In yesterday's post I said that investing in the right basket of 20 or so individual stocks could give you the same performance and diversification as owning an S&P Index fund but without the fees. Many of you thought that was a bad idea. Allow me to acknowledge those criticisms and suggest a modification to the plan that addresses them.

Criticism 1: Exchange Traded Funds (ETFs) mimic the S&P 500 (see ticker symbol SPY), and their fees are trivial, so forget the basket of 20 stocks and invest that way. (Full disclosure: That's mostly how I invest in stocks.)

Answer: If you had $350,000 in stocks, your annual fee for an ETF would be in the range of $1,000 a year. That is small compared to a managed fund which might charge you $5,000 per year, but it is still real money. If you could save $1,000 per year and give up nothing, you would do it.

Criticism 2: Most of the historical gains of the S&P 500 came from a handful of hot stocks, such as Dell. Your basket of 20 stocks has a good chance of missing the hot stocks that make all the difference.

Answer: Good point. Let's modify my plan to say that each time you put money into the market you pick a company from the S&P 500 that meets two criteria:

The stock has one of the highest ratings of the stocks you don't already own, according to a source with no conflict of interest, such as Charles Schwab. This increases your odds of getting a hot stock, since those would be rated high.

The stock improves your diversification compared to the stocks you already own.

Criticism 3: If you buy stocks every month, as you earn money to invest, the transaction fees can get expensive.

Answer: That's true, so don't buy stocks every month. Do it once or twice a year. Each stock you buy or sell will cost about $9 once. Or if you have lots of patience and discipline, invest only when the market drops from its high by ten or twenty percent.

Criticism 4: The S&P 500 changes composition over time, weeding out the weaker companies in a crude way. Your basket of 20 stocks wouldn't get that benefit.

Answer: After you own twenty stocks, sell off the lowest rated stock and replace it each time you add money to your investment, once or twice a year. This prunes the laggard stocks in a crude way similar to how an ETF would rebalance its position.

The most important element of this revised investment plan involves ignoring the advice of pundits and columnists, and especially ignoring your own gut feelings about stocks.

I hope it is obvious that you shouldn't get your financial advice from cartoonists. And feel free to tell me why this modified approach is defective. That's always the point of anything you see on this blog.

Rank Up Rank Down Votes:  +2
  • Print
  • Share


Sort By:
+2 Rank Up Rank Down
Oct 30, 2008
You are mistaken about the cost of investing in the S&P 500.

If you have $350,000 that you want to invest in the S&P 500, you can buy VFIAX, the Vanguard S&P 500 index fund, Admiral shares (minimum investment $100,000). The expense ratio of that fund is 0.07%, which means that the annual expenses are about $250, not $1,000.

Good luck trying to track the S&P on your own for that price.

Oh yeah, VFIAX doesn't have buy/sell spreads, NAV/selling price premiums or discounts, or any other hidden fees.
+2 Rank Up Rank Down
Oct 30, 2008
Scott, you're closing in on a strategy that used to be very popular. It was called "Dogs of the Dow" where once a year, you shuffled your portfolio to have an equal dollar amount of each of the 10 highest yielding stocks in the Dow 30. The reasoning was that the Dow is comprised of all large, reliable stocks. The 10 highest yielding ones are likely to be out of favor and stand to rebound when "irrational panic" goes away and buyers realize a stock is beaten down because of guilt by association. The beauty of the strategy was that it only required about 5 minutes of your time, once a year. Even your friends at Motley Fool came up with a variation on that strategy (although, they later decided it wasn't all it was cracked up to be).
Keep up the good fight, and have a good day.
Oct 30, 2008
Scott, when you say, "The stock has one of the highest ratings of the stocks you don't already own", what units are you using for the rating? SAP (Stock Awesomeness Potential)?

If you haven't noticed, anyone rating stocks is rarely doing it for your benefit.

Unfortunately, your two posts on this topic are worth as much as one saying, "You should buy stocks that are going up".
Oct 30, 2008
Buying "hot" stocks (trying to pick up the next Dell) is a poor strategy. Take a look at this article:

The money quote: "Yet in the next five years, the hot stocks underperformed the market by a negative -26% on a P/BV basis, and -30% on a P/CF basis. The out-of-favor stocks did 33% and 22% better than the market, respectively. This is a HUGE reversal of trend."

The hot stocks outperformed the market by 186% in the ten years before they were bought, and underperformed in the 5 years after they were bought. It's not your imagination! Stocks do start to go down as soon as you buy them!
Oct 30, 2008
About 12 years ago, the Bloomberg network approached The Overstreet Comic Book Guide folks to put together a "Blue Chip Portfolio" of 20 key comic book issues (First appearances, short print runs, etc., all in NM condition) for the purposes of comparing an investment in comics to the top 20 S&P stocks. The results were that after 10 years of monitoring, the comic portfolio was only about 2% less growth than the stock portfolio. However, as the stocks had ups and downs, key comics basically never decrease in value. So based on the relative market over the measured time period (whether there are predominantly bull/bear markets), the value of the comic portfolio could easily outstrip the stocks (as it would if the current market was the endpoint of the time period). I believe this information was printed in Vol 36 of the guide, which may be available in your local library.

That isn't to say that you should take out a mortgage to buy Action Comics #1, but I certainly thought it was an interesting study.

And comic books are a lot cooler looking than stock certificates.
0 Rank Up Rank Down
Oct 30, 2008
Would you please stop posting about stocks? They just don't capture a 13 year old's attention the way funnier posts do.
Oct 29, 2008
You're not interested in my Brownian Motion Stock Picks? Pay me some money, I'll push a random number generater, then I'll spit out a stock option for you. That goes for anybody in here, also, I don't discriminate against anybody just so long as they pay me!
Oct 29, 2008
By buying a "hot" stock and selling your worst performer, aren't you then buying high and selling low. From what I've read, that isn't generally the best way to make money in the stock market.
+1 Rank Up Rank Down
Oct 29, 2008
Actually, speaking as an "insider" at one of the big banks, that's pretty much how ETFs and other index trackers are created - it's a small basket (30 - 50) of stocks that are considered representative of the full index.
Oct 29, 2008
A problem with saving up all your investment for a once-a-year splurge is that you are buying at one price which could be high or low. If you spread out your investing over every trading day, you maximise your chance of not losing a whole lot. As the price drops you are getting more for your money as you buy, and as it rises your existing stock goes up while the new stuff may be more expensive. I think they call it cost price averaging. You would have to decide what value you put on the risk of losing lots - if that's high compared with the cost of trading, spread, if it's low, splurge, and good luck to you! (obviously you can opt to buy at some other frequency than 1 or 255 (or however trading days there are per year!))
0 Rank Up Rank Down
Oct 29, 2008
Stock "ratings" seem to be a *terrible* way to decide which stocks to put in your portfolio. Stocks that are highly rated are the ones that all the big investment houses think will do well, which means that their prices have probably already been inflated to account for their high rating. There's a lot to be said for a contrarian investment strategy, in which you purposely invest in lower-rated stocks on basis of the fact that they are much more likely to be under-valued.

But if you really want a diversified, pundit-free portfolio, you've got to ignore the ratings altogether. Diversification across an incomplete sample of a large number of stocks is by definition impossible if you use any deterministic strategy to choose that sample. You need to choose randomly.
Oct 29, 2008
My concern in reducing fees would be putting the mediocure investment advisors on the street, to peddle whole and universal life to the masses. That and single pay annuties. Just having them out on the street makes me feel less safe.

Scott, it really depends on what you use to select your base stocks and how hard you work to minimize the fees.
We all have a bias based on our acceptance of risk. Some people don't want the responsibility to pick their own stocks. Some people of course blow all their cash and run up the credit cards and plan to invest around age 59.
Some people will pick based on the names they hear/see/read in media. Some people will pick all computer tech stocks, some will pick all bio-tech. Some people put it all in their own company stock, even their investments outside of work. The end result for most people is: "He chose, poorlyyyy."

So, the question is can you pick 20 stocks to out do the S&P 500, sure, but depending on your bias and comfort level you may, or you may not win big because of your bias.

Now if you could hypnotise me and eliminate my bias in choosing stocks, it may work.

My strategy involves a mix, mostly reading the bible, and sacrificing goats until the voices in my head pick random strings of letters and some of them are stock symbols.
Oct 29, 2008
Scott, I have a couple questions about your proposal:

1) Are the Charles Schwab ratings really "pundit free" and have they been shown to be good indicators of future performance?

2) You're only talking about the S&P500. Don't you think investments should be more diversified in terms of global coverage?
Oct 29, 2008
I can't find anywhere I can get trades for $10. At least not for me in Canada unless I have $100,000 in assets which I do not. But I would still like to invest at this time because of the great chance that in 5 years they could be a large profit margin. But I don't want to have to pay 30 dollars a trade. Should a 18 year old just not invest (and save) or is their away around this?
Oct 29, 2008
While reading these comments I get the impression you are all racist's. No one has mentioned that minorities should not have to pay fee's regardless. I believe that affirmative action takes care of that issue.
Oct 29, 2008
So...you've got $350,000 to invest. You spend a bunch of time picking stocks and making deals (perhaps not a lot of time, but some). You incur dealing fees of $9 a time, which if you did all the things you suggest above would work out at about $100 a year. And by doing all this you save $1000 a year (so a net $900), a quarter of 1% of the wealth you happen to have in the stock market.

I think you're probably right. It probably is worth a few hours a year for a guy with wealth in the $350k range to save $900. But it's pretty marginal. Also I'm not sure what happens to that saving when you factor in the additional risk you've introduced to your portfolio by reducing the diversity of your holdings, especially given the more work you put in to diversifying those holdings the more time you eat up, the more $9 fees you incur and the less you've really saved.
+2 Rank Up Rank Down
Oct 29, 2008
Scott - Beating a dead horse here, but if you attempting to replicate S&P 500 performance, do you not spend an inordinate amount of time in stock selection? Even if you use Schwab's ranking system (which, by the way is a quant model based on momentum), you will still need to spend time and effort and human emotional effort selling old and buying new. If matching performance is all that is important, pony up the puny management fee (buried in return Dilgal2, not just a commission) and buy the ETF. You must consider all of the costs involved in what you are suggesting, not just the monetary ones.

Of course if you want better than market returns, you must concentrate - both literally and figuratively!
Oct 29, 2008
@Algonad - I agree with the viewpoint. I don't think they would necessarily perform worse, but i think that the ratings of stocks have virtually no correlation with performance.
+2 Rank Up Rank Down
Oct 29, 2008
What makes you think the higher rated stocks would do better? I'm sure many times the opposite is true.
Oct 29, 2008
If you are willing to up the number of stocks to 30, the Dow 30 would be a great basket. With a 10 year look back, the Dow has outperformed the S&P 500 for 210 out of the last 228 months (that is equivalent to 17.5 out of the last 19 years).
Get the new Dilbert app!
Old Dilbert Blog