My post yesterday about indexing drew a slew of great comments, thank you. While a follow up is appropriate it may take a couple of post to finish the thread.
TomG who knows a thing or three stated a point I have been making, only worded a little differently, he said he wants to capture stocks’ general trend of going higher. He rightly questions the value of paying for help that may not get you to your financial goal.
TomK logically points out that a portion actively managed (either on your own or with help) blended with passive buy and hold has merit which it does.
George tied it all together noting that to many do-it-yourselfers succumb to emotion, make mistakes and then repeat those mistakes later. The context of George’s point is along the lines of mutual fund shareholders lagging the funds they own by a mile due to poor investment decisions. The studies done on this reveal some horrible numbers.
There are obviously a lot of moving parts and aspects of this to analyze and believe it or not we won’t solve this here. Capturing most of the effect, as TomG says, is the big macro behind this entire discussion. What is the best way to capture most of the effect is the entire discussion. Success can be had with buying four funds and rebalancing once a year, scalping $0.20 a dozen times a day and everything in between. So this is about finding the strategy that is right for you.
The obstacle to doing it yourself is emotion. I write this about when I say this is just how market’s work. Markets go down every now and then and the economy has a recession every now and then. The markets also have fast nasty declines that seem to come out of the blue. The events triggering these declines may change a little but the market response is very similar to past market responses. A common mistake is to sell into these declines; selling stock on September 17, 2001 was not the right trade. Likewise buying hog wild at the height of euphoria is also not the right trade very often.
This is probably the type of thing that has to be learned first hand, meaning bad trades have to be experienced in order to understand this.
I will say I am not a fan of blind devotion to indexing. I do not buy into the idea that a US index fund, foreign index fund, REIT fund and a bond fund are all you need. This has its proponents, and I hear you but it is not for me and I certainly do not think people should pay ongoing management fees for this type of portfolio.
I believe a lot of value can be added by taking a top down approach to the world and adding a few ideas in with whatever you have going on in your portfolio. I have been writing about Ireland and Australia since I started this blog. I own a bank stock for each country. In the last three years the Irish stock is up 85%, the Australian stock is up 70% and neither one has been the best possible way to own these countries but these stocks each capture most of the effect. In the same time period the S&P 500 is up 30%.
The idea of picking these stocks was not that I thought these stocks would go up by X percent in a certain time frame but instead these are countries that I want to maintain exposure to over the long term. These themes, Ireland and Australia, are important to me. Chances are there are other themes that are important to you. Much as I would like you to think this type of thing is difficult, it isn’t. An economic expansion is generally good for a stock market. Beyond that selecting the best way to access a theme, in this case a foreign country, requires a lot more work. Obviously a fund of some sort takes less work than picking a stock.
If you only limit yourself to the broadest funds you will not benefit from some ideas that could add value and again are not that complicated. While this will not be for everyone I think more than a few people could withstand exposure to a country if they are willing to stay up to date with that country’s current events.
There was one comment left that I think dangerously misses the boat. The reader says that “In practice, it is relatively easy to beat S&P 500 index as an individual or portfolio manager. The 30% gain of foreign currencies over US dollar in the past 5 years gave international large cap stocks a 30% advantage over US large cap stocks assuming everything elase being equal. So you decide to beat S&P 500 by choosing international stocks.”
I’m as big a fan as anyone of foreign investing but I don’t put that kind of faith in it. I am not an expert in behavioral finance I think this comment is hitting several fallacies at once. I probably can’t make this commenter believe otherwise but trust me it is not that simple.
This issue is not resolvable so this post can’t really have a conclusion. While I believe you have to be comfortable with your investment strategy I also believe in trying expand your horizons. If you read a site like this one, maybe you believe expanding your horizons too.