of the medical field. I can be a “guidelines fanatic” and apply the same advice to every patient with a given set of symptoms, or I can trust my experience and training, that of my esteemed colleagues whose character I have come to know over the years and trust them to treat my patient in an exemplary fashion. I happen to feel that the latter approach makes for a better therapeutic relationship, as it is engaged, personal and exploits mutual trust and obligation between individuals, rather than pointing to some journal article when things aren’t working out as expected.
I think you underestimate the difficulty of choosing the “good stocks” and avoiding the “bad stocks.” The data suggests that is a very difficult thing to do well enough that you will outperform the market after-cost.
If I’m going to spend a lot of time and effort on an investment, it will be one where I have a much better chance to add value with that work, such as real estate, websites, or other small businesses.
hmmm…did I say anything about beating the market? I don’t think so…I did say I don’t pay much attention to market indexes. I have made some bad decisions, purchased some companies I wouldn’t purchase today based on more experience and understanding of risk. However, a complete meltdown of those companies didn’t destroy my overall portfolio performance. My individual stock portfolio started long before the 2008-9 total market meltdown.
I’m not estimating the difficulty of anything… I’m purchasing a few excellent companies in all sectors, first large-cap and later mid-cap+small-cap, holding, monitoring and reinvesting. There’s no estimating, just doing.
Since my retirement portfolio needs to be a cash generating engine, that’s what I am monitoring; a rising stream of cash flow through the portfolio. It all gets reinvested across the entire portfolio, so I’m not trying to pick winners for reinvestment. I’m making a total portfolio bet. Since I have a Roth 401k, traditional 401k, Roth IRA and traditional IRA, I guess I have 4 portfolios. They don’t totally overlap, so I am yet more diversified than 50 equities.
I’m getting the feeling that contributing an alternative pathway to safe retirement investing isn’t welcome on this forum, so I’ll end with this comment. Best of luck with the passive index investing!
The forum can be found here: https://www.whitecoatinvestor.com/forums/
Feel free to contribute anything you like within forum guidelines. Certainly there is no guideline against advocating for a dividend-based approach. There are lots of people who do that. But given that a forum is about the free exchange of ideas, including their criticism, you have to have a bit of thick skin.
Best of luck investing.
hmm…guess I’m not done after all. One thing I didn’t point out about those broad based funds; the more stocks they hold, the more of them there are that help make up total market performance, which is a weighted average of individual performance. Every not-so-well-managed company that performs tepidly or melts down is a boat anchor on the best in class. Owning hundreds of companies through a mutual fund does not insulate you from the failures; it DOES dilute the also-rans and black-swan events into the successes, to produce a weighted average index performance.
I’m diversfying broadly, not trying to match some index closely. I’m diversifying adequately that a black swan event doesn’t dramatically effect my composite investment performance. I’m doing some screening to identify companies that have performed well over long periods, spanning market cycles. I’m tossing in some factor tilt, like roughly equal weighting rather than capitalization weighting into my personal conglomerate. I tilt towards higher dividend stocks, based on historic analysis of performance versus lower dividend yield stocks. But more importantly, I view my purchases as ownership stakes in the companies in which I invest. If I’m an owner, I’m interested in earnings, profits, long term strategic planning and hardly give a hoot about day to day fluctuations in market price per share. I wonder if any mutual fund investor gives a passing thought to thinking like an owner?
with that, I have said my piece. I’ll shrink back into my contrary hole and stop stirring the passive index fund investing pot.
Stir it all you like, as long as you do it politely and focus on ideas.
If you find you can do it well enough to beat the performance of an equally risky index fund, then I would suggest you go get a job as a mutual fund manager as you’ll be better than 90% of them.
I can’t imagine anything more boring than managing a mutual fund, beyond my one personal one. I don’t pay much attention to indices, so beating them doesn’t fit into my performance metrics. I’m content to earn my living caring for people rather than worrying about other their money. I do believe that no-one is more interested in my investment performance than me. I invest for retirement for security, so I am very interested in mitigating risk and
avoiding loss of capital.
The ideas are safety, income security, diversification, low expenses, escaping the “beat the market” mantra, increasing cash flow within the portfolio that can be directed by me rather than someone else. It’s also about choosing ownership in companies whose philosophy includes paying owners some of the company’s profits. A certain amount of discipline in capital allocation comes along with the knowledge that owners expect to be paid on a scheduled basis and for that reason earnings really matter.
i don’t “have to” spend time paying attention, I GET to. What I don’t HAVE to do is spend a lot of time at it, or pay someone else to do it.
Some credit unions and banks also offer special “high interest” savings accounts for kids too. That’s also a more fundamental way to ease the kids into understanding finance.
Sounds like your 7-year-old is quite advanced. Clearly he’s got the right start to learn not to become a doctor when he grows up. 😉
He is an economics major.
I run the Bank of Mom. Back when interest rates were 6%+ I paid the kids 10%. As they dropped toward 3% and downward I cut it to 6% but the kids were already hooked. Oldest emptied her account finally at 22- had used it to pay car insurance starting from when it became her expense (college) and then telephone when she chose to stay on our plan, and a few big expenses along the way.
I did the same. Also offered them matching funds if they put their earned income into a retirement plan while in college.
There are merits to different positions taken by Dr. Fawcett and Nak and WCI. Average return equaling market means that there are some who lag the average performance and there are some who beat the average, although all boats rise with the tide to some degree, except the one with a hole. It all depends on the goal that you are set out to achieve. I have put on different robs for different jobs and take a bucket approach. I enjoy active involvement and enjoy the thrill of rollercoaster rides and have been doing it for past 40 years from the age of 15. I have seen and lived and prospered through many ups and down, bull and bear and disaster markets.
Warren Buffett gives an advice to average investors to invest in index funds, but he, himself invests in businesses directly owning companies or in some of the top businesses as shareholder. He is not invested in indexes and for a reason that NAK alludes to that bottom performing companies are going to act like an anchor on a boat. If you select top 20% of market/sector/industry/country or region, your returns should be better than average. It does cost to invest, rebalance, diversify and reinvest and pay taxes on taxable account dividends and profits (can be offset/minimized by losses) and have to be taken in to account. Indexing removes lot of interventions for a low cost of investment (as long as you are not in high annual cost mutual funds) and reduces the risk. Nak’s position that a concentrated portfolio of 30-50 stocks is better with dividend growth investing is true for risk/reward in the long haul but still requires enough of active involvement. There are different options to go about different approaches. I personally have accounts with two investment companies ( this is not a sales pitch and I am not looking for any referral commissions with links and one can find similar other options), Folio investing provides stock selection tools and portfolio building and investing for a flat fee of $295 dollars a year including dividend reinvestment and unlimited trades during certain window periods. On the other hand, Wisebanyan robo advisor provides index investing without any direct management cost, although one would pay for underlying index costs indirectly. With the current brokerage transaction costs as low as $4.95 per trade at several of the top brokerages, $295 cost would equal about 59-60 trades, enough to be about 5 trades a month. That equals 0.0295% for a million dollar portfolio, definitely lower than lowest indexing costs but a physician’s time cost needs to be added to that.
For most physicians, from the beginning carrier and having free funds available for investing over the years, would mean direct investment would relatively cost more than indexing but ultimately be a superior approach if one can do it. My children, both out of college and specifically my son, who is in medical school have likened the idea of indexing and are comfortable with the passive investing at least at this stage of their careers.
If it were easy to pick 30-50 stocks that would beat an index fund, you would think you would see evidence of that among mutual funds, no? Yet the evidence shows just the obvious. It is hard, and particularly hard after costs.
Difference is that mutual fund managers get paid for management, while an individual investor does not have to pay himself for the management. If you are comparing index fund to mutual fund, you are right that index strategy will mostly get superior performance. Mutual funds are hemstrung by their own design flows. Even for the same design to track the same index, additional cost causes the lower performance. However, as an individual, You do get paid extra for the concentration risk with limited stock portfolio and can design the stock selection any way that you want or are comfortable with. I can live with -50% to +50% swings in a part of my portfolio, a mutual fund would get liquidated with people running for the exit. Individual investor can let a position get somewhat lopsided to let the winner run, while mutual funds are going to start rebalancing, although market weighted indexing may allow that.
For example, (I am not subscribed to this service and I am neither a CFP/advisor/agent nor work for anyone else and do not manage other people’s money. Total stocks rated #1 are 220/4400, 5% of available to invest. Not the 30-50 stocks but you can even be more selective out of a list like that (IBD 50).
Zacks Rank Returns
Portfolio Annualized
Zacks #1 Rank 25.37%
Zacks #2 Rank 17.87%
Zacks #3 Rank 9.11%
Zacks #4 Rank 4.77%
Zacks #5 Rank 0.86%
S&P 500 10.07%
Zacks Rank Performance Summary – Monthly Rebalancing
Year #1 Rank #2 Rank #3 Rank #4 Rank #5 Rank S&P 500
1988 39.18% 29.69% 20.79% 19.13% 18.39% 16.20%
1989 39.58% 26.84% 15.85% 9.55% -5.10% 31.70%
1990 -2.64% -13.69% -21.32% -23.85% -34.71% -3.10%
1991 81.36% 56.80% 45.98% 36.60% 34.35% 30.40%
1992 40.97% 29.63% 18.04% 12.24% 17.31% 7.51%
1993 45.26% 26.86% 14.78% 8.59% 9.54% 10.07%
1994 12.73% 5.15% -3.56% -11.14% -10.90% 0.59%
1995 52.56% 46.84% 30.63% 17.35% 9.11% 36.31%
1996 40.93% 28.60% 16.07% 7.71% 8.02% 22.36%
1997 43.91% 33.87% 22.93% 10.17% 3.05% 33.25%
1998 19.52% 12.92% -3.47% -8.77% -14.84% 28.57%
1999 45.92% 35.53% 31.02% 18.46% 17.69% 21.03%
2000 14.31% -1.47% -17.75% -19.52% -3.95% -9.10%
2001 24.27% 11.70% 14.09% 17.93% 20.20% -11.88%
2002 1.22% -13.50% -17.75% -24.03% -15.85% -22.10%
2003 67.03% 69.52% 64.91% 54.96% 54.38% 28.69%
2004 28.71% 23.74% 15.75% 11.47% 14.58% 10.87%
2005 18.80% 12.57% 6.75% 0.51% -5.95% 4.90%
2006 27.31% 26.26% 16.85% 15.01% 18.18% 15.80%
2007 19.71% 5.37% -4.34% -13.07% -24.04% 5.49%
2008 -40.41% -43.48% -48.70% -45.75% -50.95% -37.00%
2009 65.85% 84.19% 78.79% 60.36% 49.41% 26.46%
2010 28.98% 35.17% 27.87% 29.28% 27.22% 15.06%
2011 -3.79% -4.89% -13.47% -18.58% -21.37% 2.11%
2012 24.95% 19.06% 16.42% 6.53% 8.08% 16.00%
2013 47.48% 37.24% 30.56% 23.89% 17.99% 32.39%
2014 11.40% 4.00% -0.48% -3.72% -12.95% 13.69%
2015 -1.33% -0.42% -12.18% -11.06% -21.49% 1.38%
YTD 316 -3.24% 0.76% 1.60% 2.23% 4.09% 1.34%
Average 25.37% 17.87% 9.11% 4.77% 0.86% 10.07%
and IBD 50 vs S&P 500 (http://www.investors.com/stock-lists/ibd-50/ibd-50-performance/) giving almost double (17.9% vs 9.2%) the advantage (from 2003 to 2015). And that is just 50 stocks.
I disagree that an individual investor gets paid for concentration risk. In the investment world, a risk that can be diversified away is an uncompensated risk. Unless you have information that the market doesn’t have, you’re just gambling when you’re investing in a few stocks instead of buying them all. The approach may still work out fine if adequately funded, but it is unlikely to be the best way to do it. Many roads to Dublin and all that.
Gambling is a loser’s game with house advantage, even if minute. But investment is not gambling. Investment is not without risk. Even indexed investment is ultimately taking risk the economy and businesses will do better over time. Even if you do not have more information than the market at any given time, investments in better businesses and companies will get rewarded.
Again, I believe that every one has to choose the right approach to personal finance, in what ever form they feel comfortable. For majority of physicians, we are skilled at our occupation and skill in one field does not extend to another automatically just because we are smart and have wits and I agree that steady plodding is very good for most with indexing to diversify, reduce risks, costs and hands off approach. I, on the other hand love to involve myself in self selection of good companies/businesses, industries/sectors and am happy with the outcome. In fact, some of the companies have lower risk, volatility as measured by beta and have better long term performance.
As Warren Buffett says:
“According to Buffett, risk is exactly as the Merriam-Webster dictionary defines it:
“The strategy we’ve adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as ‘the possibility of loss or injury.’“
“Risk comes from not knowing what you’re doing.” – Warren Buffett
You’re not Warren Buffett. Think about what he does. Not only does he pick stocks, but he puts himself on the board of directors and fixes the company. You can’t do that.
You are far more likely to generate a better return on your time in a less efficient market.