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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.
 
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Oct 28, 2008
I have to disagree with you here, Scott. In many cases, you'll be better off with an index fund.

Every mutual fund does have management fees, but a good index fund is very, very low. For example, the Vanguard S&P 500 index fund has an annual management fee of only 0.15%. In the world of stock investing, that is negligible.

At the same time, buying individual stocks requires transaction fees, which you often do not have with mutual funds. If you buy 20 stocks and invest monthly, that is 240 transactions a year. Even at a discount broker, you are talking thousands of dollars in transaction fees.

Maybe if you invest a large sum up front, and then never add any additional money, and then hold for a long time, you'll be better off with your individual stocks. But I think most people would find it cheaper and less hassle to get into a low-expense index fund.
 
 
Oct 28, 2008
You have to do a little more than just sit on the stocks, since over time some stocks will grow more than the rest and start to dominate your portfolio - likewise some will shrink and be a lot less than 5%. So every once in a while you need to rebalance to get everything approximately equal. It may be hard for a small account to get fees lower than an SP-500 ETF if you want to rebalance annually.
 
 
 
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