Individual stocks vs. Index funds

[texastumbleweed]

I know mmm advocates specific index funds, but I saw another poster say they regretted ever buying individual stocks.  I have been investing and buying stocks for 15 years and I have gone through a bunch of strategies and made mistakes and such, but lets say I was just starting.  Can someone point me to an article or some statistics that shows me why index funds are better than buying good blue chip dividend stocks?  I'm not talking about trying to pick the best new IPO's or popular fad stocks, but I am speaking specifically of huge companies with strong dividend histories.  I feel like it makes way more sense to buy 10-15 dividend paying stocks rather than a smaller handful of index funds.

Thanks.

[protostache]

Index funds are easy. Automatically invest into an extremely broad slice of the market at cut rate prices. Comparatively, picking stocks requires research, thought, and activity every time you have fresh capital. If you have to think every time you do something, you'll probably make a mistake.

Basically, index funds are the best option for most people most of the time.

[sabertooth3]

I feel like it makes way more sense to buy 10-15 dividend paying stocks rather than a smaller handful of index funds.

You could do that, or you could buy 2 index funds (US and international) and own pieces of over 5,000 companies. Index funds pay dividends too!

[mjs111]

Buying individual stocks makes sense if you're good at stock valuation, enjoy keeping track of the companies you're buying (updating valuations every quarter with earnings reports, listening to or reading conference call transcripts, maintaining familiarity with the industry your companies operate in), and have the proper psychological makeup to act rationally when it comes to buy/sell decisions.  If that doesn't sound like your cup of tea, index funds are the way to go.  And like sabertooth3  said, index funds pay dividends too. The yield on the S&P 500 Index these days is about 2%.

Mike

[MDM]

Consider Why do investors chase dividend paying strategies - Bogleheads.org and SPIVA scorecards - Bogleheads.

[Spork]

I have both.

Both pay dividends.

I have a better return from my individual stocks BECAUSE I WAS REALLY DAMN LUCKY A COUPLE OF TIMES.  I don't think I have a winning strategy with stocks.  There is a reason why only about 10% of my stash is in stocks even though my "returns are better."  It's fun.  It's entertaining.  But I will never rise to the top of the brokerage food chain.

[FinanciallyIndependent]

Do not invest in Individual stocks unless you are so confident that you will buy more if it were to keep dropping.  Do not invest more than 10% of your stash in individual stocks.  If you do then be prepared to lose everything.  Best way to invest in stocks I have found is to do the following....

step 1. Buy 1 stock of the company you are confident to invest in.
step 2.  Buy a lot of it after it drops 50%. (You will be ecstatic you got great deal on price per stock)
step 3. buy a lot more if it drops more. (You will be scared unless you are warren buffet)
step 4.  pray and hold for atleast 20 years.

[faramund]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

I own stocks in almost 50 stocks that are highly biased towards dividend/value stocks and am a buy-and-hold investor.

I also own small amounts of a general index fund, and a Vanguard fund that buys dividend stocks.

Over the last 10 years, my general stocks beat the Vanguard dividend fund, that beats the general index fund.

So far this year, the general index fund, beats the dividend fund, which beats my general stocks.

Go figure!

[Monkey Uncle]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Which studies?

[Bateaux]

I've been buying mutual funds since 1992.  One of my first and largest percentage was VFINX.  But I've owned many others.   I've always said that when I get more savvy I'll start buying individual stocks.  Not savvy enough yet.  Many can make more by doing so.  I'm either too dumb or too scared to do so. 

[BTDretire]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Which studies?

Google is your friend.
  I agree with Monkey Uncle, the research does show Index funds out perform Actively Managed Funds over the long term.
 I just did a search and picked one that was pro Actively Managed Funds, but wise comments
countered that "While it might be true that a certain percentage of active funds may beat the S&P index, its my understanding that its not the same one year after year.  So it may be true that 90% of individual active funds do not beat the S&P index."
  That last sentence is poorly worded without reference to the article's title.
"Index funds beat active 90% of the time. Really?"
 I also added, that I saw nothing in the article about performance after fees, so I don't know
if the authors numbers included fees or not.

Edit to add a link
http://www.marketwatch.com/story/whack-a-mole-fund-managers-cant-beat-index-funds-2014-05-14

[scottish]

I also have both.     One year I wrote a script to scrape Yahoo finance and collect all the dividends, splits, etc. so I could compare in detail.    My index funds generally to a bit better most of the time.  <shrug>

Too many capital gains now to convert all my individual stocks.   Plus Canadian dividends get special tax treatment and the Canadian dividend ETFs aren't well diversified and have some stocks I don't like.    But we're converting the tax sheltered accounts to ETFs in preparation for retirement.

[Seppia]

Happy to see some others that own individual stocks.
Indexes are easier and will generally do much better than individual stocks, but sometimes the anti-individual stock paranoia is just too much.
The big difference is between those who invest and those who don't.
I'm positive if one just bought at monthly intervals PG, XOM, IBM, PFE, GE etc for many years, the result would be similar* to one buying an index fund.
Of course assuming you buy and hold forever.

*meaning: closer to those who buy index funds than to those who don't invest at all, which is still the vast majority of people.
I lived in Europe till 2010 and index funds were unknown then.
Still today, VGK (vanguard developed Europe, USA version) has a mkt cap of 13billions, VEUR (same fund but in Amsterdam, London and Zurich) barely gets above 1 billion. VTI is at 60 billion. Index funds are still close to unknown in Europe

[Monkey Uncle]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Which studies?

Google is your friend.
  I agree with Monkey Uncle, the research does show Index funds out perform Actively Managed Funds over the long term.
 I just did a search and picked one that was pro Actively Managed Funds, but wise comments
countered that "While it might be true that a certain percentage of active funds may beat the S&P index, its my understanding that its not the same one year after year.  So it may be true that 90% of individual active funds do not beat the S&P index."
  That last sentence is poorly worded without reference to the article's title.
"Index funds beat active 90% of the time. Really?"
 I also added, that I saw nothing in the article about performance after fees, so I don't know
if the authors numbers included fees or not.

Edit to add a link
http://www.marketwatch.com/story/whack-a-mole-fund-managers-cant-beat-index-funds-2014-05-14

I'm not necessarily disagreeing with faramund, I'd just like to see his/her information sources so I can judge for myself.  Sure, I could do some googling, but when someone makes a claim, I think it's on them to provide the documentation.

[FIRE 20/20]

I'm surprised no one has posted JLCollins stock series.  He answers exactly these questions:
http://jlcollinsnh.com/stock-series/
http://jlcollinsnh.com/2013/02/05/stocks-part-xv-index-funds-are-really-just-for-lazy-people-right/
http://jlcollinsnh.com/2011/06/02/why-i-cant-pick-winning-stocks-and-you-cant-either/

[faramund]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Which studies?

Google is your friend.
  I agree with Monkey Uncle, the research does show Index funds out perform Actively Managed Funds over the long term.
 I just did a search and picked one that was pro Actively Managed Funds, but wise comments
countered that "While it might be true that a certain percentage of active funds may beat the S&P index, its my understanding that its not the same one year after year.  So it may be true that 90% of individual active funds do not beat the S&P index."
  That last sentence is poorly worded without reference to the article's title.
"Index funds beat active 90% of the time. Really?"
 I also added, that I saw nothing in the article about performance after fees, so I don't know
if the authors numbers included fees or not.

Edit to add a link
http://www.marketwatch.com/story/whack-a-mole-fund-managers-cant-beat-index-funds-2014-05-14

I'm not necessarily disagreeing with faramund, I'd just like to see his/her information sources so I can judge for myself.  Sure, I could do some googling, but when someone makes a claim, I think it's on them to provide the documentation.

On outperformance of dividend stocks (from another post of mine):

My favourite book about what sort of things to invest into, is:
What works on Wall Street, O'Shaughnessy: he divides stocks into deciles of all sorts of things, say from highest to lowest PE, and then he calculates what has worked best over the last 40/100 years. My only problem with it, is that his calculations are all based on rebalancing each year - which would kill me with capital gains tax - but his insights like, stocks which pay higher dividends, return more total value each year, than those with lower - guide me in which stocks I buy.



On the inability of the majority of market funds to outperform index.
This crops up in many Economist articles, but its behind a paywall.
At least one of those articles referred to a morningstar article, so after a bit of searching
http://global.morningstar.com/activepassiveJune2015/
Gives a very good overview of active/passive performance.

[Monkey Uncle]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Which studies?

Google is your friend.
  I agree with Monkey Uncle, the research does show Index funds out perform Actively Managed Funds over the long term.
 I just did a search and picked one that was pro Actively Managed Funds, but wise comments
countered that "While it might be true that a certain percentage of active funds may beat the S&P index, its my understanding that its not the same one year after year.  So it may be true that 90% of individual active funds do not beat the S&P index."
  That last sentence is poorly worded without reference to the article's title.
"Index funds beat active 90% of the time. Really?"
 I also added, that I saw nothing in the article about performance after fees, so I don't know
if the authors numbers included fees or not.

Edit to add a link
http://www.marketwatch.com/story/whack-a-mole-fund-managers-cant-beat-index-funds-2014-05-14

I'm not necessarily disagreeing with faramund, I'd just like to see his/her information sources so I can judge for myself.  Sure, I could do some googling, but when someone makes a claim, I think it's on them to provide the documentation.

On outperformance of dividend stocks (from another post of mine):

My favourite book about what sort of things to invest into, is:
What works on Wall Street, O'Shaughnessy: he divides stocks into deciles of all sorts of things, say from highest to lowest PE, and then he calculates what has worked best over the last 40/100 years. My only problem with it, is that his calculations are all based on rebalancing each year - which would kill me with capital gains tax - but his insights like, stocks which pay higher dividends, return more total value each year, than those with lower - guide me in which stocks I buy.



On the inability of the majority of market funds to outperform index.
This crops up in many Economist articles, but its behind a paywall.
At least one of those articles referred to a morningstar article, so after a bit of searching
http://global.morningstar.com/activepassiveJune2015/
Gives a very good overview of active/passive performance.

Thanks.  The Morningstar study suggests it isn't quite as simple "passive always wins."  It suggests that perhaps managers are able to generate alpha, but fees eat up most of it unless you're invested in relatively low-fee funds.  It also suggests a pretty clear value premium, with a significant minority (and in some cases a majority) of active value managers beating their passive counterparts.  And finally, the fact that asset weighted results beat equal weighted results suggests that investors do display some skill in picking winning managers.

[Tyson]

I have thought about owning individual shares, but I realized it's just going to cause me extra worry.  Might I be able to do better by spending a lot of time and treating my investments like a job?  Sure.  But I'm trying to retire, not saddle myself with another job.  So passive indexing it is for me.  Over time it's still the best strategy and a lot less stressful.

[forummm]

I have thought about owning individual shares, but I realized it's just going to cause me extra worry.  Might I be able to do better by spending a lot of time and treating my investments like a job?  Sure. But I'm trying to retire, not saddle myself with another job.  So passive indexing it is for me.  Over time it's still the best strategy and a lot less stressful.

Might you be able to do worse? Sure.

It would be terrible to have a job where you put in a lot of effort--and then became poorer each day. I prefer those jobs where you are guaranteed to make money each week.

I forget which of the most recent articles it is, but the author (rather verbosely) makes the argument that as indexing becomes more popular, it gets much harder to beat the market because all the riff raff get pushed out into indexing. So the only people left are the real pros that really know what they are doing (and probably have inside info). And even then, as a group they can only match the market return--and that's before their analysis and transaction costs.
http://www.philosophicaleconomics.com/

[faramund]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Thanks.  The Morningstar study suggests it isn't quite as simple "passive always wins."  It suggests that perhaps managers are able to generate alpha, but fees eat up most of it unless you're invested in relatively low-fee funds.  It also suggests a pretty clear value premium, with a significant minority (and in some cases a majority) of active value managers beating their passive counterparts.  And finally, the fact that asset weighted results beat equal weighted results suggests that investors do display some skill in picking winning managers.

This pretty much matches with my original comments. I have often thought about whether it would be possible to match an active manager, but beat the index because I wouldn't be paying their fees. But that sounds like too much work, and at the risk of being asked for another reference, studies also seem to say that in general, the more you trade, the lower your return.

Lastly, while it is true that some active managers beat the market, the question is, how do you know who will beat the market in the future. Studies seem to show past out performance is no indicator of future performance (and to back this up, I'll give a link (http://www.economist.com/blogs/buttonwood/2015/06/investment) which reports on a study about this - I think you can read a couple of articles without subscribing to the economist - so it might be readable. If anyone reads the comments on that article, the faramund on the economist is the same one on here (:

[Monkey Uncle]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Thanks.  The Morningstar study suggests it isn't quite as simple "passive always wins."  It suggests that perhaps managers are able to generate alpha, but fees eat up most of it unless you're invested in relatively low-fee funds.  It also suggests a pretty clear value premium, with a significant minority (and in some cases a majority) of active value managers beating their passive counterparts.  And finally, the fact that asset weighted results beat equal weighted results suggests that investors do display some skill in picking winning managers.

This pretty much matches with my original comments. I have often thought about whether it would be possible to match an active manager, but beat the index because I wouldn't be paying their fees. But that sounds like too much work, and at the risk of being asked for another reference, studies also seem to say that in general, the more you trade, the lower your return.

Lastly, while it is true that some active managers beat the market, the question is, how do you know who will beat the market in the future. Studies seem to show past out performance is no indicator of future performance (and to back this up, I'll give a link (http://www.economist.com/blogs/buttonwood/2015/06/investment) which reports on a study about this - I think you can read a couple of articles without subscribing to the economist - so it might be readable. If anyone reads the comments on that article, the faramund on the economist is the same one on here (:

One could nitpick that study by noting that they are looking at the wrong metric.  Rather than top quartile performance in individual years, they should be looking at total (or annualized) returns higher than the benchmark index over long time periods (say, 10 years).  Right now I don't have the time to poke around for any studies that might have investigated that metric.  Might do that later...

[faramund]

Studies seem to say that index funds outperform the vast majority of managed funds (largely because of fees).

Studies also seem to say that dividend (and some other value strategy) stocks outperform index funds.

Thanks.  The Morningstar study suggests it isn't quite as simple "passive always wins."  It suggests that perhaps managers are able to generate alpha, but fees eat up most of it unless you're invested in relatively low-fee funds.  It also suggests a pretty clear value premium, with a significant minority (and in some cases a majority) of active value managers beating their passive counterparts.  And finally, the fact that asset weighted results beat equal weighted results suggests that investors do display some skill in picking winning managers.

This pretty much matches with my original comments. I have often thought about whether it would be possible to match an active manager, but beat the index because I wouldn't be paying their fees. But that sounds like too much work, and at the risk of being asked for another reference, studies also seem to say that in general, the more you trade, the lower your return.

Lastly, while it is true that some active managers beat the market, the question is, how do you know who will beat the market in the future. Studies seem to show past out performance is no indicator of future performance (and to back this up, I'll give a link (http://www.economist.com/blogs/buttonwood/2015/06/investment) which reports on a study about this - I think you can read a couple of articles without subscribing to the economist - so it might be readable. If anyone reads the comments on that article, the faramund on the economist is the same one on here (:

One could nitpick that study by noting that they are looking at the wrong metric.  Rather than top quartile performance in individual years, they should be looking at total (or annualized) returns higher than the benchmark index over long time periods (say, 10 years).  Right now I don't have the time to poke around for any studies that might have investigated that metric.  Might do that later...

I think its ok, if you put it together with the other findings, there argument is really, given that only a minority of active managers beat the index, and that those manager's who do outperform in a prior time period (i.e. 5-10yrs ago), do not outperform in the next time period (0-5yrs ago) - there is no obvious rational basis for choosing a successful manager. So given that on average a manager doesn't beat an index, there is no obvious rational reason to choose an active manager, rather than just buying an index fund.

I think research still shows a possible way of beating the market, and that would be a low cost,  value-based manager. But I don't know of any research that's tested it.

But there are certainly options to do that - I have a vanguard, dividend focused fund (Australian VHY), that over the longest time period, has beaten the Australian index (VAS). Although that hasn't been true over the shorter time periods.

I'm sure there are similar funds in the US, but I don't know them. Although I do know of Berkshire Hathaway - which seems very much like a value-focused fund with low costs. if I was in the US, I'd have some of that.