Index Funds vs Individual Funds

[Thremp]

Meditate,

Are you beating the market on a risk adjusted basis?

[maxtower]

Stocks aren't more risky than index funds. Stocks are in index funds. So it depends on how you are discussing risk. If you own a stock or an index fund, you have the same asset class risk. A lot of the time, especially large caps, the share price of a particular stock will move with the market.
The risk you are talking about is the risk of owning one or a few companies versus owning hundreds through an index. This is hard to quantify. I think you would obviously want to be in more than one position to eliminate the risk of bad information creating a nightmare scenario for you, but if you have about 10 positions across different industries and geographies, you could eliminate most of this risk.

Some people also talk about risk in terms of the daily fluctuations of the price of the asset when compared to another. (Look up Beta) You could probably pick 10 stocks that have less of this kind of risk than the entire S&P 500. It has a lot to do with the type of business. Utility stocks for example don't move around a lot. A lot of them have a virtual monopoly, and inelastic demand for their services. Owning 10 utilities would give you a pretty stable portfolio.

[Thremp]

Maxtower,

Yeah, RoR v variance is an issue as people use "risk" to describe both. You have nonsystematic risk with <20 stocks IIRC. Obviously these would also need to be diversified with reasonable respect to industry as just buying every uranium stock isn't going to cut it.

Beating the market isn't very hard in a given time frame. Beating it on a risk adjusted basis is much more difficult.

[meditate89]

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Meditate,

Are you beating the market on a risk adjusted basis?

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I already asked if you could explain what exactly you mean by this, do you even read my posts?

I also ALREADY STATED that I don't really want to comment on whether or not I'm capable of beating the market or not based on two years of results.

[Thremp]

Hrm, I read the long one and it sneaked in there I guess in between my responses. Though stocks hold a different type of risk than index funds. I'm asking about a variance measure. Like how a stock is riskier than a bond, which is riskier than a T-bill etc.

Beta will work.

[DesertCat]

Do you guys get together and conspire to put up threads like this just to jerk my chain and get me foaming at the mouth? Ok, for the last time

1) Beta isn't risk for a long term investor. True risk is business risk. Your risk isn't how often the stock flunctuates, it's whether it's another Enron, or whether it's business will go bad.

2) If you know how to value companies well, and you are a long term investor, diversification will not only hurt your results, it will create more risk than it solves. Essentially Buffett will tell you it's better to own fewer companies that you can know well, than too many stocks to know any deeply.

3) As proof of this, look at Buffett's results. Not only has he beaten the market by over 2x for a very long time, he actually has only one down year in 50. He's done this by running a very concentrated portfolio for most of his career.

Now that I've said all that, I still don't recommend individual stock picking to most people. It's not the amount of time you spend, Buffett could spend ten hours a month and still crush the market (with the right size portfolio). But he's a freak in terms of capabilities (50 years of reading thousands of annual reports, photographic memory, perfect disposition for the job).

The first problem is that most people don't understand how to value companies. Even for those that do, most don't have the psychological temperament to commit to buying cheap and selling dear. The ability to wake up one morning and see your biggest position down 35% and immediately think about buying more instead of running for the exits. The ability to ignore "price trends". To focus on what you know and ignore what you can't predict. And utter patience to wait with all your money in cash when you can't find anything attractive and keep yourself from buying something that looks sortof cheap just to do something.

Most people trade too much, they can't even hold an index fund for the long term. They'd be better off accepting "average" results from holding a single index fund forever because instead they buy and sell hot funds and stocks and sectors and trade until their results are way worse than that "average return" index fund produces.

[Thremp]

DC,

For #2 what do your recommend? I've always heard that ~20 is a golden zone. Too few and you have greater risk, too many and as you said you dilute yourself needlessly.

[meditate89]

I would never buy a uranium stock- i have absolutely no idea how much the stocks or uranium is worth. Just because there are many people on here who have gold, uranium, timber, penny stocks, poker stocks( I do own CRYP actually), 50 PE growth stocks, etc as 1/2 of their portfolio doesn't mean that I'm one of those people.

I don't really understand your point about RoR- unless every company I own goes bankrupt, how can i possibly be ruined? If my stocks tank in price, I'm very likely to buy more of them- I don't see the risk here. After all, their intrinsic value has nothing to do with current market prices.

I assume we're all talking about long term holdings here- short term price fluctuations should be seen as nothing but buying opportunities. I have only made about 8-9 trades so far in the two years i've had my brokerage account open- and I currently have about 7 long positions that I can't see closing out any time in the next 20(+++) years.

[DesertCat]

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DC,

For #2 what do your recommend? I've always heard that ~20 is a golden zone. Too few and you have greater risk, too many and as you said you dilute yourself needlessly.

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My goal is 5. Reality is I end up with 10 since I can't control how much I can buy of some positions or when I can sell some others, but if I really love a single position I'll make it up to 25% of my portfolio. I've had half my portfolio in two positions before.

There is some good discussion in "You can be a stock market genius" (goofy title, great book) where Joel Greenblatt discusses how little extra protection you get from volatility in a larger portfolio. He estimates the markets standard deviation is around 18%, i.e. it's average return is 10% two thirds of the time it will be between -8% and 28%. He then estimates that a portfolio of 5 stocks will have a standard deviation of 21%, i.e. between -11% and +31%. Not much difference in volatility range between one of the least diversified portfolios possible and the most diversified portfolios (the market).

Of course if you are -EV at picking stocks, then concentration into a smaller portfolio is likely to help you lose money faster. It only works if you are skilled at valuing businesses and if you pay attention to what you have. Otherwise I've given you very bad advice.

[bav]

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...unless it was BRK-A =p).

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BRK is almost just another sort of mutual fund.

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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?

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Give yourself a few more years and a few more investments and you'll get stomped by one. The company doesn't have to go bankrupt...there are probably twenty companies that drop to 1% of their former value and then get bought in a firesale and avoid bankruptcy for every company that actually drops to 0.

My sis-in-law years ago took her IRA money and basically handed it to a full-service stock broker. She didn't know any better. She told the guy "buy some Microsoft and buy some Starbucks and do whatever you think is best with the rest". So she got 10% into MSFT, 10% into SBUX, and 80% into Lucent. She made a little with MSFT, made a lot on SBUX, and lost 90% of her 80% on LU. (I told her ages ago she shoulda sued the bastards... no way in Hades a rational investment professional could possibly think 80% into Lucent was an appropriate retirement choice.) LU isn't bankrupt, but it fell to almost nothing before Alcatel bought 'em. Who coulda thunk a piece of the former-glory that was the pre-breakup AT&T could do this?

And how often do banks and S&L's and Credit Unions go bankrupt and have to be saved by FDIC and FSLIC and whatnot? What're the odds? Somehow I've had money in two of these. Fortunately, not >$100K or I woulda lost it. I mean, really, how could lightning strike twice?

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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'

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ok... so you're 70 years old, disabled, and living on $1200/mo of social security and $1M invested generating $5000/mo of retirement income. If someone offered you 50:50 odds on a coinflip for your entire retirement, would you accept it? 3:2 odds? 2:1? 3:1? 10:1? At what point is the chance of eating dogfood and having no way to pay for your prescriptions worth it?

Now roll the clock back and you're 22yo with $50K and 50 years of earnings potential ahead. Where would you draw the line? Different sorta question.

Which is why one size will never fit everyone. Diversify or concentrate? Buy&Hold or Buy&Homework? Individual stocks or ETFs/MutualFunds? Leverage or not? Daytrade or Blackjack?