Experienced racers and fans know that stage races are not won on the flat stages. They are won in the time trial stages (where each racer rides alone against the clock) and on the mountaintop finishes (where a racer's fitness and skill allows him to leave his peers behind.) The reason for this is simply a case of aerodynamics.
Aerodynamics doesn't affect you much as you tool around your neighborhood on your mountain bike at 5 or 10 miles an hour. But traveling at 30 or 35 mph in a professional bike race is a completely different scenario. In TV interviews, cyclists always talk about the “work” and “suffering” they and their team did that day. In cycling, those words are euphemisms for fighting the wind. It takes 20-40% more energy to ride in the front as it does to tuck yourself in behind another rider, or better yet, in the middle of a big group of riders. Those in front are “suffering” while those in the pack behind are cruising along enjoying a nice day. The main pack of riders in a race is called “the peloton,” a French word meaning pellet, platoon, or little ball. On a flat stage with calm winds, it is relatively easy to sit in the middle of the peloton all day, save your energy, and finish about the same time as everyone else in the race. Sitting in the peloton is like index investing, you're just accepting the market return. You get the same time as everyone else, but you work a whole lot less.
How a Flat Stage Works
The typical scenario in a flat stage is that at the beginning, 20 or 30 racers are at the front, trying to get into “the break.” Finally, after 30 miles or so, the break is established, and a group of 2-10 riders is out in front of the peloton. That group works their butt off for the next 5 hours trying to stay ahead of the peloton, which is never really further behind than 2-5 minutes. Then, in the closing miles of the stage, the “sprinters' teams,” get on the front of the peloton, ramp up the pace, and reel in the break. By the last couple of miles, the pack is all back together and the sprinters' teams work hard to get their best racer into position to win the race by less than a second. Meanwhile, in the overall results for the race, everyone who stayed in the peloton all day gets the exact same time as the guys in the break, the sprinters' teams, and even the stage winner himself.
In Investing, There is No True Glory In “The Break”
The “break” is a lot like individual investors who are picking stocks. They bust their butts, give it their all, perhaps receive some temporary glory (of which they can brag at cocktail parties), but in the end are often not only caught by the peloton, but passed by it when they run out of gas. The sprinters and their teams are a lot like the teams of actively managed mutual funds. They're a little more scientific in their process, and they often achieve glory in the form of stage wins (which are meaningless in the overall race), but at the end of the day, even the successful ones get the same time as everyone else despite spending a lot more energy (and money) doing so. Sprinters are also often the ones who get dropped from the peloton first when the road tilts uphill, not dissimilar from high-flying active fund managers whose style goes out of favor with the market.
How To Win A Stage Race or Be A Successful Investor
The successful investors in the race are the “GC guys.” GC stands for General Classification, the overall winners of the race. In a flat stage, they simply bide their time. They sit in the peloton, surrounded by their team, and stay fresh, knowing that nothing anyone does today (other than wipe out) really matters at all to the end result of the overall race. They're free to save their energy for pursuits where it will actually do them some good. The best riders in the race simply accept the market (peloton) return and keep their (energy) costs as low as possible.
There are times in the race that actually matter to the GC guys, of course. For a few minutes at the end of a mountaintop stage, and for the 45 minutes or an hour in the course of three weeks where they are time trialing, their skill, knowledge, and luck play a huge part. If we stretch this cycling analogy almost to the point of breaking, we can consider this the little things an investor does on the side, such as using retirement accounts wisely, minimizing her taxes, or perhaps investing in a relatively inefficient market such as real estate. Staying in the peloton won't help you in these relatively rare instances, but with regards to investing in stocks, just stay in the peloton and arrive at your destination in record time with minimal effort.
What do you think? In what areas of your personal finance and investing life do you feel like your skills can really add value and when should you “stay in the peloton?” Comment below!
Really hits home… no need to try and be a frontrunner. My kids just told me “Everything is awesome…when you’re part of the team!!”
It feels good to actually be in the race now and not just spinning my wheels.
Also, couldn’t help to think that too often the “mountaintop champions” are cheaters who also compromise integrity and ultimately have to repay their winnings with shame and other punishment.
Ooh, good point.
Great article. Seems like so many people fail to realize that if you match the market for 30 years straight while saving at a decent rate(let’s say 20+), that it really adds up to some serious amounts of money. No need to do anything crazy or set any records. Slow and steady wins the race. Brightest stars are the ones that burn out first.
Another favorite is “The easiest way to ruin a good plan is in search of a great one.” or something similar. I know Patton’s quote about plans and that isn’t the one I’m thinking of, pretty sure it was from a president.
I think it was from General Carl Von Clausewitz …”The enemy of a good plan is the dream of a perfect plan”.
No doubt channeling Voltaire
http://en.wikipedia.org/wiki/Perfect_is_the_enemy_of_good
I have a service through the investing arm of my bank that gives me all the free trades I could ever use — no hitches, no strings (believe me, I know how to look for them), because of the large amount of money I have in that bank in my substantial rainy-day fund.
What is the disadvantage to creating my own smaller version of an index fund by frequently buying (and always holding) individual stocks that are part of the S&P 500, mostly blue chip-type stocks that are currently have a reasonable P:E ration — say in $1000 chunks 4-6 times per month? I still basically get value cost averaging, and my annual management expense is 0%
My thought is that in future years, I can use the big gainers for my charitable donations, and that I can sell off big losers to help me with capital gains taxes when I need to. With mutual funds, I have to take the capital gains and losses when the manager (or index formula) forces me to.
Am I missing something?
No, you’re not missing anything. 6 trades a month, even free ones, is enough hassle to keep me from doing that (especially when it comes time to do Schedule D). Don’t forget the spreads, of course. You’re not going to be as good at execution as the experts at Vanguard, but you may get enough tax benefit to still make it worth it.
Great article. I enjoyed reading it. I was able to stumble upon an article written by Joshua Kennon “Why do the Rich Get Richer?”
He made a statement (see below)
To put it more starkly: If you gave me total control over the finances of a young married couple around 25 years old, a police officer and a teacher, I’d be willing to wager a significant amount of money that I’d be able to get their net worth into the tens of millions of dollars by the time they retired at 65. Why? Because it took me about 5 seconds to calculate and solve for the “payment” variable of a net present value of an annuity formula assuming a return of 10% to calculate that it would require saving $22,600 per year. With most decent employers, at least $2,600 of this would come from matching funds on retirement accounts so we’re now talking about $20,000 annually. Saving that amount in the 25% tax bracket will lower your Federal taxes by $5,000, which effectively counts as the government transferring money from your tax bill to your balance sheet. That leaves $15,000 in out-of-pocket cash that the couple would need to save.
What investments was he suggesting to earn a guaranteed 10% return with a monthly contribution of $1250? I am not sure if he was suggesting stock investing or not.
You’re putting words in his mouth. He said “assuming a return of 10%” while you are asking for something with a “guaranteed 10% return.” See the difference? Also, I think 10%, after-inflation, taxes, and expenses is an extremely optimistic return. I use 5% and many people say that’s even too high. But $22,600 per year for 40 years at 5% comes out to $2.9M. At 10% it comes out to $11M. Big difference on a little assumption, no?
Aside from that issue, I like Josh’s little article, especially this part:
http://www.joshuakennon.com/why-do-the-rich-get-richer/
10%, by the way, is about what stocks have returned BEFORE INFLATION, EXPENSES, AND TAXES in the past. So that may be what he is talking about. But he could be talking about real estate or another business too. Personally, I doubt he had a specific investment in mind when he wrote what he wrote.
WCI wrote: “It’s not about choosing “good funds” or even “good fund families.” It’s about getting a plan you can stick with, even if you are extremely nervous about how high the markets are, then following that plan through thick and thin.
But to answer your question, I also like the index funds from Schwab and Fidelity, and some of the Bridgeway funds, but would recommend that as a do-it-yourselfer you look first to Vanguard to choose funds to fulfill your investing plan.”
I always hear guys saying to go with Vanguard funds so that’s what I want to do. Can I buy these through current brokerage account or do I have to have a Vanguard account? I am presently with Scott trade and I assume I can buy any Vanguard funds in my Scottrade retirement accounts but would it cost me less to close out the Scottrade accounts and buy them in Vanguard accounts, there’s usually some closing fee involved, I only have three different accounts, it is probably like $50 per account closing fee but I haven’t checked.
Thanks
The ETF versions of the funds are easy to buy at any brokerage. The funds themselves usually have higher commissions unless bought from Vanguard directly. There probably is a closing or transfer fee, you can easily look it up on Scotttrades’s website.
I’ve just recently found your blog and can’t thank you enough for your teaching. I’m still trying to learn the basics. My husband has several individual stocks that were purchased by his parents in the 1990’s in a taxable account worth approx 300k. Our income is currently less than 150k but will rise once I take an attending job in two years. Do you advise that we sell all of these individual stocks and then diversify into index funds/ETFs? I imagine there would be a tax benefit to doing this sooner rather than later?
Well, that’s a complicated question. See, while there are tax benefits to doing this sooner rather than later, there are also tax benefits to doing it later rather than sooner.
This is a good example of why it is important to really pay attention when buying stuff in a taxable account; there are some real consequences to changing your minds.
I don’t think you’ve really provided enough information for anyone to give you advice on what to do in your specific situation. Here are some general considerations:
1) Calculate out the actual tax cost to selling today. If it’s low, go ahead and sell and diversify.
2) Do you give significant money to charity now or in the near future? No sense in paying taxes that you will never have to pay. Using those appreciated shares for charitable giving not only saves you capital gains taxes, but gives you an income tax write-off. Not a reason to give to charity if you don’t do so anyway, but a great side benefit.
3) What percentage of your portfolio does this $300K represent? If it’s 20% or more, then I think the need to diversify is rather urgent and worth paying a cost for. If you’ve got some massive portfolio tucked away somewhere, it’s less of a big deal.
4) Finally, no matter what you do, be sure to thank his parents. What a wonderful gift. I know I would have made lots of decisions differently if I had had $300K to start life out with.
Love the analogy. To all readers and WCI: Any recommendations on specific funds? Are you doing it ‘own your own’ or ‘using a advisor’? What does your portfolio look like? Etc etc thanks for any recs!
Seen this post?
https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/
My portfolio is included at the end.