Pros and cons of the "holy grail"

Investing / Others
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I know, I know, I am one of the little non-believers of this religion here.

I think there are many ways to construct an average and that more than say 50-100 investments do not help reduce risk. They add risk, the risk of missing opportunities. They add to that risk because of the weighting of components. Components that have growth in the past are over represented while components having it in the future are under represented. Too much diversification and done the wrong way. More important than anything in the stock market is sector diversification and many indices do not even consider that.

Now DALBAR publishes a report on how individual investors do compared with “passive” ETF investors. I thought the result would be clearly for ETF investors, but it seems that those times are gone. individual investors did beat “passive” ETF investors, again. And even worse, individual investors were more passive than ETF managers, doing less trading and holding for longer periods of time.

Now, this is an average I trust more. Real numbers that average investors did make, not some self-constructed average with different weighting of the components.

We already established that there are more indices and more ETF than single stocks today. That is just another sign of a bubble in my humble opinion.

I think the DALBAR average may be biased too, because I suppose it includes some big investors that do good and many little investors that do not. Maybe a median calculation would be much worse.

The risk of missing opportunities (ROMO, my own construction) is the risk of missed opportunities in the future, while the FOMO is a bias that comes after the fact and makes you run after performance too late. If you have thousands of components in your ETF and even worse, if they are weighted as most indices do, you risk missing that big winner. Not because you don’t own it but because you own too little of it.

The other bad thing in owning thousands of stocks is the inclusion of companies you would not touch with gloves if you were choosing yourself. Zombies, debt-loaded, badly managed companies, cheaters that are just a burden and nothing more.

Now, the good thing is, and I understand that, that you need no knowledge. You avoid costly errors (others do those errors for you). And you don’t need to learn or spend time with your investments.

But is it really that bad to learn and spend some time with investing your hardly earned money? I don’t think so.

So, that was a con agains the holy grail. Looking forward to some pros.

The DALBAR study:

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Or just invest 100% in bitcoin. Every diversification is just reducing your return.

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Suppose you forgot the smiley.

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It would be a good thing that not only active investors outperform “passive” ETF investors, but also that active investors trade volumes be significantly higher than “passive” ETF.

There’s a larger danger, also for passive investors, when index ETFs that follow the market actually make the market.

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An ETF, like any other fund, is essentially an asset management service. You are paying someone else to manage your investments and assets for you.

There is no reason why you could not put together and manage a diverse portfolio yourself. There are obvious benefits like being able to select stocks yourself, quickly offload failing companies (a flaw in indexes, in my opinion), etc. The main question would be cost efficiency compared to paying an asset manager. That would depend on brokerage and custody fees, currency exchange, taxes, etc. Also on how much your time is worth.

For small indexes (the SMI, for example), it’s actually hard to find an argument for ETFs vs. direct investments. Much less still for single assets like gold, etc. Maybe for short-term trading. The cost of using ETFs will pretty much always be higher for long-term investments.

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Thanks, good points.

But the difference is higher than that fees would explain.

Unfortunately I cannot study the complete report so I’m not sure how the numbers were constructed. Individual investors did 18% better than ETF investors, 19.6% vs. 16.54%.

Did anybody here study that report? I imagine they compare the net result for investors. That could only mean that ETF investors did more behavioral errors buying and selling their ETF. That may be explained with all the youngsters investing in the holy grail and buy expensive and sell cheap.

That effect was already described by Peter Lynch. It was difficult to lose money with his fund, but he said once that most of his clients did exactly this: lose money. They bought it at highs and sold at lows.

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I’ll read it post work.

For me it’s lack of time, skill and mainly testicular fortitude that makes me an ETF-only holder.

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This is the argument I hear most. I even did recommend to a friend a combination of NDX and SCHD ETF. He did beat all index, but that was pure luck with timing.

Now when I think how much time I did spend on making my money, working 7 days a week, travelling all around the world just for work and compare this with the one or two hours per week I spend with my investments, I think “time” is a no-argument. I spend that time because I like it, but my mechanical strategies would even allow for much less time spent.

But the knowledge and the errors that come with missing knowledge are a very good argument. I mean, an index which is chosen by a board like the SP500 has a history of errors. But probably the errors of a single investor are even more expensive.

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Exactly, this is a valid point (time is not as I explained in my last post).

If you can avoid behavioral mistakes you have an edge. But that is more difficult than it sounds, a hundert thousand years of bias building up in our brains that helped survive and does harm investing.

There are solutions for this, I use purely mechanical strategies. But this does not come in one day, you have a learning curve.

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As of earlier this year I do the same with my USD holdings, 3:1 ratio of SCHD and TQQQ, bought deep in the “Liberation Day” days, but after Trump’s “it’s a good time to buy” insider trading thing. It’s done well but it’s luck isn’t it as @oslasho also says.

There’s two points in there, maybe three: a) coming up with a strategy, b) having the time and c) allocating it because you want/like to. I like going to the gym, I also like playing computer games, and spending time with my wife and kids, factoring in 8-10 hours’ work, morning coffee, gym, family eating, and sleep there’re pockets of time but not that many. That said, when people who don’t invest hear I invest they picture I am Patric Bateman minus the homicide, or Jordan Belfort minus the drugs and prostitutes, sitting behind 5 Bloomberg terminals, they struggle when I say that I spend minutes per month actually doing anything investing-related.

I could get the skill, I could also find the time, but it’s the testicular fortitude I am not sure about!

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I understand all your points. But then

For me it was good business time-wise; I did FIRE with 51 and got all the time I want, even if I still spend a little on investing.

The time I invested came back hundredfold. That is why I give more weight to your other points.

Learning is difficult and may be costly, not only time-wise. And that is exactly the best argument for ETF investing.

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I think the question is how much time is invested and how gains compare versus a set it and forget it approach where you invest it and then just let it run e.g. put everything in one low cost tracking ETF. Or in more complicated scenarios in multiple assets that have automated re-balancing.

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Time invested in yourself is never lost.

The title says holy grail, so why not compare some other ETF. As I said, 50-100 stocks are enough to reduce risk, more stocks do not reduce risk. They even add to risk as I explained in the ROMO part. Even if some studies say they do not because having many thousand of stocks you are sure to catch the big winners. You are not. Very small companies are normally not included and the included companies have so little weight that even a big winner brings you almost nothing.

So for me the ideal ETF has 100 stocks or less and is constructed in a mechanical way. Both, the Nasdaq 100 and the U.S. Dividend 100 index are constructed mechanically, that is why I recommended a combination to an inexperienced friend who got into some money. He is probably too old to learn something so completely new for him. I helped him set up automatic dividend reinvestment so he does not have to do anything, not spend a single minute with his investments.

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I guess there are no shortages of potential ETFs.

You have some like: QQQ, VTI, VT.

They’ve returned between 170% and 10x depending on how far back you go.

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Now back to this argument. It is funny and very important, but not in the way most think.

Balls of steel can create big damage, probably the most damage of all. Because they make you take risks that do not add to performance. That is very bad! And I speak of experience…

More important is to know your risk tolerance. Be a realist. Then set up your investments according to risk tolerance, but take only risks that get you better performance.

You can remove behavioral risk with mechanical investment. You can avoid single risks with diversification. But you cannot avoid market risk. But you can model it and then decide how much to invest where.

I am afraid many holy grail investors don’t do that. They will wake up one day with big losses even they always thought they are not big risk takers.

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I am currently invested in VT and ASTS (a bet toward FIRE or at least FI early). If you asked me, “Would you like to be an active investor with 50–100 holdings?” I would say absolutely, I genuinely would love that. But it quickly became overwhelming… There are thousands of companies, across different countries and sectors, and it is hard to know where to even begin.

I believe you when you say it only takes you 2 hours a week now. But I wonder, how much time did you spend upfront to build your portfolio? Both, your dividend portfolio, and your mechanics portfolio, plus how much time you have spent to set your mechanics rules. Could you provide an estimation of hours?

When I look at the companies you have chosen, most are unfamiliar to me. That tells me you have invested significant time researching them. And when you sell one to buy another, that’s more time spent evaluating new opportunities, understanding what they do, whether they are worth investing in, and whether they have the potential for +500% returns, etc.

If I were to shift from VT to a portfolio of 50–100 individual stocks, I could probably identify 20–25 solid picks fairly quickly. But for the remaining 75, I would need 2–3 hours minimum per company just to research and decide. That’s 150–225 hours just to build the portfolio, not exactly easy.

But as I said, I would really love to do it.

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They also write about lower equity allocation and shorter holding period for mutual fund investors which in part explains the lower performance.

“The average retention for equity subaccount investors was 5.23 years, higher than the 4.79 years for mutual fund equity investors. Longer retention supports greater investment growth through market cycles.“

“Subaccount investors tend to allocate more aggressively into equities (approx. 80% vs. 74% for mutual fund investors). This higher equity allocation, combined with greater patience, amplifies returns when markets are strong.“

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I agree with the overall sentiment, so it’s a balancing act on my part between having “the market” (ie FTSE all-world) as the core holding, and satellites. SCHD and QQQ have basically no overlap, and are both selecting based on something. Less convinced about the NASDAQ100 (QQQ) though, “has Pepsi but not Coke” is a common argument about it being a nonsensical index. It’s also called a “tech index” but even more ignorant people, which it is not. SCHD’s selection criteria appear very solid to me.

It’s important to also note that index investing won’t make anyone rich, not any time soon anyway. For people who’ve amassed >1mn with a very reasonable middle class salary (I know a few) it’s a combination of intense saving and big bull run, so that’s part effort part luck. If eg one started investing in 2000 their CAGR would be half of that of a person starting in 2010. More specifically - and interestingly - is to see what % of gains is due to contributions vs compounding, in the first timeframe compounding does basically nothing, in the second it does >75% of the work.

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While still working I did not spend much time with my investments. I did re-evaluate once a year or so. But then my performance was not very good. I did start long before the internet was available, today everything is more easy.

Now, you don’t need 100 holdings. For my mechanical dividend strategy 25 are enough. The important thing is sector diversification. I did write down all my rules for this strategy in the mechanical investment thread, feel free to pick any idea that you like there.

Now the momentum strategy is different. This did cost me more than 10 years of evaluating, trying, paper trading and so on. Countless hours invested, maybe over 1000, but it paid out. I did not start before I was sure to be able to survive with the dividend strategy and could lose all the money invested in the momentum strategy. That is probably the most important point. High risk, high reward.

I did not spend much time in selecting or researching stocks. I did spend much time in defining the rules for position and money management and stock picking. That time spent saves time (and money) on every single trade.

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Around 134 years I think…

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