Mutual Funds vs Individual Stocks

Hey Tim4:

I did a $US20,000 put on the S&P500 on October 1st 1987. I spent 17 jarring days checking the index...once in the morning, then at noon, then at the close of business. Needless to say I made millions... the only problem was I undertook the venture on paper, not real cash.

Damn!

"Personally, It rankles meto pay a Mer to a manager who cant even beat an index. However, it does consume considerable time to pick the right stocks but I do like those dividend cheques so will continue."

hmmm...sounds like an argument for indexing ;-)

While there is a place for MF's, I shudder when people build their entire retirement portfolio with funds. Just the idea of handing life savings over to someone else who fits my "investment objectives" is scary enough. What do they know about me? Besides, I don't want to get taxed just because the manager decided to raise cash for redemptions and sell some securities. I'm not saying I'm smarter than any money manager, I could never be as affluent in the world of finance as any of them. These people have their own agenda, objectives of the fund or not. (wow, what a long post for me, I've had too much Starbucks)

Bylo, there is definite case to be made for indexing. However, say you chose the S&P 500 for an index. Within those 500 companies there are bound to be some goings down some holding aand some going up. Of course, we all want to invest in the ones going up but the ones in an index that are going down drag the others down. Therefore, FWIW, I will continue with my feeble attempt at just picking the ones that will continue to go up and hopefully ignore the ones going down. I dont believe timing works and try to value invest with the research available. On June 11/98 SGP was at 92.50 which according to most experts was too high and today it is at 99.00 something. Did SGP beat the index, you bet it did and so did a lot of others. I am fascinated by the markets and dont find research tedious but interesting. My 2 cents worth.

I started in mutual funds then switched to individual stocks as I learned to read the financial statements. Would never switch back, although I still have my mutual funds, you can make a s**tload more money in individual companies, and it doesn't take too much of your time.

Tim,

Judging by the number of posts you've made about stock picking you obviously must enjoy it. Far be it for me to try to persuade you to become an indexer. But since you asked...

When you invest in a broadly diversified index like say TIPs 100, you own a large selection of stocks in all industry segments. You have to believe that in the long run you'll own far more Barricks and Bombardiers than Bre-Xs and YBMs. You also have to believe that no active manager can consistently beat your portfolio. Bogle among others, presents compelling evidence that this is the case, however unintuitive it may seem. Even consummate stock pickers like Warren Buffett and Peter Lynch freely concede that most investors will do better by buying and holding low-cost index funds. Finally numerous academics have come to the same conclusion.

After you've owned an individual stock for a long period, even though it may have performed well, there may come a time when you want to sell it. Perhaps the stock is in an industry that's in decline, or perhaps you find that you're overweight in a particular industry or stock. In any case when you sell, you incur a significant tax on the capital gain. With an index fund you don't have to worry about individual stocks. In theory you should only need to sell an index fund when you need the money, e.g. when you retire. While index funds do pay out small capital gains distributions as stocks enter and leave the index, well run -- and especially the most broadly diversified index funds -- can approach the tax efficiency of a portfolio of DRIPed stocks.

With an index fund you get distributions at most 4 times a year. With a portfolio of individual stocks you get 4 dividends per year -- per stock. And of course if you make regular investments it's easier to record one transaction a month than several. The same argument goes for tax reporting.

In both cases costs are crucial. While owning individual stocks in DRIPs costs you nothing after your first purchase of each stock, with TIPs the effective "MER" is an almost negligible 0.05%. That's a small price to pay for the convenience. Bear in mind that 0.05% of a $1,000,000 portfolio is just $500 a year. Even Vanguard MERs of 0.2% would be $2,000 a year. Not insignificant, but still an order of magnitude less than for most managed funds.

In the end what's important is what your gut tells you. If you're uncomfortable with the notion of putting your portfolio "on autopilot" then indexing is not for you.

Bylo, thanks for the response. During this recent downturn some stock were almost bulletproof although Im sure that if it had've continued they would've felt some downward pressure too. If you are in a correction with a declining index fund but it is the time to take money out, what do you do??? With individual stocks you have the flexibility of deciding which sectors to reduce your holdings in or even eliminate a whole sector. For fun you should look at the 10 year charts for the giant pharmas and compare that to any index. Yes, it is 20/20 hindsight to say I couldve bought Pfizer at 2.00 but your using historical information to support your position on indexing also. The best part of this whole discussion is that I can move to indexing if I am unhappy with my approach.

Tim,

No doubt there's more flexibility with individual stocks. I suspect that most MF investors, whether indexers or not, invest their portfolio in several funds. I certainly do. While I may have less flexibility than you, I nevertheless have options in the event I need cash. Moreover, since I've never been more than about 65% in equities, I always have even more options.

I know that some assets have far outperformed the S&P500. In fact although Warren Buffett's own BRK is one, he advised his shareholders a couple of years ago "Most investors ... will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals." Now he did say professionals, so perhaps he thinks amateurs have a better chance of beating the index :-)

As I said at the outset, I'm not trying to convert you (or anyone else.) I think we're in agreement that such discussion is healthy and helps makes both of us better investors.

Professionals may become handicapped in that the actual money begins to be simply numbers. Fortunately, I do remember what real money is and kinda like to hang on to it. Ive stayed the course with 100% equities as I feel more comfortable with this position (due to my young age) than with a mix of fixed instruments. Brave, not really, My holdings are largely conservative and didnt suffer the setbacks experienced by most MF's or Index's. G&M has an interesting article this am about the very subject of indexing. GL Health Sciences performance this past year could've been beaten by a dart throwing chimpanze but the Mers remain the same. Dont forget, in the long run, we're all dead.

Bylo and Tim: Your posts are excellent and should be a reference link for anybody asking similar questions in the future.

I'm in both camps; funds and stocks.

Our stock funds are now exclusively index ones. They used to be mostly Sceptre, but no more because today there are other and lower mer options available. We now have SD-RRSPs which only have index funds and money market holdings. The index are both the International and the US Index RRSP funds from TD. But I may switch to the new ones from Royal if TD does NOT lower its mer to Royal's 0.55% level shortly. Outside our RRSP we hold Vanguard index funds. The money market cash may well end up in TIPs but other options are being considered. [The common theme is broadly based equities and low ongoing costs or mers. At present we have no bond funds.]

The stocks are all outside an RSP and fall into two groups. One grouping is a mix of about 20 large-cap US stocks that in effect mimic the S &P. They reside in a TD account and we get a quarterly dividend stream from them. It's a buy-and-hold operation. The other is a heavy concentration of high tech, via only Microsoft and Hewlett-Packard at present. The latter two have of course made the largest capital gains returns [unrealized] over the past five years.

I would echo Bylo's views that low mers [or maintenance costs] and tax efficiency are the two main issues. [Assuming of course that the proper diversification, or asset allocation, consistent with ones risk tolerance is already in place.]

My main two problems come about from the 20-stock basket. I cannot keep track of all of them properly. But since they have been doing ok as a whole, as all are large companies, I have not worried about this too much recently. The more serious bugaboo that I have run into is that Revenue Canada nicks me for taxes which I did not expect, because of some stock distribution or re-organization within one of the 20 US companies, which in the US has no tax penalty. But in Canada there is tax penalty.

An example of the last point. At the moment I must decide whether or not I should sell our General Re Corp holdings BEFORE its amalgamation with Berkshire takes place. If I do not, there is the possibility I could be hit with a made-in-Canada "dividend distribution:" tax ruling from Revenue Canada. This sort of tax issue is the down side of "doing it yourself" investing. While I enjoy the financial investment aspect, I do not enjoy trying to become a tax expert. Life is too short.

Cheers.

Thanks to all for an interesting and informative discussion. For us rookies-where could we get an unbiased view of index funds?

George, thanks for the kind words. I'll bookmark this thread and archive it on my website once activity here dies down a bit. Also, welcome aboard as a BRK shareholder.

Hiltz, there are no "unbiased" sources of information on indexing -- or anything else for that matter. :-) Most of the material on indexing and related investment strategies comes from the US:

George, I echo Bylos thanks. FWIW, I ignore most tax considerations when buying and selling as it is much too complicated and not a field I really wish to know about other than getting reacquainted with my accountant from time to time. HP and MS are great stocks and should continue to outperform. In addition to my conservative stocks, I do confess that I speculate a little on potential 10 baggers but outside my RRSP. I suppose people do this with sector MFs of which some have been outstanding but alot suffer abysmally. I do feel that the very term Mutual Fund conjures up some sort of safe investment whereas that nasty stock market which is full of crooks and manipulators is a place to avoid. Alas, this recent downturn perhaps will cause people to begin to THINK for themselves.