Here in South Carolina, there’s a student-run portfolio at the local university, where I’ve taught and served on some sort of economic advisory board. The students don’t manage a huge amount of money—around $140,000. But they put a lot of work into it, which they share with the board.
At one of the last meetings, the students said their portfolio’s performance matched the S&P 500’s performance, almost exactly. So, I looked deeper into their portfolio. They had miniscule positions in a few single stocks. But most of the portfolio was made up of sector ETFs—the Energy Select Sector SPDR Fund (XLE), the Industrial Select Sector SPDR Fund (XLI), and the like. And they had allocated these funds in such a way that their portfolio mirrored the S&P 500.
In other words, they were actively managing an S&P 500 index fund. Or more precisely, a closet index fund.
Don’t get me wrong, index funds serve a valuable purpose…
But the purpose of a student-run portfolio should be to encourage college kids to research individual companies and take some risks. Some of those risks will pay off and some won’t.
Index funds, on the other hand, are for people with no special knowledge of the market or individual stocks—which is most people.
Maybe you think, “I’m a contractor/dentist/teacher/whatever. I don’t know much about this stuff. But I’m going to bet that over time the economy will expand, corporate earnings will increase, and stocks will go up.”
There is no Newton’s Law of Stocks stating that stocks must go up over time. Sometimes they go up. Sometimes they go down. But over a long enough time horizon—20, 30, 40 years—it’s reasonable to bet that stocks will climb higher. So, you want to have some (but not all) of your money in stocks.
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When should you handpick individual stocks?
You want to pick individual stocks when you have done a lot of research and know something about the stock’s fundamentals. And because of that, you think the stock will go higher.
A knowledgeable, disciplined investor can build a portfolio of 30 or so stocks, spread across various sectors, and have some chance of beating of the market. Some people say you need 100 stocks to really be diversified. But that’s impractical. And it can lead to something called diworsification, where adding more stocks adds risk without improving performance.
The caveat here is that most people who think they know something about stocks know little to nothing. They have a range of uniformed opinions. On the low end, you’ve got the people who pour into meme stocks like AMC Entertainment Holdings Inc. (AMC). Then you’ve got the guys who buy Amazon (AMZN) just before Christmas because they think sales will jump over the holidays.
However knowledgeable you think you are, there are plenty of investors who are more informed, more experienced, and more technically sophisticated. Therefore, you are at a huge disadvantage if you try to pick individual stocks.
Ninety-nine percent of people reading this should not worry about individual stocks, and they should not worry about diworsification. Instead, they should buy index funds, dollar-cost average, hold on for 40 years, and enjoy a comfortable retirement.
But people don’t follow that guidance because Americans are degenerate gamblers.
We are a country of risk takers. We love to play the stock market because it is fun—because money won is sweeter than money earned. (People don’t do this in other countries.)
The solution here is to put 90% of your investable assets in something safe and stable, like the Awesome Portfolio. We backtested the portfolio over several decades, and it delivered the best risk-adjusted returns over time, with only a modest drawdown in its worst year. Even this year, when the market has seasoned investors panicking, the Awesome Portfolio is outperforming a so-called “safe” portfolio of 60% stocks and 40% bonds by 5.6%.
Anyway, when 90% of your money is safely invested in something like the Awesome Portfolio, you are free to take the other 10% and mess around with speculative bets in the stock market, with full knowledge that those bets are just that… bets.
Jared Dillian
P.S. With the stock market down 20% this year, even pro investors are in crisis mode. But folks with most of their money in the Awesome Portfolio have nothing to sweat. That’s because I designed the Awesome Portfolio to outperform in good times and in bad. And anyone, even first-time investors, can easily set it up. Learn more about the Awesome Portfolio by clicking here.