Many say that an actively managed mutual fund is not worth it because
most do not outperform the market and hence investors are encouraged
to invest in index mutual funds.
However, is it a good idea to put your money into an index mutual fund
and pay management fees every single year? Why not buy and hold shares
through a discount broker? Buying and holding through a discount
broker may be cheaper because you only pay brokerage fees once and
there are no management fees. The stocks you buy can be purchased in
such a way that you replicate an index.
One potential problem with this idea is the lack of diversification
you may get. Mutual funds can invest in thousands or companies but
investing in thousands of companies through direct stock can be time-
consuming. However, is it necessary to hold so many companies? What
about the 15-stock diversification rule?
Advantages for an index fund:
Ability to invest a little at a time
Some asset classes are very difficult to build a decent
diversified portfolio unless you are investing very very
large quantities of money
Management fees (though at as little as 10bp, that's not
much of a criticism)
Certain asset classes aren't well covered by decent indices
Tax management (ie. tax loss selling - also not much of
a criticism, as one may certainly sell off
some lots and as long as they are not
reinvested in the same index, no problem)
For the vast majority of investors, those advantages
outweigh the disadvantages so enormously that it's
Picking funds is as difficult as picking stocks.
Many funds have low management fees and it's difficult to hold stocks
over a long period of time so brokerage fees aren't much of an
An advantage of a full service brokerage is that you can borrow
against your investments to meet emergency needs to avoid bad tax
investors need diversification, but having only one fund doesn't give
all the advantages of diversification. It's better to have an
assortment of funds and stocks. I feel more comfortable with about 30
stocks, but if an investor has a considerable amount in broad funds,
the number of stocks can be less.
ETFs allow an investor to get into markets (foreign and commodity)
that aren't available through conventional stock buying.
On some mutual funds, the fees are so low that they are not
material. For example, fees on Vanguard index funds are usually under
Also, using your discount broker, you can buy securities that
represent some stock index, for example symbol SPY represents 1/10 of
S&P500. SPY has very low management fees and some advantages over
Where can people go to find out which funds and stocks to own? The
problem with financial experts is that there are so many of them and
past performance isn't a good sign of future performance.
I don't see why people shouldn't take the time to get some knowledge
about economics and investing especially when they will end up having
several years of income tied up in investments. 25% of the US
population has at least a 4 year college degree and they should be
able to acquire financial knowledge.
Personally I use Morningstar. But that's getting advice from
I have been investing in the stock market for over 20 years. I have
an advanced degree. I have some knowledge of how to evaluation
stocks. Yet, I have neither the time nor the knowledge to evaluate a
number of stocks to put myself in a diversified portfolio.
Sure, they can acquire some average amount of financial knowledge. But
remember that "stockpicking" is a competitive activity, so any
investor is compating with others, including some bright people. So,
to make more money than average, by picking stocks, you have to know
much more than average.
While I have noticed a correlation between education and income, my
experience has been that there is no general correlation between
education and good money management skills (budgeting, cash flow
-HW "Skip" Weldon
Ron Peterson writes:
Most people, even educated people, have neither the time
nor the inclination to become investment experts. They
often, very reasonably, feel that their time is best
spent doing the things they are best at - and financially,
that's often just a matter of them doing their jobs,
whatever they are.
There's no need for investing to be a full-time job
or even for it to suck up much of their time. But there
is an enormous incentive within the industry to try to
sell the notion that it can only be done by experts and
that folks need complex products. Most folks don't,
and most of their investing needs can be handled through
very simple portfolios. But how to tell this quiet
truth over the din of advertising and "advisors" selling
products (with some of the slickest marketing materials
I've ever seen)?
Sadly, it's almost as difficult to pick an advisor as
it is to pick a fund or a stock. But there are some
good guidelines out there and folks either need to spend
a lot of time educating themselves, or they have to choose
to trust someone, sometime. And much of the value of
a great advisor is not even the selection of stocks
or funds - a great advisor helps an individual with
other issues which may outweigh the security selection
choices by a long shot - things like getting them to
max out retirement plans (or at least get the full
value of an employer match), titling assets and
accounts correctly and naming appropriate beneficiaries,
making sure they have the right kinds of insurance, etc
and how to take advantage of tax issues (like tax loss
harvesting), and maintaining discipline.
It'd be nice if there were more unbiased investor and
financial education out there. Folks should know how
to balance a checkbook (even if they don't actually
do so - and whether to bother balancing it each month
or not is a whole other discussion). Folks should
understand compound interest. And marginal tax rates.
But who's going to teach all that? At the moment, folks
need to be self-motivated and capable of distinguishing
the real education from the sales materials. And it's
that latter problem which may be hardest of all.
In the meantime, how much better off would the average
investor be if he'd just gone with a 60/40 broad index-
based portfolio and left it alone, versus all the
ongoing, often conflicting advice out there? It's about
as uninteresting and unglamorous as it gets, but the
long-term return of such a portfolio is surprisingly
good. Since '92, that portfolio has had almost the
same compound return as a 100% stock index (a bit under
7%) - with only about 2/3 the volatility. Over the last
10 years, it's beaten the 100% stock index handily. With
a little bit of tweaking the asset allocations, it may be
possible to beat that - slightly better return and/or lower
volatility. But that simple benchmark is a heck of a
good starting point, and that portfolio can be built
and managed easily for less than 15bp/yr.
At the very least, people with limited spare time can read a couple of books
like "Investing for Dummies" or "Mutual Funds for Dummies" and get some
basic information, enough to steer clear of scams and avoid major pitfalls.
Also, they can make use of many web resources and read newsgroups like this
Peter Lynch has long been a proponent that a man who can select a
refrigerator or a house or a good restaurant, who can decide on a
doctor or a diet, can also select and decide on a portfolio of stocks.
All that is required is looking at the company's annual reports, and a
history of their earnings. Keep it simple, keep it solid. I have
experience with my own portfolio as well as with a handful of funds.
In all instances, I outperformed my funds, and frankly, accounting for
funds is a nightmare.
I'm not promoting anything here - just providing links to a portfolio
of ten stocks I slapped together a couple of months ago because they
looked like they'd been slapped down, and to an index Tad suggested,
for comparison. The dollar amounts were supposed to be 100k but it ot
complicated, I got lazy, and the percentages remain constant
One big advantage of one's own portfolio I have found is that you
decide when to sell or not, and do not have to put up with "surprises"
around tax time, "window dressing", short-term gains, high turnover
and so forth . It is also much easier to keep track of which companies
you own. I will put in a little more work next month and start a
simple spreadsheet to keep track of the earnings of the companies. The
earnings are the dog that wags the tail (no pun with 'dog' stocks
I would openly invite and welcome any criticism of the portfolio I
slapped together. It really is not hard guys. And if I wanted to sell
covered calls, I could. I usually wait until the holding period is 12
The one diversified fund I do own was heavily weighted in "Financials"
last year, and has lost more than half its value. I did not understand
bank reporting, had been told that banks are slow growth, was a little
puzzled how banks could grow so quickly, and so I had only a small
position in my portfolio. Privately, I thought I was stupid, and was
*sure* the fund's research and analysis was *much* better than mine.
Ha. Haha. It does not make me feel better to know they were stupider
And constant vigilance. Just because most folks, with some
education and effort, may be capable of managing an adequate
portfolio of individual stocks doesn't mean that it's the
most effective use of their time or efforts. In fact, for
most folks, it's probably nowhere near worth it. Most of
us are perfectly capable of baking our own bread, and some
of us even make fabulous bread when the mood strikes and
time is available. But most of us simply don't have the
time nor inclination to bake daily, nor is it even likely
to be financially advantageous to to so, either.
Are you kidding? Accounting for a taxable portfolio of
individual stocks - unless one pretty much never ever sells
anything - is far more complex. And while I'm sure it's
possible that you outperformed your funds (I've no idea
which funds you have), the vast majority of folks can't
even figure out what their performance was, no less be
able to reasonably compare it to an index.
Note that I'm not saying you didn't beat your funds or
whatever benchmark you feel is appropriate. I am fairly
certain, however, that whether you beat them or not, you
spent a lot more time on it than most folks are willing
to spend. Or need to.
Thanks for the links - I'm looking into Stockalicious
for some portfolio analysis now.
You don't normally have much of that in index or index-like
funds or ETFs, either. Nor is most of that an issue in an
IRA, 401k or other tax-advantaged account, which is probably how
most average folks are building their retirement savings,
if they are saving at all...
Again, not even remotely reasonable for most folks. Talk to
people. Most just don't want to spend the time or even want
to know too many details. They just want to set it and forget it.
And most folks results would actually be better if they did
Because it is expensive to maintain the portfolio of individual stocks
so that it tracks an index. Back of the envelope calculations:
The annual turnover of the S&P 500 is on the order of 3%. So figure a
total of 15 sell orders and 15 buy orders a year at a cost of $10 per
transaction. It will cost you $300 a year to track the index.
The annual expense ratio of a popular S&P 500 ETF, say SPY, is 0.08%.
So an amount invested in the ETF that is less than $375,000 ($300/.0008) will produce lower annual costs than buying a basket of
Many caveats attach to this example, but the point is that, if one
wants diversity, low cost index funds are a bargain for many people.