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Author: luke77 Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76419  
Subject: Index fund investing versus stock selection Date: 10/6/2007 1:12 PM
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Hi eveyone,

I am a long-time reader of the fool boards, and a recent college graduate. I very much enjoy following the stock market, and am actually working in finance on wall street. For the first time in my life, I am making enough money that I am able to start saving substantially for retirement. I am lucky enough to have no debt, no student loans, and no credit card balance. I also have enough liquid cash to cover my expenses for a while if something horrible happens, plus I have a supportive family that would take me in. I am planning on maxing out my 401K but need some advice regarding how to invest the other money that I will be putting towards retirement.

I think I have basically two options. Either invest in no-load index funds like the s & p 500, or try to beat the market by selecting individual stocks to hold for the long term. Basically, I'm confused by the contrasting information that there seems to be out there. One the one hand, the index fund folks like to espouse the view that the majority of money managers and individual investors do not beat the market over the long term. Although I do think that I am probably an above-average investor, I don't think it's smart to assume that I would do better than average, esspecially since money managers spend their entire lives analyzing stocks (though I know they have some liquidity constraints that I do not). It usually gets people in trouble when they assume they are smarter than everyone else.

On the other hand, the other school of thought for retirement investing seems to be "You're young, invest aggressively, you can deal with the risk and volatility since you won't need this money for 10+ years. Your best bet is to build a small portfolio of high-quality growth stocks". To me, this seems paradoxical if you assume that the index-fund stats are true. If most people cannot beat the market, what is the reasoning behind buying individual stocks, even if the outlook is long-term? My goal is to get the best return possible - if, on average, most people underperform the market when they do this, why would it matter what my risk appetite is? The assumption seems to be that more risk=greater return, but the index fund stats would suggest that this is false, right?

Out of necessity, my 401k money has to go into funds, so at most about half of my savings will be invested at my discretion. The only decision I have to make is whether to invest ALL of my money in index funds or whether to build a portfolio with half of it.

I guess the reason that I ask this question is because I'm thinking about using one of the Fool's advisory services - either Stock Advisor or Hidden Gems. Although I'm disheartened at the level and tone of advertising that these services have developed, I've been very impressed by the quality of these products (I did the free trials a while back), and if you look at their performance (although admittedly fairly short-term), they've outperformed the market by a good deal. If I do decide to buy individual stocks it will probably be under the guidance of one of these services...so I guess this just restates my original question - is it better to try to beat the market in this way, or should I buy straight index funds?

Thanks very much for any advice, opinions, or even direction for good sources of advice on this issue.

Luke
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Author: mrparrotfez Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59452 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 2:25 PM
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Howdy, Luke,

I like your overall thinking. You'll do well.

And I HEAR YOU on the tone of the ADVERTISEMENTS!!!! It is just getting FLAT OBNOXIOUS as newsletter people seem to THINK that SPEAKING LOUDER MEANS BETTER COMMUNICATION! In reality, it makes them sound like carny shills. It's like they're going after the moron market, which is very odd because their potential customer base doesn't include very many morons.

Now. Here's my creative suggestion. Divide your investable money up in some proportion: say, 70/30%, two portfolios. Invest the 70% in index funds to your taste. Meanwhile, subscribe to one of the publications, whichever is best suited to your style. Read it, digesting it thoroughly without buying anything, until New Year's. On the first trading day after New Years, note:

--The dollar amount the 30% began with
--The status of the indices on that day (whichever ones you consider relevant).

Then begin investing according to the newsletter. Do that through 2008. Buy, sell, whatever, but withdraw no money from the active investing account. Reinvest dividends or not; it's up to you how you do it.

As the markets close for the New Year's holiday to welcome 2009, note your dollar amount and the indices to finish the year. See how they did, and how you did. If you beat the indices, then you have grounds to believe the newsletter is a good method that you're using sensibly. If you did not beat the indices, consider canceling the newsletter and unloading the portfolio to buy index funds.

Either way, you'll have your savings for that year sitting by in cash. If you're winning with the newsletter, you'll have some ready capital to invest as you see fit. If not, you can buy index funds with that too. Either way you'll have made a little money with it that year in the MMA.

Good hunting. Get your FY money.

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Author: joelxwil Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59453 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 2:39 PM
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There is no reason to stick with index funds alone. I just posted a long list of funds that have out-performed the S&P 500.

http://boards.fool.com/Message.asp?mid=25969833

The list deserves further examination, and of course your 401K choices are limited.

You say selecting individual stocks to hold for the long term. Great if you can do it, but every time you buy a stock you should know the circumstances under which you should sell it. Enron and World Com were supposed to be long term holds, according to some brokers.

So you need an understanding of how to trade. I made a lot of money on stocks like SUNW, (now the symbol is JAVA) but only because I sold some place in the low 60's (split adjusted). I just wish I had shorted it.

The same is true of mutual funds - re-evaluate at least every 6 months.

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Author: SethNC One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59454 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 2:50 PM
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I just posted a long list of funds that have out-performed the S&P 500.

I don't think many people would consider 1-2 years the long-term. Many funds beat their index over such a short period. Very few beat their index every year over a 5 year period and almost zero funds beat their index every year (or even on average) over a 10 year period.

To the OP: I would agree with the other advice you have received. Put the bulk of your money in various index funds and then use 20%-30% as "play" money.

You mention that you may be above average. That very well may be true, but above average is not good enough. There are only a handful of managers ever to beat their index every single year for a long period of time. Peter Lynch and Bill Miller being two of the most notable.

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Author: joelxwil Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59458 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 3:32 PM
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Many funds beat their index over such a short period. Very few beat their index every year over a 5 year period and almost zero funds beat their index every year (or even on average) over a 10 year period.

That is why you re-evaluate your funds regularly. If one begins to fall behind, dump it and replace it.

But there is no reason to use the S&P 500 as a benchmark anyway. Other domestic indices beat it from time to time, and recently nothing has beaten the emerging markets.

Best to go where the action is, so long as you are willing to get out if the fund begins to under perform.

I am trading a mechanical system which moves in and out of some ETFs, mostly foreign and domestic indices. It has trounced the S&P, even without market timing, which I also employ.

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59461 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 4:24 PM
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..."You're young, invest aggressively, you can deal with the risk and volatility since you won't need this money for 10+ years. Your best bet is to build a small portfolio of high-quality growth stocks".....

You also need to consider that if you loose $10,000 now that that loss will also cut down your retirement money dramatically since it will not compound for many decades. For example a stock portfolio might be expected to double every ten years(after inflation). If you are 25 now, by the time you are 85 that $10K could have doubled 6 times and be worth $320K in today’s dollars!.

...Although I'm disheartened at the level and tone of advertising that these services have developed,...

Go to a used book store or library and check out a Motley Fool book from the mid to late 90’s and look what they had to say about newsletters back then.

...I've been very impressed by the quality of these products...

Over the years they have probably had 20 different portfolios or newsletters. It is not surprising that the ones that remain look good. Google “survivorship bias”.

Over the last five years the NASDAQ 100 has more than doubled after the dot com crash.

http://finance.yahoo.com/q/bc?s=QQQQ&t=5y

One of my pet peeves about the advertisements is that sometimes compare their results to the S&P 500 index but lots of the stock that are recommended are not part of the S&P 500


Greg

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59462 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 4:47 PM
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...If you are 25 now, by the time you are 85 that $10K could have doubled 6 times and be worth $320K in today’s dollars!.


A math error, that should have been $640K

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Author: epc53 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59463 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 5:47 PM
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Watty56 said:

...If you are 25 now, by the time you are 85 that $10K could have doubled 6 times and be worth $320K in today’s dollars!.


A math error, that should have been $640K
-------------------------------------------

epc replies:
You also made a logic error in that in 2067 those $640 will be
in 2067 dollars.

To put that into today's dollars you'd have to deflate that number
by 60 years worth of inflation/deflation.

example: iif there were 2% annual inflation over 60 years
(1.02 ** 60) = 3.281030

$640K / 3.281030 = $195,060 in 2007 dollars.

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Author: pedorrero Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59464 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 7:03 PM
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OP sounds like he has most of his facts right. The consensus (at least, among those not offering stock or investing services) is that you can't do better than the market, so an inexpensive index fund is almost the best way to go. Your choices in a retirement plan may be limited. However, such gurus as Bogle recommend 100% invested in stock funds for most folks.

Picking stocks that beat the market is, long term, a fool's errand. The big enemies are the commissions the "Wise" collect off your trading. The more you subscribe to newsletters (the Fool's included, alas), the more you trade, the more the Wise make off you, and the lower your returns.

It's human nature ("behavioral investing") to try to beat the market. Good advice is to allot part of your capital for your own trading: perhaps 10 or 20%. Buy and sell stocks you pick, or someone else does. Somebody recommended that. Probably good advice. If you trade infrequently, and diversify, you'll probably perform close to a similar index.

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59465 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 9:44 PM
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...You also made a logic error in that in 2067 those $640 will be
in 2067 dollars.

To put that into today's dollars you'd have to deflate that number
by 60 years worth of inflation/deflation....


My assumption was that the historical average return was around 10.5% and after inflation you might conveniently clear 7.2% after adjusting for inflation. By the “rule of 72” it would double in around ten years.

so the values at different ages would be;

10K at 25
20K at 35
40k at 45
80K at 55
160K at 65
320K at 75
640K at 85

Admittedly this is VERY rough but it already takes inflation into account.

Greg

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Author: alchook Big gold star, 5000 posts 10+ Year Anniversary! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59466 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 10:00 PM
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I guess the reason that I ask this question is because I'm thinking about using one of the Fool's advisory services - either Stock Advisor or Hidden Gems. Although I'm disheartened at the level and tone of advertising that these services have developed, I've been very impressed by the quality of these products (I did the free trials a while back), and if you look at their performance (although admittedly fairly short-term), they've outperformed the market by a good deal.

Be careful about that.

I read a promo for the one of the TMF newsletters once. It bragged that since inception it had returned 28% vs. 8% for the S&P 500.

I did a quick search and noticed that the MSCI World Index had returned 31% over the same time period.

There are markets and there are markets. The US stock market has lagged the rest of the world for quite some time. You pretty much needed to at it to under perform the S&P 500 over the past 4-5 years.

The one advice I might give you is to pick a sensible strategy and avoid chasing whatever did well last year. At your age you'll probably do well with index funds. If you pick stocks carefully you'll likely do well.

You won't do well buying what you should have bought a year ago.

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Author: KlangFool One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59467 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 10:04 PM
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Luke,

I agree with what other posted. But, I will give you a different point of view of why it makes sense.

1) Majority of my money is in index fund (90%)

2) Less than 10% of my money is in individual stocks.

For (2), why do you want to just beat the market?? If you are just going to beat the market by 5% to 10%, why bother?? You will be spending a lot of your time picking and monitoring the stock. You want to double or triple your money or it is not worth your effort. Now, if you are aiming for risky and high pay back stock investment, you do not need that much money for you investment / speculation to be worthwhile. 5% to 10% of your portfolio is more than enough if you bet correctly.

In my opinion, the main portfolio (1) will generate on the average annual return of 9%. For me to invest on any stock, it has to double or triple or it is NOT worth my effort.

KlangFool

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Author: epc53 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59468 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/6/2007 11:09 PM
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Watty56 said:
My assumption was that the historical average return was around 10.5% and after inflation you might conveniently clear 7.2% after adjusting for inflation. By the “rule of 72” it would double in around ten years.
------------------------------------------------------------------

Yes, that's quite reasonable.
I beg your pardon.

Ed

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59474 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/7/2007 12:05 PM
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...Yes, that's quite reasonable...

No problem, over that sort of time period, the results of compounding interest seems does come up with some numbers that do seem too high.

Greg

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Author: LGM2007 One star, 50 posts Old School Fool Motley Fool One Everlasting Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59490 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/8/2007 12:45 PM
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Here's another view along with one man's experiences - you may identify with some of these ideas and want to give it a try - if not, there's nothing wrong with index funds either:

- Part (and I do mean part) of why professional money managers (and here, I mean mutual fund managers) don't beat their benchmarks is due to the limitations they have placed on them - such as specific industries they can/can't invest in, specific market caps they can't touch, etc. An individual investor doesn't have these issues - you can buy anything, of any size, use options, vary your mixes, etc. That's one reason why hedge funds have become so popular. But that's an entirely different issue and I'm not recommending that route.

- I use 3 TMF advisory services. Yeah, I know they had newsletters that may have failed in the past and are no longer around. But an inventor may also fail several times before getting it right. I can't vouch for their future viability, but I've made enough outsized returns (as defined by comparison to appropriate benchmarks) in the past 3 years that I could endure a bad year or so (when I would switch courses) and still be ahead of the game. And though some of TMF's advertisements look like they were written by used car salesmen (oversensationalized), it doesn't change their results.

- The Hulbert Financial Digest is an independant (as far as I know) source that provides the performance of newsletters. There are many that have been beating index returns for 10 and 20 years. There are many many more that haven't, but if you use letters that have been successful and cherry pick their suggestions (based on which ones they are highest on), it can be done.

- You should only buy individual stocks if you will commit to following them and being critical of what you read. And it helps if you enjoy it as well - i.e. don't consider investing a chore, but almost a hobby as well as a necessity (to fund your retirement).

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Author: 2old4bs Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59498 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/8/2007 2:13 PM
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I think I have basically two options. Either invest in no-load index funds like the s & p 500, or try to beat the market by selecting individual stocks to hold for the long term.

Even 'basically' you have far more options than just the two you mentioned.

I agree with other posters that if you like to spend your time researching and following individual stocks, simply decide on a set percentage of your portfolio that you will do this with. I would determine that percentage by asking myself "What percentage of my portfolio am I willing to lose 70% of?" The preceding question is framed just this way based upon the tech decline in year 2000--if all your stock picks were in tech, you were down about 70%.

But as joelxwill pointed out, you don't marry a mutual fund (nor stock) position. If either is a dog, you can always get out.

I happen to rotate in and out of certain market sectors via mutual funds as they come into, and go out of, favor. I do that with a percentage of my portfolio, while the bulk of my portfolio is in index funds.

However, I believe that any investing style other than straight indexing requires an awful lot of time and attention. Only you can decide for yourself whether or not you're willing to do that. As KlangFool noted, if an individual stock isn't going to at least double, why bother with all the work? And for each one that doubles, you might have 2 or 4 that don't, so if you average the return overall, it might just not be worth the work.

If I were in your position right now, I would read "The Four Pillars of Investing" to help you determine an allocation for the major portion of your portfolio. After you've done that you can decide what portion of your port you're willing to 'play' with, and how.

2old

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Author: BordLyron Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59529 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/9/2007 10:01 PM
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The more you subscribe to newsletters (the Fool's included, alas), the more you trade, the more the Wise make off you, and the lower your returns.

pedorrero


I don't agree. I have subscribed to two MF newsletters (SA for over three years, HG for over two) & trading has certainly been discouraged by both. Sell recommendations are rare & well-reasoned.

For what it's worth, my personal opinion is that you already have about half of your savings going into funds (which hopefully can match market average returns), and I do believe that long-term, you can beat the market averages by selecting quality companies with the other half (If you haven't read it yet, find a copy of Peter Lynch's book: One up on Wall Street). On the other hand, I don't have the expertise or time to find those companies on my own, so I am quite happy to rely on these newsletters, which have helped me more than double market returns (granted, for a short period of time).

Finally, I echo all other respondents about the shilling of these services! It is rare, if ever, that an article doesn't end with a sophomoric "so if you want to know more about how to... try a free trial of...".

Ugh.

Byron

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Author: sunshinebottom Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 59533 of 76419
Subject: Re: Index fund investing versus stock selection Date: 10/10/2007 10:54 AM
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Take some time and do some reading. 4 Pillars, Random Walk Down Wall Street--a good easy read is the new Larry Swedroe's Wise Investing Made Simple. Go on the index board--wander over the diehards.org. After digesting some of this, then make your decisions about investing in stocks.

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