Index Funds vs Individual Funds

[squiffy]

There is no need for a lot of intellectual debate. Try it yourself and see how you do over the long run. You can do a real trial, splitting your money up 50-50 and seeing how you do over 5-10 years.

Or you can index your real money and do paper trading to see how you would have done.

There is no substitute for trying it on your own, for real, as there are trading costs, and fear and greed.

I started out with index funds and probably had about 80K to 100K, built up over 5 years, before I took 12 K and tried to pick my own stocks.

It's hard for anyone to generalize about how you might do. We have no idea about your stock picking abilities, etc.

I have always loved economics and investing. So it's fun for me. And I probably put in more than 10 hours a month. Though how much time I put into it is really hard to guage.

[bav]

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Do you see why?

[/ QUOTE ]No

[meditate89]

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What's the rationale for having both index funds and individual stocks? Either you expect your picks to beat the market or you don't. I see no strong reason for straddling the fence. Reduction of risk isn't a good argument in this case. Do you see why?

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I agree with your first point to a certain extent... pick whatever you expect to perform best. I don't really understand what you're trying to say about reduction of risk- but I think that if you truly understand the underlying business that you're invested in, and feel as though you own a part of it, it's unlikely that you'll sell if the price drops dramatically. In fact, you might see this as an opportunity to buy more

[meditate89]

Wouldn't you all rather debate this NOW than see how you do over the next 5 or 10 years in index funds? ...and then be hesitant to switch because of capital gains taxes, stubbornness, etc.

I think anyone who spends some time studying the stock market will realize that your highest expected return is certainly not in index funds.

[Dazarath]

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What's the rationale for having both index funds and individual stocks? Either you expect your picks to beat the market or you don't. I see no strong reason for straddling the fence. Reduction of risk isn't a good argument in this case. Do you see why?

[/ QUOTE ]
If you expect it to take you x hours/week (on average) to do thorough research for a single stock, then it will take you some Cx hours (not necessarily linear) to do research on multiple stocks. Someone may have enough time to cherry pick a stock or two on their own, but not enough to research enough stocks for an entire portfolio, no?

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I think anyone who spends some time studying the stock market will realize that your highest expected return is certainly not in index funds.

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No one is saying this isn't true. The problem isn't that we think index funds are unbeatable. The problem is that you basically want to open up the newspaper a couple times a week and somehow magically beat the market as a result, something that many professionals who work full-time at can't even achieve.

[meditate89]

How many stocks do you need? 90% of my portfolio is in 5 of them.
I don't believe that you need to check on your stocks every day or even every week if you just want a better return than index funds. I check my watch list every other day to see if anything good is on sale, but I certainly don't spend a lot of time running numbers every day, or trying to predict what may or may not happen in the next month or the next year. Once you discover and acquire your target business, it'll keep running itself whether you pay attention to it or not!

I honestly think it can be done in 10-20 hours a month... but only determination and due diligence will help you here- I'm not suggesting you go read the paper, see the picture of the pretty Iphone, and go buy AAPL for $97. That doesn't really count as research.

[bav]

Taking some of these theories to the extreme, everyone should invest in one company. Who needs diversity when all it does is reduce risk while also reducing performance? With that perspective, you should thoroughly research things and drop 100% of what you have into the single investment you think has the greatest probability of returning the most. Doing anything else decreases your expected return, after all, since you believe every other investment has a lower expected return.

But I'm not a gambler...I don't play black chip craps or blackjack and I don't dump $thousands into slot machines. I don't believe 5 stocks is nearly enough diversity.

If diversity is not what turns your crank, fine. If you're 22yo and you've got found money burning a hole in your pocket, gamble away. But that's not advice that fits very many investors; I'm investing a lifetime of earned income that I've worked my fanny off to get for almost 30 years and I don't like the idea of a single Enron or MCI event wiping out 30% of my networth.

[Thremp]

Meditate,

I think you aren't beating index funds on a risk adjusted basis and are exposing yourself to a large amount of non-systematic risk purely from a lack of knowledge.


gull,

I don't see why either. If you feel you need ~3 hours per week to pick one winning stock, and are only able to spend 10 hours a week... What would be wrong with straddling the fence? And shouldn't we differentiate retirement funds from discretionary income (Of course, but rarely stated on this board)? Why not use your discretionary funds to pick stocks before delving into money that is earmarked?

[meditate89]

Bav, I realize I may be more against diversification than many people- I would rather focus on a few great ideas than spread my money over 10 or 20 stocks- but only 1 probably wouldn't make me very comfortable( unless it was BRK-A =p).
Also I am trying to keep some money liquid for merger/ arbitrage opportunities- if I wasn't doing this I might have a few more long positions.

I'm also young and have more time than you probably do to recuperate if I somehow lost money. However, I think the Sarbanes Oxley act will help to prevent future Enrons from occurring. I think it is also very important to scrutinize the actions of management and make sure the financial statements of a company makes good sense to you before you invest of course. It would be devastating if one of the companies I own went bankrupt... but it's hard for me to calculate the likelihood of this. One in a million? It's not that I believe it's impossible... but do you worry about getting hit by lightning whenever there's a storm? I think that because of my tendency to pick stocks with strong balance sheets, solid earnings, trustworthy and competent management, usually low debt to asset ratio, etc, that it wouldn't be fair to say... for example... there are 10,000 companies, 100 went bankrupt, therefore you have a 1% chance of each of your companies going bankrupt.

Also, I don't think it's fair to compare the stock market to blackjack or slot machines which are -EV games that you can never ever win in the long run. I think everyone can agree that with a larger amount of time to dedicate, anyone can beat an index fund- but I don't know anyone who can beat slow machines or blackjack ( assuming no card counting), no matter how much effort/ time they dedicate

I'd say it's more like this:

Would you rather get all in with AA vs AK for a $1200 pot,
or get in with KK vs AK for a $300 pot, 4 times in a row?

Your expectation is higher with AA vs AK, but your likelihood of having SOME money left at the end is MUCH greater showing down KK four times.

Assuming my bankroll could handle the swings, I would much rather buy the one AA 'stock' than the 4 KK 'stocks'

[meditate89]

thremp- you may or may not be right. I've only held stocks for about 2 years, and right now my record is rather good- hopefully it will remain this good for the next 8+ years so I have a track record worth bragging about.

Could you please explain what you mean by a risk adjusted basis? Stocks are clearly much more risky than index funds, but is there any way you could quantify this risk for me? Are stocks twice as risky as index funds? 1.5 times? 5/10 times?!!? I feel that many of your comments just aren't specific enough to really add much value to the discussion... i'm not trying to call you out or anything, but every post i see of yours seems to be like 2-3 lines long- how can you possibly explain and articulate an important point?