I have friends and co-workers who do not trust the stock market or are intimidated by it. I have also read comments on various blogs where the commenters mention the same thing. I was a little hesitant about writing a post about investing as it is more of a hobby for me and I have no professional knowledge. Also, I hadn’t put up my disclaimer page until recently! (just in case…you never know)
How I became interested in investing
First, let me explain how my interest in the stock market was sparked, and how my experiences shaped my investment philosophy. When I was about 11 years old, my father bought me a Nintendo game called Wall Street Kid. I was a nerd and loved that game, but I’d hide it if my friends came over for fear that I would be teased. I did beat this game, which is an accomplishment that should qualify me to give you all investing advice.
Not only did my father buy me an investing game, he invested in a mutual fund for my college education and showed me the statements. They didn’t have 529 plans back in the day when I was a kid. My father bought an actively managed mutual fund from American Century called the Ultra fund. It was a great fund that was “synonymous with stellar growth.” I looked at the statements seeing 20% to 40% growth and I was hooked.
When I was still in college back in 2001, I remember everyone and their mother and their grandmother investing and making money in stocks. Everyone thought they were expert stock pickers and everyone was glued to CNBC. I decided that I was missing out and took all the money that I saved up to open a trading account. It was a lot of money to me at the time. I bought some internet stocks that were recommended by analysts which I had never heard of. I also bought well known stocks like AT&T (they were soon offering a wireless IPO and IPOs were hot!). Yes this is AT&T wireless. To you youngings that don’t know a time without cellphones, wireless phones were a big deal and this stock would no doubt be a big deal (so I thought). About one month after I opened by stock trading account, the internet bubble burst and my stocks came crashing down. I lost 50% of the value in the account.
When I started working, I had a little more money to invest with and put more money into the stock market. Be greedy when others are fearful according to Warren Buffet. I picked up Nokia stock at $14 (I had Nokia phones and liked them). The stock went up to around $40 and I held on because its a stable company. It was a buy-and-hold type of company. An industry leader. A “rule maker” as the Motley Fool called it. I kept it all the way until now. With the advent of smartphones, Nokia phones were an after thought. It’s now at around $4. I bought shares of Starbucks at one point…I wasn’t a customer, but saw how popular the store was. They could probably open a Starbucks inside another Starbucks and still have crazy lines. Well I sold the stock during the latest recession trying to cut my losses. I figured people would save their money and spend it on other things rather than $5 lattes. I must be wrong because the stock is worth about 4 times more than what I sold it for.
My timing was horrible. It probably has a lot to do with loss aversion and the endowment effect which is explained well in this fantasy football analogy by Done by Forty. When I bought a stock, there was an endowment effect or ownership bias. I placed a higher value on it and didn’t want to sell as I thought it would go up more. When the stock went down, I didn’t want to sell and take a loss, hoping that it would go back up.
I invested in some winners and some losers, but the losers probably outweighed the winners. Good thing I was also investing in mutual funds through my deferred compensation plan and IRA. Based on my history, if I only invested in individual stocks, my portfolio would be in shambles. You might be asking with mutual funds, why not invest in a professionally managed fund. Obviously the fund managers are more adept and competent as this is their profession. Remember the “Ultra” mutual fund that my father invested for me which was a high flying fund. It was a great fund…until it wasn’t. During the tech boom in the late ’90s it did well investing in tech stocks, but did horribly when the bubble burst. The managers seemed to panic and changed gears, trying to invest in safer stocks. Those didn’t do that well either. Janus funds also were coveted by investors, but were crushed during that tech bubble. Legg Mason Fund’s manager beat the S&P 500 15 years in a row and this was a well respected fund recommended by many financial magazines, but struggled during the latest financial crisis.
So why index funds?
-With actively managed funds, you have to be able to pick the fund that will actually outperform the market. Will you pick the right one?
-Even if the fund managers can beat the market, can they do this consistently year after year?
-Actively managed funds have much higher fees and expenses
-Actively managed funds have much more turnover because they have to buy and sell stocks in an attempt to beat the market. This causes higher costs and it is not tax efficient as it results in capital gains. On the other hand, index funds invest in an index and therefore do not have much turnover.
Still not convinced, read this article by Rick Ferri in Forbes entitled 5 Lies About Index Funds.
I prefer Vanguard index funds as I find that they have the lowest fees.
There will always be an allure with investing in individual stocks. It is sexier than a diversified portfolio of stocks. There is more risk, but the rewards can also be greater. You’ve probably heard something similar to the following:
If you bought 100 shares of Apple Stocks back in 1997 when Apple wasn’t the high-flying company it is now, your stocks would now be worth about $150,000. In the back of my mind, I always think I’ll hit that home run with a stock.
Because of the risk, I’d say that for the majority of people, it is better to keep individual stocks as only a small part of your portfolio such as 5% which is what I do. Do you really have the time and patience to research stocks? Even if you do, are you confident in your abilities to consistently buy low and sell high?