[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!
The Vanguard Total Stock Market Index Fund has 3575 separate holdings. The index fund mimics the index. The turnover on these equities is pretty low. a few will be de-selected every so often. Their relative position as far as weighting will change a bit from year to year. There are over 9000 equities traded on the NYSE, so the index fund has the potential of not holding some equities that might otherwise make a meaningful difference in performance. However, those who describe the index and those who choose the index fund holdings are doing some sort of screening themselves, or they’d just purchase all 9000+ equities. Cap weighting of an index fund means that Apple, Microsoft, Amazon, Exxon Mobile and Johnson&Johnson will have a disproportionate influence on how the fund performs.
My 50 holdings won’t exactly mimic the index, but with some simple screening criteria, I can select companies with superior earnings growth, dividend growth and shareholder friendly histories. Scanning very quickly, I own 33 of it’s top 150 holdings. I’m guessing I’ll find the rest of the 50 some-odd equities in my traditional IRA in the top 300 holdings out of 3575.
Essentially every one of the top 50 in the index are equities I might consider owning, except they don’t all meet my earnings growth, valuation, payout ratio and yield criteria.
If I were to screen all 3575 for low volatility and my yield threshold, I would find almost every one of the stocks I hold within the screened subset.
50x$4.95 equals just under $250 to establish the portfolio, after which there are no further expenses if one uses the DRIP option at the discount brokerage where the account is held.
So, if you believe that screening for earnings growth, valuation, yield and dividend growth are likely produce an inferior set of equities to the weighted average of all 3575 in the Vanguard Total Market Index Fund, you should own the index fund, by all means. If you would like to put that extra $500 in your pocket every year and actually know which companies are part of your personal conglomerate, build your own broad based collection from within one of those index funds and avoid the ones you wouldn’t want to be associated with. I find it very easy to give up the stellar performance of Phillip Morris and other tobacco stocks. I’m perfectly happy to avoid gaming stocks and cruise-ship companies. I’m not very interested in owning gun manufacturers or motorcycle manufacturers. It turns out there are ample options to create an acceptably diverse collection of holdings without participating in industries whose products I wouldn’t recommend to my own patients.
Don’t get me wrong; I have nothing against the broad market low fee index funds. They are a very prudent approach for the “set it and forget it” investor.
Unfortunately, my mind doesn’t work that way. I need more engagement than that, just like I need to understand more about pathophysiology than the bare minimum to decide which pill to prescribe first, second and third. Index fund investing on a steady, month to month basis is a great way to avoid all the pitfalls of the investor mentality. It also deprives the investor of any active engagement in the activity. One can exercise discipline AND take personal ownership of one’s retirement security objectives. I’ll warrant that if you shovel the same maximum allowable deferred income into your retirement plan with either approach, you’re going to retire securely.
Yes you can. What you cannot do, however, is guarantee that by doing so that you can outperform the market on a risk-adjusted basis in the future.
Here’s the deal. You’re confident you can pick stocks well enough to beat the market. I encourage you to go ahead and try to do so. But keep very careful records including your extra expenses in comparison to an index fund. These include commissions, fees, bid-ask spreads, taxes, and the value of your time.
If after five years you’re convinced that you’re trouncing the market, not only should you keep doing this, but you should invest money for other people too. I mean, even then you might just be lucky, but better to be lucky than good anyway.
Just realize that you’re hardly the first that has tried this. Even Warren Buffett himself recommends the vast majority of investors should be investing using an index fund. It takes a great deal of confidence to think you are in the minority for whom picking stocks is a good idea.
I know it is counter intuitive, but the data suggests that applying extra time, energy, intelligence, and activity in this regard, unlike almost everything else in life, is more likely to decrease your returns than increase them. That is why money is flowing like crazy from active managers to passive managers.
NAK – I have a Merrill Lynch brokerage account. If you have 100k+ in your account (or combined with Bank of America) you get 30 free trades a month. Plus I believe if you transfer your account over to them you could get a sign up bonus.
PERFORMANCE of one account over ten years annualized with 25 stocks (mostly US with mix of industries/caps and some with markets and revenue outside the US). commissions, fees and bid-ask spreads are included in the performance. Being IRA, does not apply for taxes until taken out (granted it will be ordinary income and not capital gains, but in retirement, I expect to be in lower tax rate than at present). Value of time at a rate of $100 (without tax/FICA etc equals other work) would be about 10 hours a week initially and would be $50,000 for ten years equals half a million dollar if remained constant. However, time put in actually goes down for long term less maintenance positions. Transaction cost are about $2500. For a $ 500,000 dollar portfolio to start, it will be about 10+% cost but by ten years, cumulative assets of 700%, it comes to 1.5%, almost similar to a mutual fund, but with greater performance.
YTD 1 YEAR 3 YEARS 5 YEARS 10 YEARS LIFETIME INCEPTION
+17.29% +34.36% +18.68% +20.08% +23.60% +23.57% 12/31/2006
As I had written before, I would not put all my eggs in one basket and do have other index/funds/bonds in other accounts that does not give performance like this and are hands off approach for comparison. One has to be able to have performance like above to justify playing active role as an individual. I agree that for beginners and for most people, investing in indexes is the right way.
Looks to me like you should be managing money for other people to me.
I spent a few nights last week and some time this weekend analyzing my portfolio and at first it looked like my picks had a nice pick-up over my index funds, but when I weighted the returns, the index funds were actually winning. My picks are getting weighed down by one particular bad choice, which turns out to have been a triple loser, because not only did I “double-down” on it, but I sold part of one of my index funds to do so which has fared much better. I was confident this comment was going to go in a different direction, but numbers don’t lie.
I wish your experience were less common. Thus the importance of actually tracking your returns to find out if you have stock picking talent. Remember, most people (including me) don’t have any, so you’re certainly not alone in your experience.
That was the whole point of my article. I thought I was doing great, but reality was not equal to my thinking. I have found this also is true with dieting. The number of calories estimated don’t match the actual number of calories eaten. The mismatch causes frustration when you think you should have lost weight, but you didn’t. The scales don’t lie.
I’ve been investing for almost 25 years now and do find this to be true. Most market timing decisions haven’t worked out for the better. Not so much directly losing money but the opportunity cost that I could have done better. And Im not convinced spending many hours of your time researching (and worrying) will pay off enough for the time spent long term. Even if you were to beat the market over 10 years, by how much and how much money did you really make for the time spent and likely additional risk? Even though I’ve always read up on investing, mostly I set up my accounts on automatic/ DCA and just went to work and let them do their thing. For many years I just checked in on them every few months. I figured it was retirement money that I cant touch anyway and its still got a long time to go. I dont work in the medical field and never made more than 50k/ yr but now my accounts huge. Funny part is I dont feel that I’ve put that much effort into it other than the going to work part of coarse. I didnt get as serious about my finances till about 10 years ago. Making smarter financial decisions, cuttiing out wasteful spending, and a more frugal mindset helped also. Pick a group of low cost funds and add to them every year. Hold them for a long time and your results should be great.
Well said Arrgo. Glad you have done well.