The Most Valuable Information in the World
Oct 28, 2008 General Nonsense |
Experts tell us that a small number of carefully selected stocks - fewer than twenty - would nearly mimic the S&P 500 in terms of diversification and performance. That means you could buy just those stocks and never have to pay a fee for fund management.
Avoiding fees is a huge deal when it comes to lifetime earnings. Managed mutual funds have substantial annual fees. Even an index fund has a management fee. So does a SPDR. If you buy your twenty stocks and just sit on them, you avoid all of the fees while enjoying the same performance and diversification as managed index funds.
It wouldn't be hard for experts to tell you which stocks to buy, and how much of each, in order to mimic the S&P 500. But you will have a hard time finding that sort of information because no expert has an incentive to produce it. Perhaps an author of some sort has produced it, but I haven't seen it.
Obviously everyone can't buy the same twenty stocks because they would quickly become overpriced. But there are many combinations of stocks that would give you the same performance and diversification as the S&P 500. All you need is a computer program that randomly spits out a different basket of stocks for each investor, so the buying gets spread around.
For the lack of that simple information, and the false believe that managed funds have some magic advantage, investors spend billions each year. Arguably, that makes it the most valuable information in the world.
Avoiding fees is a huge deal when it comes to lifetime earnings. Managed mutual funds have substantial annual fees. Even an index fund has a management fee. So does a SPDR. If you buy your twenty stocks and just sit on them, you avoid all of the fees while enjoying the same performance and diversification as managed index funds.
It wouldn't be hard for experts to tell you which stocks to buy, and how much of each, in order to mimic the S&P 500. But you will have a hard time finding that sort of information because no expert has an incentive to produce it. Perhaps an author of some sort has produced it, but I haven't seen it.
Obviously everyone can't buy the same twenty stocks because they would quickly become overpriced. But there are many combinations of stocks that would give you the same performance and diversification as the S&P 500. All you need is a computer program that randomly spits out a different basket of stocks for each investor, so the buying gets spread around.
For the lack of that simple information, and the false believe that managed funds have some magic advantage, investors spend billions each year. Arguably, that makes it the most valuable information in the world.
Votes: +1
Comments
User Name: tatsuke
Nov 2, 2008
0
It's funny that there are quite a few comments knocking the "obviousness" of the post. I recall reading a paper where two economists obtained information on 40,000 brokerage accounts. Their study revealed that something like (it's been a while) 75% of the accounts held 4 or fewer stocks and 90% of the accounts underperformed their baseline index portfolio.
I guess we're all above average around here.
I guess we're all above average around here.
User Name: EMU
Oct 30, 2008
0
Those experts are wrong. The EUROSTOXX 50 and the DAX are the two counter examples.
Have a look at Sharpe, the guy with the ratio named after him.
Have a look at Sharpe, the guy with the ratio named after him.
User Name: jackjumper
Oct 29, 2008
0
Umm, but isn't the S&P 500 equivalent to a managed fund? Someone has to decide which 500 stocks are in it, right? Isn't that person the 'manager' of the 'S&P 500 fund'?
User Name: IgnatzBaluba
Oct 29, 2008
+1
Scott says : "Experts tell us that a small number of carefully selected stocks - fewer than twenty - would nearly mimic the S&P 500 in terms of diversification and performance. "
The number 20 comes from a statistical analysis comparing individual stock price volatility to overall market price volatility. If I remember correctly, it takes 20 to eliminate 99% of the volatility and it takes 12 to eliminate 95% of it.
"Beta", which is shown for stocks on most finance sites, is the relationship of that stock's price volatility to the overall market volatility. A beta of 2 means that if the average daily price swing of the market is 1%, the average for that stock is 2%. Beta is calculated using price swings over time, and does not mean this happens every day.
Whether one uses 20 or 12 stocks, what matters is that the selected stocks are not significantly correlated. For example, picking GM and Ford would not count as 2 since their stock prices are strongly correlated. Neither would picking one of the car manufacturers and a car parts manufacturer. What makes finding the 20 (or 12) difficult is finding stocks that do not correlate. Ideally, you would want to find stocks with inverse correlation.
But doing all the work necessary to achieve this type of diversification will only save you the relatively small fee that comes with buying an index fund. A lot of work for mediocre return.
"the most valuable information in the world"? Hardly.
The number 20 comes from a statistical analysis comparing individual stock price volatility to overall market price volatility. If I remember correctly, it takes 20 to eliminate 99% of the volatility and it takes 12 to eliminate 95% of it.
"Beta", which is shown for stocks on most finance sites, is the relationship of that stock's price volatility to the overall market volatility. A beta of 2 means that if the average daily price swing of the market is 1%, the average for that stock is 2%. Beta is calculated using price swings over time, and does not mean this happens every day.
Whether one uses 20 or 12 stocks, what matters is that the selected stocks are not significantly correlated. For example, picking GM and Ford would not count as 2 since their stock prices are strongly correlated. Neither would picking one of the car manufacturers and a car parts manufacturer. What makes finding the 20 (or 12) difficult is finding stocks that do not correlate. Ideally, you would want to find stocks with inverse correlation.
But doing all the work necessary to achieve this type of diversification will only save you the relatively small fee that comes with buying an index fund. A lot of work for mediocre return.
"the most valuable information in the world"? Hardly.
User Name: Noesveritat
Oct 29, 2008
-1
The incremental diversification decreases by every stock you add the portfolio. After 20 stocks its meaningless.
The number of stocks in a portfolio has no effect in its performance, only to diversification.
No one can consistently predict the performance of individual stocks.
So, its irrelevant which stocks you select for your portfolio. Just pick 20 randomly and it will work.
The number of stocks in a portfolio has no effect in its performance, only to diversification.
No one can consistently predict the performance of individual stocks.
So, its irrelevant which stocks you select for your portfolio. Just pick 20 randomly and it will work.
User Name: BobNL
Oct 29, 2008
0
Rebalancing your portfolio sounds like solid advice. It means you buy the more of the stocks that are low-priced. That works pritty well, assuming that this particular firm will stay in business. If it is going bankrupt however, the stocprice will plummet and you will buy more of it, because the price is low and you are rebalancing. Now the firm goes bankrupt. Whoops, there goes the money.
I agree with phb. Concentration is the key. Pick a few firms that you trust will stay in business. But most of all, use your common sense.
I agree with phb. Concentration is the key. Pick a few firms that you trust will stay in business. But most of all, use your common sense.
User Name: georgbuehler
Oct 29, 2008
0
This kind of thinking -- "gee, I bet I could pick stocks just as well as those guys, if someone just gave me a good list of stocks to buy" -- is what has fueled an enormous market for investing newsletters, in which stock-pickers who are supposedly smarter than the rest of us share their picks and their strategies.
And that, in turn, created a market for meta-newsletters to pick the stock-pickers, like Mark Hulbert's !$%*!$%*!$%* !$%*!$%*!$%*!$%*!$%*!$%*!$%*!$%*! let's not forget the American Association of Individual Investors (http://www.AAII.com) which provides getting-started help for generating that "computer program that spits out different baskets of stocks".
It is possible for individual managers to beat the market. But, unfortunately, picking the people who will beat the market is almost as hard as picking the stocks themselves. "Past performance does not indicate future gains." In the end, what looks on the surface like a simple problem of consistently picking twenty diversified stocks is actually an enormous problem. If you enjoy that sort of thing, it might be worth the effort . . . but in the meantime, I would stick with the index funds.
Also, don't underestimate the "honey-our-lost-our-shirts-in-the-market" effect. The reason so many people willingly turn over their finances to "expert" managers is they don't want to accept the blame for making a bad decision. The thrill of beating the market doesn't always outweigh the terror of possibly losing everything . . . and it being all your fault.
And that, in turn, created a market for meta-newsletters to pick the stock-pickers, like Mark Hulbert's !$%*!$%*!$%* !$%*!$%*!$%*!$%*!$%*!$%*!$%*!$%*! let's not forget the American Association of Individual Investors (http://www.AAII.com) which provides getting-started help for generating that "computer program that spits out different baskets of stocks".
It is possible for individual managers to beat the market. But, unfortunately, picking the people who will beat the market is almost as hard as picking the stocks themselves. "Past performance does not indicate future gains." In the end, what looks on the surface like a simple problem of consistently picking twenty diversified stocks is actually an enormous problem. If you enjoy that sort of thing, it might be worth the effort . . . but in the meantime, I would stick with the index funds.
Also, don't underestimate the "honey-our-lost-our-shirts-in-the-market" effect. The reason so many people willingly turn over their finances to "expert" managers is they don't want to accept the blame for making a bad decision. The thrill of beating the market doesn't always outweigh the terror of possibly losing everything . . . and it being all your fault.
User Name: Zowie
Oct 28, 2008
-1
Stockpicking is dangerous. An index fund is safer.
Here's an attempt at debunking the idea:
http://www.efficientfrontier.com/ef/900/15st.htm
Here's an attempt at debunking the idea:
http://www.efficientfrontier.com/ef/900/15st.htm
User Name: OrionStyles
Oct 28, 2008
0
I half expected to see a sales pitch to get a fool.com Stock Advisor account at the end there. :)
But you did hit the problem right on the head with a nail.... how could this benevolent and free stock advice ever possibly work if everyone is doing it? It would quickly be usurped by the weasels one way or the other, even if indirectly.... you know the whole "selling short" concept in which someone's misfortune is your gain.
I say it's time for separation of business and state like we have for church and state... because you never know if a corporation is truly viable, or if it's just getting the proper lovin from a congressman or senator because they have a vested interest which won't last forever. Real free markets forever! (something the USA has NOT done).... well except for the military industrial complex. You can be the wealthisest nation in the world.... but if you can't build tanks someone will mug you.
But you did hit the problem right on the head with a nail.... how could this benevolent and free stock advice ever possibly work if everyone is doing it? It would quickly be usurped by the weasels one way or the other, even if indirectly.... you know the whole "selling short" concept in which someone's misfortune is your gain.
I say it's time for separation of business and state like we have for church and state... because you never know if a corporation is truly viable, or if it's just getting the proper lovin from a congressman or senator because they have a vested interest which won't last forever. Real free markets forever! (something the USA has NOT done).... well except for the military industrial complex. You can be the wealthisest nation in the world.... but if you can't build tanks someone will mug you.
User Name: Ollimegroeg
Oct 28, 2008
+1
The most valuable information in the world? What about next week's winning lottery numbers?
User Name: bbarber3
Oct 28, 2008
-1
"The Most Valuable Information in the World"? Christ died for your sins. He stands knocking at the door, he's not going to force his way in, but if you invite him in, He will come in and change your life.
User Name: yonibak
Oct 28, 2008
+3
Anyone notice that when the Dow loses 400 points its front page headlines, but today the dow is up 700 points & CNN doesn't even show it on its home page.
User Name: davematt@pdq.net
Oct 28, 2008
0
If you could replicate the performance of the S&P 500 (or entire stock market) with a small number of stocks, it might avoid some fees. Howevere, you'd still be stuck with having to rebalance frequently, making numerous small purchases when doing dollar-cost-averaging as you deposit 10% of each paycheck (or whatever), and over time you'd need to move companies in & out of this portfolio as their fortunes change - just like the DOW needs to every now and then. Overall, seems more trouble than it's worth - unless you're planning on making a one-time investment or you get 30-60 "completely free" stock trades a month.
User Name: tartanmarine
Oct 28, 2008
-2
unfortunately for us, especially people hoping businesses will expand a create jobs for them, A lot of people will be avoiding stocks for sometime, CERTAINLY THE NEXT TWO YEARS.
I received an e-mail today from a friend who has been quite successful as a professional, and done well thereafter investing the money he earned. Through his hard work, he certainly meets the Obama definition of "rich," if not that of the Kennedys, Heintz-Kerrys or George Soros. I have deleted his name and the fairly prominent person he was visiting, which might identify him.
"I was at …. on Friday night, sharing some sober thoughts about what is pending next Tuesday night. ….. We are facing some rough times. I liquidated all of our market investments early in the Summer and went into 100% cash. We are now considering getting everything out of the U.S. and into another currency, while it is still possible. Once you see a restriction placed on the free movement of capital, you will know that that the game is over. Hyperinflation of the Dollar will then be inevitable."
Maybe he is just an alarmist. But if the "rich" flee the US Economy and sock market because they are worried about the Obama economic policies, there will be no investment in jobs, no economic recovery, and those in the bottom half of incomes, who are voting for Obama because he is going to take money from the "rich" and send them a payoff check, will be those who suffer the most. (Look at how the hyperinflation in Zimbabwe under Mugabe has hurt the poorest people, whose life expectancy has dropped from 63 to 37.) Your 20 stocks will not do so well, either.
The reaction to the 1929 market crash was to pass the Smoot-Hawley tariff bill to protect American jobs. It locked in the Great Depression. Look for similar feels-good-but-kills-the-economy moves from the Obama administration.
Unfortunately, even most people who are nominally well-educated have a very limited understanding of economics and the role of investments, profits and prices in making us better—or worse—off.
I got my family debt-free to weather the coming storm, though of course, I still owe oney to help those poor, unfortunate people who bought bigger house than I did, that they can not pay for. Unfortunately, I was not paying attention when McCain, Bush and others warned in 2005 that Fannie and Freddie were going to create huge problems, so about 40 percent of my IRA is still in mutual funds (but the percent is lower every day!). I bet they wish they had been a little louder when the Democrats were saying Fannie and Freddie were sound as a dollar.
Of course, Europe and Asia were even more over-leveraged in junk mortgages than the US. Hard to see how I can blame Fannie and Freddie or Democrats George Bush & the Republicans for that. More a case of everyone seeing vast profits and blindly piling on, like the Tulip Bulb Bubble or the Darien Colony in the 1600s.
The guys with a gun and a box of Krugerrands under the bed may turn out to have a better strategy than 20 stocks, and not be as far out as I have thought.
I received an e-mail today from a friend who has been quite successful as a professional, and done well thereafter investing the money he earned. Through his hard work, he certainly meets the Obama definition of "rich," if not that of the Kennedys, Heintz-Kerrys or George Soros. I have deleted his name and the fairly prominent person he was visiting, which might identify him.
"I was at …. on Friday night, sharing some sober thoughts about what is pending next Tuesday night. ….. We are facing some rough times. I liquidated all of our market investments early in the Summer and went into 100% cash. We are now considering getting everything out of the U.S. and into another currency, while it is still possible. Once you see a restriction placed on the free movement of capital, you will know that that the game is over. Hyperinflation of the Dollar will then be inevitable."
Maybe he is just an alarmist. But if the "rich" flee the US Economy and sock market because they are worried about the Obama economic policies, there will be no investment in jobs, no economic recovery, and those in the bottom half of incomes, who are voting for Obama because he is going to take money from the "rich" and send them a payoff check, will be those who suffer the most. (Look at how the hyperinflation in Zimbabwe under Mugabe has hurt the poorest people, whose life expectancy has dropped from 63 to 37.) Your 20 stocks will not do so well, either.
The reaction to the 1929 market crash was to pass the Smoot-Hawley tariff bill to protect American jobs. It locked in the Great Depression. Look for similar feels-good-but-kills-the-economy moves from the Obama administration.
Unfortunately, even most people who are nominally well-educated have a very limited understanding of economics and the role of investments, profits and prices in making us better—or worse—off.
I got my family debt-free to weather the coming storm, though of course, I still owe oney to help those poor, unfortunate people who bought bigger house than I did, that they can not pay for. Unfortunately, I was not paying attention when McCain, Bush and others warned in 2005 that Fannie and Freddie were going to create huge problems, so about 40 percent of my IRA is still in mutual funds (but the percent is lower every day!). I bet they wish they had been a little louder when the Democrats were saying Fannie and Freddie were sound as a dollar.
Of course, Europe and Asia were even more over-leveraged in junk mortgages than the US. Hard to see how I can blame Fannie and Freddie or Democrats George Bush & the Republicans for that. More a case of everyone seeing vast profits and blindly piling on, like the Tulip Bulb Bubble or the Darien Colony in the 1600s.
The guys with a gun and a box of Krugerrands under the bed may turn out to have a better strategy than 20 stocks, and not be as far out as I have thought.
User Name: phb
Oct 28, 2008
+3
Sorry to double post - but, please don't mix risk and volatility with return. No such thing as "high reward" without "high risk" and all of you touting Vanguard or 7% mattress funds or your genius broker who demonstrated his mastery of the "efficient frontier" need to ask yourself what you want to accomplish...is it return or safety? Can't have it both ways, sorry. It is just that type of thinking that created our entire banking/financial crisis.
User Name: chrishehman
Oct 28, 2008
0
The problem with the approach of buying 15 stocks instead of 500 is your exposure to fluctuations of those particular companies.
If one of your 15 happens to be the next Enron or WorldCom, that would devastate your portfolio (but barely nudge an index fund).
If one of your 15 happens to be the next Enron or WorldCom, that would devastate your portfolio (but barely nudge an index fund).
User Name: barmstrong
Oct 28, 2008
-1
Are you sure SPDR's have management fees? You buy them just like regular stocks so I'm not sure how an additional fee could be in there. As pointed out above, buying index funds even at big firms like the Vanguard has a negligible management fee (0.15%?) a tiny of fraction of what you'd pay for a mutual fund. I haven't bought these for a while, but when I did something like that would be worth it just in convenience to get the whole S&P500 instead of 20 different stocks.
Brian
StartBreakingFree.com
Brian
StartBreakingFree.com
User Name: gal
Oct 28, 2008
-1
Well, coming from a country where savings accounts give you 7% a year after taxes, I simply cannot understand this stock market thing. So you put your money in stocks… and hope they’ll go up???
I still have some brain formatting to do before figuring that one out. I haven’t heard an argument about the advantages of the stock market that makes me believe it beats putting the money under my mattress :-)
Honestly, it all depends on when you invest. If you put your money in the stock market on 1960, you’d have pretty much the same by 1975. And it’s pretty likely that we are reaching another market stall of 15 years. So in this sense, pulverizing your stocks doesn’t really make sense – mattress it is. Putting all of them in the same stock… well, maybe if you buy Sleep Country’s stocks… :-)
I know I’ll change my mind, it’s not like there’s an option… but right now, I’m just glad my money IS under my mattress, hehehehe
I still have some brain formatting to do before figuring that one out. I haven’t heard an argument about the advantages of the stock market that makes me believe it beats putting the money under my mattress :-)
Honestly, it all depends on when you invest. If you put your money in the stock market on 1960, you’d have pretty much the same by 1975. And it’s pretty likely that we are reaching another market stall of 15 years. So in this sense, pulverizing your stocks doesn’t really make sense – mattress it is. Putting all of them in the same stock… well, maybe if you buy Sleep Country’s stocks… :-)
I know I’ll change my mind, it’s not like there’s an option… but right now, I’m just glad my money IS under my mattress, hehehehe
User Name: phb
Oct 28, 2008
+1
Scott - I have blathered on here before about the myth of diversification and you have just made my case, partly! Despite the popular myth that "proper diversification" will provide better than market returns, it is all bunk! Real returns happen in only one way, CONCENTRATION. All other strategies are nothing more than risk management techniques, including the much lauded "Modern Portfolio Theory." So, the most "valuable" or most expensive information in the world is the knowledge of what single stock to buy. All of you index fund buyers and diversification flag holders are flat wrong. Tell me, how did your well diversified portfolio perform over the last month? Thought so...
User Name: risingstarlp
Oct 28, 2008
+2
Wow, this was pretty much a pointless article. Find a good mutual fund like CGM's Focus Fund (cgmfx) managed by Ken Heebner. Or invest in the Proshares Ultra S&P 500 (sso). If you think the market will go up over time the sso gets you double the return on a daily basis. Also since it works as a doubler for daily fluctuations, a long term uptrend gets you more than double due to a compound interest factor.
