Author Topic: inexperience investor question  (Read 8336 times)

johnny_b123

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inexperience investor question
« on: November 25, 2014, 12:04:05 PM »
I have two stocks which have low dividend yields (~2%) but both have increased in price by about 13% within the three months. I would have been happy for 5% over a year. they are in a tax free savings account so no capital gains are applicable.

The amount they've appreciated in this short time is far more than the dividends they would have paid for a couple years. Both companies are large have bright futures and relatively low P/Es compared to others in their sectors. I'm thinking about selling both of them and picking up something with a higher dividend yield that's at a better price right now (maybe oil related).

Would a more experienced investor comment on how they would view this situation after some of their own successes and failures?

randommadness

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Re: inexperience investor question
« Reply #1 on: November 25, 2014, 12:40:14 PM »
What stocks do you have, and which would you consider picking up instead?

lielec11

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Re: inexperience investor question
« Reply #2 on: November 25, 2014, 12:44:05 PM »
It depends on your short and long term goals. As a long term investor I would probably just hold both and accumulate dividends over the years despite the price adding to the stock at appropriate valuations. If you're looking to "get rich quick" so to speak, then you may want to sell and re-invest the money into higher yielding stocks. However, you mention they're both large companies with bright futures. If you truly believe in them why not invest more, while simultaneously finding yield elsewhere?

One other thing..I always come across recommendations from other (and much more wise) investors stating "don't chase yields". Keep that in mind as well.

Just my two cents...

skyrefuge

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Re: inexperience investor question
« Reply #3 on: November 25, 2014, 12:48:45 PM »
I have two stocks which have low dividend yields (~2%) but both have increased in price by about 13% within the three months. I would have been happy for 5% over a year.

You're picking individual stocks, and you would have been happy with 5% return a year? Why in the world would you have been happy with that? Would you also be happy with lighting your money on fire? Vanguard's Total Stock Market Index fund has returned 17% in the last year. Why not just buy that, hold it, and never have to think about buying and selling stocks again?

The amount they've appreciated in this short time is far more than the dividends they would have paid for a couple years.

Yes, you should expect most stocks to provide more return via price-appreciation than via dividends, especially ones with 2% dividend yields. No one invests in stocks to get only a 2% return.

Both companies are large have bright futures and relatively low P/Es compared to others in their sectors.

Your title and the decisions you've already made reveal you to be an inexperienced investor, so realize that you have no real basis for this opinion. Even experienced investors greatly overestimate their ability to know things that the rest of the market doesn't know (and thus, has already factored into the current price of the stock). For someone like you, you're almost asking to have your money taken from you by playing this game.

I'm thinking about selling both of them and picking up something with a higher dividend yield that's at a better price right now (maybe oil related).

Why? Certainly I highly recommend selling them, since I don't think you should be messing around with individual stock trading at this point, but why do you want something with a higher dividend yield? What possible use do you have for dividends? Especially since they're in a tax-sheltered account, where you can't access the dividend payment anyway.

Would a more experienced investor comment on how they would view this situation after some of their own successes and failures?

Stop trading individual stocks. Read http://jlcollinsnh.com/stock-series/ to learn why, and what you should do instead.

Dodge

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Re: inexperience investor question
« Reply #4 on: November 25, 2014, 01:55:25 PM »

I have two stocks which have low dividend yields (~2%) but both have increased in price by about 13% within the three months. I would have been happy for 5% over a year.

You're picking individual stocks, and you would have been happy with 5% return a year? Why in the world would you have been happy with that? Would you also be happy with lighting your money on fire? Vanguard's Total Stock Market Index fund has returned 17% in the last year. Why not just buy that, hold it, and never have to think about buying and selling stocks again?

The amount they've appreciated in this short time is far more than the dividends they would have paid for a couple years.

Yes, you should expect most stocks to provide more return via price-appreciation than via dividends, especially ones with 2% dividend yields. No one invests in stocks to get only a 2% return.

Both companies are large have bright futures and relatively low P/Es compared to others in their sectors.

Your title and the decisions you've already made reveal you to be an inexperienced investor, so realize that you have no real basis for this opinion. Even experienced investors greatly overestimate their ability to know things that the rest of the market doesn't know (and thus, has already factored into the current price of the stock). For someone like you, you're almost asking to have your money taken from you by playing this game.

I'm thinking about selling both of them and picking up something with a higher dividend yield that's at a better price right now (maybe oil related).

Why? Certainly I highly recommend selling them, since I don't think you should be messing around with individual stock trading at this point, but why do you want something with a higher dividend yield? What possible use do you have for dividends? Especially since they're in a tax-sheltered account, where you can't access the dividend payment anyway.

Would a more experienced investor comment on how they would view this situation after some of their own successes and failures?

Stop trading individual stocks. Read http://jlcollinsnh.com/stock-series/ to learn why, and what you should do instead.

Great answer. I hope he/she listens!

index

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Re: inexperience investor question
« Reply #5 on: November 25, 2014, 02:26:04 PM »
I have two stocks which have low dividend yields (~2%) but both have increased in price by about 13% within the three months. I would have been happy for 5% over a year.

You're picking individual stocks, and you would have been happy with 5% return a year? Why in the world would you have been happy with that? Would you also be happy with lighting your money on fire? Vanguard's Total Stock Market Index fund has returned 17% in the last year. Why not just buy that, hold it, and never have to think about buying and selling stocks again?

His stocks went up 13% in a quarter not 12 months. This is a 52% roi, significantly more than VTI.

There is nothing wrong with individual stocks, but your holding period should be more than a few months. Either the company can compound faster than the general market or it cannot. If the 13% run up is supported by fundamentals and the companies have room to keep growing, then keep them. If not sell them.

Asking if you should buy something because it has a higher dividend shows you don't understand what you are doing with your money. In which case, you should buy VTI.

I would recommend reading a few books in order to understand how the market works, even if you don't plan on buying individual stocks again. The Intelligent Investor, Buffet's Letters, and Margin of Safety are a good place to start.

Dodge

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Re: inexperience investor question
« Reply #6 on: November 25, 2014, 03:34:07 PM »

There is nothing wrong with individual stocks

If he/she understands that holding individual stocks over the long term is almost certainly (99.4% chance assuming you're an expert who does it for a living) going to result in less money, then sure, nothing's wrong with it. Just make sure you know what you're getting into.

index

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Re: inexperience investor question
« Reply #7 on: November 25, 2014, 04:23:18 PM »

There is nothing wrong with individual stocks

If he/she understands that holding individual stocks over the long term is almost certainly (99.4% chance assuming you're an expert who does it for a living) going to result in less money, then sure, nothing's wrong with it. Just make sure you know what you're getting into.

This is not true. The study you are referring to said after fees only 0.6% of funds showed statistical evidence of being the market. An individual invester does not have those fees, size restrictions, window dressing, and redemptions to deal with. There is nothing magical about indexing. It is only glorified because most do not have the financial literacy to do it themselves and it saves tremendously on active management fees.

If you choose 500 stocks at random keeping constant with market cap and sector, and do not sell for a market cycle, you have a 50/50 chance of beating the market.

Dodge

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Re: inexperience investor question
« Reply #8 on: November 25, 2014, 05:47:45 PM »

There is nothing wrong with individual stocks

If he/she understands that holding individual stocks over the long term is almost certainly (99.4% chance assuming you're an expert who does it for a living) going to result in less money, then sure, nothing's wrong with it. Just make sure you know what you're getting into.

This is not true. The study you are referring to said after fees only 0.6% of funds showed statistical evidence of being the market. An individual invester does not have those fees, size restrictions, window dressing, and redemptions to deal with. There is nothing magical about indexing. It is only glorified because most do not have the financial literacy to do it themselves and it saves tremendously on active management fees.

If you choose 500 stocks at random keeping constant with market cap and sector, and do not sell for a market cycle, you have a 50/50 chance of beating the market.

Yes, but the individual investor is also significantly less knowledgeable, has significantly less access to information, puts significantly less time into it, and has significantly less training.  I actually agree with you, if we're talking about the individual investor, and a long timeline (50 or so years until you die), it's likely closer to 99.99999% who will end up with less money.  But I have no data for that one :)

Correct, the 0.6% success rate mentioned was after fees and such, but how big would your fees be with buying those 500 stocks, keeping them rebalanced, reinvesting dividends, extra time spent managing it (time = money after all)...etc?  I wouldn't be surprised if it were higher the 0.05% Vanguard charges for the 3,784 stocks currently in VTSAX.  I'd be interested in hearing an estimate if you have one.

I'd argue that the 500 random stock portfolio in your example has a lower risk-adjusted return, due to less diversification, higher incidence of human error, and probably higher fees.  Indexing is glorified because it's a guaranteed way to beat or match at least half of the dollars invested in the market each year, every single year, for as long as your investing horizon happens to be.  When the gains are compounded, it's incredibly difficult to beat this.  If your portfolio has just one bad year, it will likely never catch up to the market.

Druid

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Re: inexperience investor question
« Reply #9 on: November 25, 2014, 05:51:47 PM »
I find it funny that the guy named Index is a proponent of individual stock investing. I am not taking sides in this debate, but I am saddened that Index took the name from someone who could of held it with more conviction:(

You guys have a link to that study, or at least a study name..
« Last Edit: November 25, 2014, 05:54:09 PM by Druid »

lielec11

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Re: inexperience investor question
« Reply #10 on: November 25, 2014, 06:44:10 PM »

There is nothing wrong with individual stocks

If he/she understands that holding individual stocks over the long term is almost certainly (99.4% chance assuming you're an expert who does it for a living) going to result in less money, then sure, nothing's wrong with it. Just make sure you know what you're getting into.


What about long term investors who invest in blue chip DGI stocks (i.e. JNJ, XOM, PG, etc. etc.), are they part of the 99.4% of people? I'm sure if you took a read over seekingalpha.com you'd find plenty of people who do much more than NOT lose money.

Dodge

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Re: inexperience investor question
« Reply #11 on: November 25, 2014, 06:48:00 PM »
I find it funny that the guy named Index is a proponent of individual stock investing. I am not taking sides in this debate, but I am saddened that Index took the name from someone who could of held it with more conviction:(

You guys have a link to that study, or at least a study name..

I got the quote from here:

http://jlcollinsnh.com/2013/02/05/stocks-part-xv-index-funds-are-really-just-for-lazy-people-right/

Dodge

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Re: inexperience investor question
« Reply #12 on: November 25, 2014, 06:58:08 PM »

There is nothing wrong with individual stocks

If he/she understands that holding individual stocks over the long term is almost certainly (99.4% chance assuming you're an expert who does it for a living) going to result in less money, then sure, nothing's wrong with it. Just make sure you know what you're getting into.

What about long term investors who invest in blue chip DGI stocks (i.e. JNJ, XOM, PG, etc. etc.), are they part of the 99.4% of people? I'm sure if you took a read over seekingalpha.com you'd find plenty of people who do much more than NOT lose money.

It is very possible to make money while still underperforming the market.

I am sure those 99.4% of professional investors are aware of blue chip DGI stocks.

KC1983

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Re: inexperience investor question
« Reply #13 on: November 25, 2014, 08:26:26 PM »
"There is nothing wrong with individual stocks"

If you're talking about investing in just a few stocks, then yes, there is plenty wrong with it. The odds of losing most of your investment is vastly higher than it is if you invest in an index fund. You are essentially gambling. There is a small potential upside of outperforming the market, and a substantial downside of not only underperforming, but losing it all. I know several people who thought investing in 2 or 3 blue chip stocks was a smart move, and who went on to deeply regret it. If you're holding 2 or 3 individual stocks, and those stocks are companies like P&G, Exxon, and Wells Fargo, then it's less of a gamble, but it's still riskier than VTSAX.

"An individual invester does not have those fees, size restrictions, window dressing, and redemptions to deal with."

Maybe I'm misunderstanding you, but I think you're dead wrong here. The fees for trading individual stocks are much higher than the fees for an index fund like VTSAX. The individual investor has traditionally been screwed on fees compared to institutional investors. It's less of a hammering now than it used to be, but the cost of trading individual stocks is still much higher than it is to invest in index funds.

"There is nothing magical about indexing. It is only glorified because most do not have the financial literacy to do it themselves and it saves tremendously on active management fees."

You fundamentally misunderstand why index funds usually outperform actively managed funds and almost always outperform individual investors. Please do more research before you offer advice like this.

"If you choose 500 stocks at random keeping constant with market cap and sector, and do not sell for a market cycle, you have a 50/50 chance of beating the market."

Again, maybe I misunderstand you, but the OP was talking about trading two stocks, which I assume make up a significant portion of their total investments. You give an example of someone virtually recreating an index fund on their own with 500 stocks! Who does that? What's the relevance? And you're wrong that it would be a 50/50 chance of outperforming the market. An individual would pay vastly higher fees than Vanguard to buy 500 stocks and maintain their proportions relative to sector and market cap. The overall performance might be similar (dividends and increases in value), but the trading fees would crush you compared to a Vanguard index fund. This 500-stock portfolio would probably outperform most random 2-stock portfolios over the long run, but it would but a very difficult and silly effort.

Terrestrial

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Re: inexperience investor question
« Reply #14 on: November 25, 2014, 08:56:47 PM »
"An individual invester does not have those fees, size restrictions, window dressing, and redemptions to deal with."

Maybe I'm misunderstanding you, but I think you're dead wrong here. The fees for trading individual stocks are much higher than the fees for an index fund like VTSAX. The individual investor has traditionally been screwed on fees compared to institutional investors. It's less of a hammering now than it used to be, but the cost of trading individual stocks is still much higher than it is to invest in index funds.

What is the basis for this claim.  This might be true if you are trading in small increments or have a broker with an exorbitant commission schedule, but its certainly not an ironclad rule.  I pay a flat $6 commission for trades up to 1000 shares and my normal volume is about 10k per transaction.  I have friends wealthier or older than I with much larger accounts who move money in even larger increments. 

As I see it this is ~0.06% to enter a stock position, comparable to even the very lowest yearly fees on Vanguard Admiralty share funds.  As it does take a commission to close out the position my total commissions per 10k of initiated transactions will be approximately 0.12%.  The difference is, if I hold this position for 5, 10, 20 years, that still all I will ever pay.  There is no ongoing fee for holding stocks.  The 0.07% the Vanguard admiralty shares charge hits you up every year.  Even ignoring loss of earnings on your yearly fees, depending on the holding period or transaction size it can be less expensive to hold stocks..maybe substantially so.  Even turning over my stocks once every year or two it would be close enough that I would consider it comparable, far from the 'much higher' costs that you stipulate.  This isn't an argument for or against individual stocks vs funds...just a debunking of the false statement that just because stocks have commissions doesn't mean it's vastly more expensive than using index funds in terms of investment fees.

I should also note that I don't think that's even really what the poster was referring to anyway.  He was referring to the fact that funds have restrictions on what they can/must buy according to their prospectus/charter (some cannot buy stocks below X market cap, or who don't pay a dividend, etc etc etc), and periodically must take action that may not be the 'preferable' course of action but that they are required to do, such as having to sell bunch of shares to deal with heavy redemptions (what if it's a temporary dip and it's a horrible time to be selling stock), selling a stock because it gets de-listed from the index it tracks, or buying a stock because it gets added to the index.
« Last Edit: November 25, 2014, 09:49:51 PM by Terrestrial »

Terrestrial

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Re: inexperience investor question
« Reply #15 on: November 25, 2014, 09:13:27 PM »
I have two stocks which have low dividend yields (~2%) but both have increased in price by about 13% within the three months. I would have been happy for 5% over a year. they are in a tax free savings account so no capital gains are applicable.

The amount they've appreciated in this short time is far more than the dividends they would have paid for a couple years. Both companies are large have bright futures and relatively low P/Es compared to others in their sectors. I'm thinking about selling both of them and picking up something with a higher dividend yield that's at a better price right now (maybe oil related).

Would a more experienced investor comment on how they would view this situation after some of their own successes and failures?

OP:

-Why would you be happy with 5% over a year.  You are taking the risk of an individual stock and would be willing to accept a return less than what could be expected from the broad market index, with corresponding far less risk?  If you invest in individual stocks you should expect higher returns to compensate you for that risk, otherwise what's the point.   

-You own investing dialogue has no logic.  'Both stocks have low P/E's and bright futures'...and you want to sell these reasonably valued companies with great prospects for future earnings??  Are you sure your assessment of these companies is correct?

-Buying oil stocks right now could be construed as what's commonly referred to as 'trying to catch the falling knife'.  Maybe oil related stocks are bottoming and represent value and will be 20% higher 6 months from now...or maybe oil's going to 60 due to a massive supply glut and weakening demand and they still have another 20% of pounding left in them. I don't know, you don't know.  Rid yourself of the false reasoning that just because something has come down substantially it represents a 'better price', or that they are likely/guaranteed to return to their highs in any timely fashion.  Frankly you are often better off investing in things that have a strong thesis and positive momentum than trying to pick the right turnaround story out of the dumpster.

-Dividends are nice but at least for me, rarely the focus of my investments or where I expect to generate the bulk of my returns.  I'll always take a dividend, and it may help break the tie between two or three investments i'm considering, but I don't chase yield, I seek out quality companies that will grow their earnings and are likely to appreciate, or as you seem to view it, exactly the kind of companies you want to sell.  I know there are dividend oriented investors out there and there are a variety of reasons for that which are sound...so I will not claim that mine is the 'best/correct/only' approach.  Also, for reference, even the Vanguard total market eft (VTI) yields around 2%.
« Last Edit: November 25, 2014, 09:35:08 PM by Terrestrial »

index

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Re: inexperience investor question
« Reply #16 on: November 25, 2014, 09:40:21 PM »

Yes, but the individual investor is also significantly less knowledgeable, has significantly less access to information, puts significantly less time into it, and has significantly less training.  I actually agree with you, if we're talking about the individual investor, and a long timeline (50 or so years until you die), it's likely closer to 99.99999% who will end up with less money.  But I have no data for that one :)

Correct, the 0.6% success rate mentioned was after fees and such, but how big would your fees be with buying those 500 stocks, keeping them rebalanced, reinvesting dividends, extra time spent managing it (time = money after all)...etc?  I wouldn't be surprised if it were higher the 0.05% Vanguard charges for the 3,784 stocks currently in VTSAX.  I'd be interested in hearing an estimate if you have one.

I'd argue that the 500 random stock portfolio in your example has a lower risk-adjusted return, due to less diversification, higher incidence of human error, and probably higher fees.  Indexing is glorified because it's a guaranteed way to beat or match at least half of the dollars invested in the market each year, every single year, for as long as your investing horizon happens to be.  When the gains are compounded, it's incredibly difficult to beat this.  If your portfolio has just one bad year, it will likely never catch up to the market.

The paper you are referring to is here:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869748

If you read the paper it says 24% of managers had negative alpha after fees. This means that 76% of managers actually did beat the market. They just didn't best it enough to cover the transaction costs and fees.

Transaction costs average 1.4%, fees 1.08%.

This means that 76% of mutual funds, on average, beat the market by ~2.5%. The client just never realizes any of these gains.

I actually have most of my assets in index funds, but I think it is a disservice to vilify owning individual companies.

There is a lot wrong with indexing methodology. The majority of indexes are cap weighed which increases holdings in hot stocks and decreases holdings in it off favor companies. It tilts indexes to favor mega cap companies over small caps. Stocks also have to have liquidity to be in an index. Berkshire wasn't part of the S&P until they did a 50:1 split four the b shares.

Look into equal weighed indexes. They statistically outperform cap weighed indexes.

Also, look into the actual effects of indexing on individual companies. Look up Murray Stahl's papers that compare p/b and p/e ratios for indexed companies vs non indexed companies.

Kc,

In taking about having a portfolio of 20-30 stocks, not 3.

The 500 stock argument was hyperbole. Of course you cannot buy 500 stocks cheaply enough to make sense. However, on paper a monkey selecting 50 stocks to be equal weighed in an index has has a 50/50 chance of outperforming the index.

You need to read some books on why mutual fund managers have a hard time beating the market.

 Size restrictions (having to buy certain sized companies) liquidity restrictions (being able to buy thousands of shares easily), fees (sec reporting, keeping the lights on, trading fees), widow dressing (you may think spoke is undervalued but have to sell because clients don't want to see it I in the portfolio after it goes from 700 to 450).

Read margin of safety by Seth klareman. It won't hurt you to understand how the industry and the markets work a little better.

BTW, if you have 100k at interactive brokers. You can absolutely maintain a 30 stock portfolio with rebalancing for less money than holding 100k at vanguard for 0.05%.

BTW, I advised the op to buy an index fund. I just refuted what skyrefuge was saying. Ex: he didn't comprehend the original post, and was parroting to just index because that's what he does. He asked for advice on individual stocks. I suggested he index because he didn't seem to grasp what he was doing, but offered ac few books in case he wanted to learn how financial markets work.






KC1983

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Re: inexperience investor question
« Reply #17 on: November 25, 2014, 10:19:21 PM »
"An individual invester does not have those fees, size restrictions, window dressing, and redemptions to deal with."

Maybe I'm misunderstanding you, but I think you're dead wrong here. The fees for trading individual stocks are much higher than the fees for an index fund like VTSAX. The individual investor has traditionally been screwed on fees compared to institutional investors. It's less of a hammering now than it used to be, but the cost of trading individual stocks is still much higher than it is to invest in index funds.

What is the basis for this claim.  This might be true if you are trading in small increments or have a broker with an exorbitant commission schedule, but its certainly not an ironclad rule.  I pay a flat $6 commission for trades up to 1000 shares and my normal volume is about 10k per transaction.  I have friends wealthier or older than I with much larger accounts who move money in even larger increments. 

As I see it this is ~0.06% to enter a stock position, comparable to even the very lowest yearly fees on Vanguard Admiralty share funds.  As it does take a commission to close out the position my total commissions per 10k of initiated transactions will be approximately 0.12%.  The difference is, if I hold this position for 5, 10, 20 years, that still all I will ever pay.  There is no ongoing fee for holding stocks.  The 0.07% the Vanguard admiralty shares charge hits you up every year.  Even ignoring loss of earnings on your yearly fees, depending on the holding period or transaction size it can be less expensive to hold stocks..maybe substantially so.  Even turning over my stocks once every year or two it would be close enough that I would consider it comparable, far from the 'much higher' costs that you stipulate.  This isn't an argument for or against individual stocks vs funds...just a debunking of the false statement that just because stocks have commissions doesn't mean it's vastly more expensive than using index funds in terms of investment fees.

Index gave an example of buying 500 different stocks and 'keeping constant with market cap and sector' which to me implies making a significant number of trades over relatively short periods of time. I'm quite certain this example would not be cheaper than VTSMX. And of course Index's example assumes the individual investors time has no value. I don't even want to think about the time investment required to do something I can do at Vanguard with a few keystrokes each year.

And your example comparing the costs of owning a single stock for many years to owning VTSMX for many years is comparing apples to oranges. They aren't remotely the same thing, so I don't know what your point is here.

From Index: "You need to read some books on why mutual fund managers have a hard time beating the market. "

I'm kind of blown away by this comment. I have read the books. That's why I recommend VTSMX, not a managed mutual fund (which is I think what you meant). I would also recommend VTSMX to someone trying to manage a 20 or 30 stock portfolio, unless that's how you get your kicks. In the long run that strategy is a lot more trouble, has higher risks, and the majority of non-professional investors are probably going to come out behind. But YMMV, so have at it.


Dodge

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Re: inexperience investor question
« Reply #18 on: November 25, 2014, 10:42:33 PM »

Yes, but the individual investor is also significantly less knowledgeable, has significantly less access to information, puts significantly less time into it, and has significantly less training.  I actually agree with you, if we're talking about the individual investor, and a long timeline (50 or so years until you die), it's likely closer to 99.99999% who will end up with less money.  But I have no data for that one :)

Correct, the 0.6% success rate mentioned was after fees and such, but how big would your fees be with buying those 500 stocks, keeping them rebalanced, reinvesting dividends, extra time spent managing it (time = money after all)...etc?  I wouldn't be surprised if it were higher the 0.05% Vanguard charges for the 3,784 stocks currently in VTSAX.  I'd be interested in hearing an estimate if you have one.

I'd argue that the 500 random stock portfolio in your example has a lower risk-adjusted return, due to less diversification, higher incidence of human error, and probably higher fees.  Indexing is glorified because it's a guaranteed way to beat or match at least half of the dollars invested in the market each year, every single year, for as long as your investing horizon happens to be.  When the gains are compounded, it's incredibly difficult to beat this.  If your portfolio has just one bad year, it will likely never catch up to the market.

The paper you are referring to is here:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869748

If you read the paper it says 24% of managers had negative alpha after fees. This means that 76% of managers actually did beat the market. They just didn't best it enough to cover the transaction costs and fees.

Transaction costs average 1.4%, fees 1.08%.

This means that 76% of mutual funds, on average, beat the market by ~2.5%. The client just never realizes any of these gains.

I actually have most of my assets in index funds, but I think it is a disservice to vilify owning individual companies.

There is a lot wrong with indexing methodology. The majority of indexes are cap weighed which increases holdings in hot stocks and decreases holdings in it off favor companies. It tilts indexes to favor mega cap companies over small caps. Stocks also have to have liquidity to be in an index. Berkshire wasn't part of the S&P until they did a 50:1 split four the b shares.

Look into equal weighed indexes. They statistically outperform cap weighed indexes.

Also, look into the actual effects of indexing on individual companies. Look up Murray Stahl's papers that compare p/b and p/e ratios for indexed companies vs non indexed companies.

Kc,

In taking about having a portfolio of 20-30 stocks, not 3.

The 500 stock argument was hyperbole. Of course you cannot buy 500 stocks cheaply enough to make sense. However, on paper a monkey selecting 50 stocks to be equal weighed in an index has has a 50/50 chance of outperforming the index.

You need to read some books on why mutual fund managers have a hard time beating the market.

 Size restrictions (having to buy certain sized companies) liquidity restrictions (being able to buy thousands of shares easily), fees (sec reporting, keeping the lights on, trading fees), widow dressing (you may think spoke is undervalued but have to sell because clients don't want to see it I in the portfolio after it goes from 700 to 450).

Read margin of safety by Seth klareman. It won't hurt you to understand how the industry and the markets work a little better.

BTW, if you have 100k at interactive brokers. You can absolutely maintain a 30 stock portfolio with rebalancing for less money than holding 100k at vanguard for 0.05%.

BTW, I advised the op to buy an index fund. I just refuted what skyrefuge was saying. Ex: he didn't comprehend the original post, and was parroting to just index because that's what he does. He asked for advice on individual stocks. I suggested he index because he didn't seem to grasp what he was doing, but offered ac few books in case he wanted to learn how financial markets work.

You think you have a good chance to consistently beat the market over the long term (typically 30-60 years) with 20-30 hand-picked stocks, because you have the financial literacy to do it yourself and you keep your fees low with a discount broker?  For any new investors in the thread (it is a thread for inexperienced investors after all) I recommend watching video #3 - , from:

http://www.bogleheads.org/wiki/Video:Bogleheads®_investment_philosophy


Terrestrial

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Re: inexperience investor question
« Reply #19 on: November 26, 2014, 06:17:19 AM »

And your example comparing the costs of owning a single stock for many years to owning VTSMX for many years is comparing apples to oranges. They aren't remotely the same thing, so I don't know what your point is here.


As I gave my example as an expense rate per 10k invested, my example could also be expanded to apply to a 500k account where one bought from 25 to 50 stocks in 10-20k allocations, vs one large chunk of 500k of VTSMX...not an  unrealistic scenario, 25-50 different stocks is enough diversification to reasonably approximate market performance for the purposes of this discussion, albeit with a larger expected beta.  As long as you are only turning over your stocks once every year or two, the fees spent will be roughly the same.

Again I wasn't saying this approach was superior, recommended, or that I even do this (I don't), just that the reason to not do it is not because the trading fees would be unreasonable or vastly higher, which is what you stipulated.  Saying something is not a good investing approach because it takes too long, carries more risk than it's anticipated reward would dictated is appropriate, etc are valid reasons that something like this is probably not optimal for people. Saying it is because fees will eat you up is not.

For my personal portfolio I hold a large majority in index type funds, but do have a portion allocated to some individual stocks.  So I was also pointing out that in this case, which I would imagine is fairly common for investors, my trading/investing fees across both types of securities I hold are roughly the same.
« Last Edit: November 26, 2014, 07:47:23 AM by Terrestrial »

skyrefuge

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Re: inexperience investor question
« Reply #20 on: November 26, 2014, 07:38:02 AM »
Okay, okay boys, settle down!

I don't think this thread is a very good place to debate whether market-beating is possible/likely/easy. That's a question that's pretty difficult to answer, mostly because it's so difficult to tease out skill from luck.

But this is a specific person in a specific situation, where the answer is much less debatable. I think we all agree that in this case, the OP, at his current state of education, is highly unlikely to beat the market, and thus, continuing down his current/proposed path is not recommended.

Can I get an A-MEN?

His stocks went up 13% in a quarter not 12 months. This is a 52% roi, significantly more than VTI.

Yeah, I know. I brought up VTI to compare it to the 5%/year expectation that he would have been happy with, not his 13% quarter-to-date result.

Dodge

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Re: inexperience investor question
« Reply #21 on: November 26, 2014, 08:04:23 AM »

Okay, okay boys, settle down!

I don't think this thread is a very good place to debate whether market-beating is possible/likely/easy. That's a question that's pretty difficult to answer, mostly because it's so difficult to tease out skill from luck.

But this is a specific person in a specific situation, where the answer is much less debatable. I think we all agree that in this case, the OP, at his current state of education, is highly unlikely to beat the market, and thus, continuing down his current/proposed path is not recommended.

Can I get an A-MEN?

You're right! Don't think anyone disagrees with this. Might as well close the thread :)

index

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Re: inexperience investor question
« Reply #22 on: November 26, 2014, 08:39:52 AM »
From Dodge -
Quote
Yes, but the individual investor is also significantly less knowledgeable, has significantly less access to information, puts significantly less time into it, and has significantly less training.  I actually agree with you, if we're talking about the individual investor, and a long timeline (50 or so years until you die), it's likely closer to 99.99999% who will end up with less money.  But I have no data for that one :)

The paper he quoted said 75.4% of active mutual fund managers have returns consistent with the market over a long time frame. 0.6% consistently beat the market. 24% returned less than the market after transaction costs and fees. Keep in mind transaction costs and fees average 2.5%

KC and Dodge, I would hope that you educate yourselves on why active managers have a hard time beating the market.

Let's look at at individual investor vs an active mutual fund manager:
 
Transaction Costs and Securities available-
The individual investor can pay as little as $1 per trade on a couple hundred shares or $7 per trade for up to 2k shares. These shares are held at a brokerage. He submits a limit order, and the order is traded electronically. 2k shares represents about 4% of the daily volume of a relatively illiquid stock that trades 50k shares per day.

The fund manager may hold 1M or more shares. That company that trades 50k shares per day, it would take the manager well over a month to establish that position. Does the manager do this?

No, they limit themselves to stocks with more liquidity. This is one of the huge problems with index funds as well. Large well run companies are often not in the indexes because of liquidity ie. Berkshire - 200B at the time and not in the S&P.

If you are a fund manager and want to buy 1 M shares of TWC (an S&P 500 company with good liquidity) it would take you about a week to establish the position. This requires a trader to sit at a desk and manually trade large blocks of shares with other traders. This guy is billing at >$300 an hour. You also cannot say buy or sell XX at $20. These are huge positions. You will buy and sell something between $20-21 after a week your average price may be $20.10 meaning the transaction cost you 0.5% over an individual investor saying sell at $20.

Redemptions-
In 2008 an individual investor holding a IBM had the ability to sell it a buy WFC. (this is an example, it could be any company or group of companies). In this case, the individual investor would have made twice as much money in WFC than in IBM.

In '08 the fund manager was hit with people pulling money out of his fund left and right. He may have wanted to sell IBM to buy WFC, but has to sell IBM to give money back to a client. This is a huge problem for the fund managers and one of the reasons funds with lock up periods - hedge funds - or permanent capital - Berkshire out perform active mutual funds.   

Window dressing-
An individual investor doesn't have to deal with this. They don't answer to clients.

The fund manager has to explain why Apple is their largest holding after the stock tanked from $700 to $450. They often sell a company after a large fall because clients may think: I'm taking my money out, this idiot didn't even predict Apple was going to lose 35%. This is dressing up your quarterly and annual reports to make them look prettier to your clients.

76% of fund manager managed to match the index despite the above working against them and while charging an average fee of 1.08%! I'm not saying this means you should be investing with active managers. I am saying they have a lot working against them and by virtue of matching the market after 2.5% worth of fees and having to deal with redemptions and keeping clients happy the majority are actually beating the indices.

I am spoon feeding this to you all because instead of thinking critically about the article you posted, or typing window dressing, the effect of redemptions, or mutual fund investment universe size limitations into google; you look at a chart and say "see indexing wins!" Indexing provides clients superior returns due to index funds not having to deal with many of the detractors facing active funds. Indexes are not magic and active managers are not stupid. They just cannot outperform the market by >2.5% on a consistent basis.

As far as individual investing in individual stocks or ETFs is concerned. An individual investor could use low cost vanguard ETFs to simulate a more equal weight index that will beat VTSMX. Index funds two largest problems are being market capitalization weighted, and having a smaller universe of companies to add to the index because of liquidity.

VTSMX has a good performance history but you are a fool if you think it is well diversified. It has more money in its first 6 holdings (AAPL, XOM, MSFT, JNJ, WFC, GE) than in their last 1470 holdings. Why is this? It goes back to their potential investment universe with size and liquidity restrictions.

Indexing and ETFs also artificially inflate the cost of stocks which are included in the index by virtue of having a huge portion of the available share float held by the index fund vs companies not a part of the index. See this paper by Horizon Kinetics detailing US vs Canadian REITs and the effect of indexing on available yield:

http://www.horizonkinetics.com/docs/December_Commentary_Canadian_REIT.pdf



Dodge

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Re: inexperience investor question
« Reply #23 on: November 26, 2014, 10:40:42 AM »
From Dodge -
Quote
Yes, but the individual investor is also significantly less knowledgeable, has significantly less access to information, puts significantly less time into it, and has significantly less training.  I actually agree with you, if we're talking about the individual investor, and a long timeline (50 or so years until you die), it's likely closer to 99.99999% who will end up with less money.  But I have no data for that one :)

The paper he quoted said 75.4% of active mutual fund managers have returns consistent with the market over a long time frame. 0.6% consistently beat the market. 24% returned less than the market after transaction costs and fees. Keep in mind transaction costs and fees average 2.5%

KC and Dodge, I would hope that you educate yourselves on why active managers have a hard time beating the market.

Let's look at at individual investor vs an active mutual fund manager:
 
Transaction Costs and Securities available-
The individual investor can pay as little as $1 per trade on a couple hundred shares or $7 per trade for up to 2k shares. These shares are held at a brokerage. He submits a limit order, and the order is traded electronically. 2k shares represents about 4% of the daily volume of a relatively illiquid stock that trades 50k shares per day.

The fund manager may hold 1M or more shares. That company that trades 50k shares per day, it would take the manager well over a month to establish that position. Does the manager do this?

No, they limit themselves to stocks with more liquidity. This is one of the huge problems with index funds as well. Large well run companies are often not in the indexes because of liquidity ie. Berkshire - 200B at the time and not in the S&P.

If you are a fund manager and want to buy 1 M shares of TWC (an S&P 500 company with good liquidity) it would take you about a week to establish the position. This requires a trader to sit at a desk and manually trade large blocks of shares with other traders. This guy is billing at >$300 an hour. You also cannot say buy or sell XX at $20. These are huge positions. You will buy and sell something between $20-21 after a week your average price may be $20.10 meaning the transaction cost you 0.5% over an individual investor saying sell at $20.

Redemptions-
In 2008 an individual investor holding a IBM had the ability to sell it a buy WFC. (this is an example, it could be any company or group of companies). In this case, the individual investor would have made twice as much money in WFC than in IBM.

In '08 the fund manager was hit with people pulling money out of his fund left and right. He may have wanted to sell IBM to buy WFC, but has to sell IBM to give money back to a client. This is a huge problem for the fund managers and one of the reasons funds with lock up periods - hedge funds - or permanent capital - Berkshire out perform active mutual funds.   

Window dressing-
An individual investor doesn't have to deal with this. They don't answer to clients.

The fund manager has to explain why Apple is their largest holding after the stock tanked from $700 to $450. They often sell a company after a large fall because clients may think: I'm taking my money out, this idiot didn't even predict Apple was going to lose 35%. This is dressing up your quarterly and annual reports to make them look prettier to your clients.

76% of fund manager managed to match the index despite the above working against them and while charging an average fee of 1.08%! I'm not saying this means you should be investing with active managers. I am saying they have a lot working against them and by virtue of matching the market after 2.5% worth of fees and having to deal with redemptions and keeping clients happy the majority are actually beating the indices.

I am spoon feeding this to you all because instead of thinking critically about the article you posted, or typing window dressing, the effect of redemptions, or mutual fund investment universe size limitations into google; you look at a chart and say "see indexing wins!" Indexing provides clients superior returns due to index funds not having to deal with many of the detractors facing active funds. Indexes are not magic and active managers are not stupid. They just cannot outperform the market by >2.5% on a consistent basis.

As far as individual investing in individual stocks or ETFs is concerned. An individual investor could use low cost vanguard ETFs to simulate a more equal weight index that will beat VTSMX. Index funds two largest problems are being market capitalization weighted, and having a smaller universe of companies to add to the index because of liquidity.

VTSMX has a good performance history but you are a fool if you think it is well diversified. It has more money in its first 6 holdings (AAPL, XOM, MSFT, JNJ, WFC, GE) than in their last 1470 holdings. Why is this? It goes back to their potential investment universe with size and liquidity restrictions.

Indexing and ETFs also artificially inflate the cost of stocks which are included in the index by virtue of having a huge portion of the available share float held by the index fund vs companies not a part of the index. See this paper by Horizon Kinetics detailing US vs Canadian REITs and the effect of indexing on available yield:

http://www.horizonkinetics.com/docs/December_Commentary_Canadian_REIT.pdf

To any new investors who read the previous post and now think they can beat the market, I recommend watching video #6 - , from http://www.bogleheads.org/wiki/Video:Bogleheads®_investment_philosophy.



Again to the new investor, if you think you can end up in the green part of this chart this year, and every year thereafter, for the next 30-60 years (or however long your investing horizon is), understand that the odds are incredibly against you.  Even if it's 50/50 for the first year (it's not), it would also be 50/50 for the next year, then 50/50 for the year after that, then 50/50 again for the year after that...etc.  Having just one really bad year can put you far enough behind that you'll never catch up.  If you choose poorly and lose 50% one year, while the market overall is flat, you'll need to gain 100% to get back to break even.  The odds of greatly underperforming the market in any one particular year, with only 20-30 stocks in your portfolio, are very high.  Depending on how long your investing horizon is, it's almost inevitable.

Remember, there will always be someone who says you can beat the market, who says this time is different, and indexing no longer works.  These people come and go.  This is why staying the course is so hard.  Ignore the noise, stay the course, and 30-60 years later odds are you'll be in a much better position.  Indexing guarantees you will beat or match at least half of the dollars invested in the market each year, every single year, for as long as your investing horizon happens to be.  When the gains are compounded, it's incredibly difficult to beat this.

KC1983

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Re: inexperience investor question
« Reply #24 on: November 29, 2014, 06:06:16 PM »
What Dodge said.

Or, if you want a real expert: http://www.aaii.com/journal/article/achieving-greater-long-term-wealth-through-index-funds.touch The first paragraph really tells you all you need to know about active management.

Or, pick one of these: http://www.amazon.com/William-J.-Bernstein/e/B001H6ID14

Or, if you want to read a forum with vastly more investing expertise than you'll find here: http://www.bogleheads.org/forum/viewtopic.php?f=10&t=88005 (that's just a good thread to start with).