When I wrote The Intelligent Asset Allocator, I thought I was producing a volume for the average investor. Turns out I was wrong: the book's audience was closer to the average electrical engineer. So I tried a little harder and produced The Four Pillars of Investing. Close, but no cigar: still lots of complaints about all the math and graphs.
This time around, the approach is even more down-to-earth. I think that most of my old readers, and perhaps some new ones as well, will find the contents of this work even more readable than the last two.
Once more, the debate comes down to one of putting together a broad portfolio using index funds vs. picking individual stocks. Approximately 85% of all investors go the route of selecting individual stocks.
Lowell,
I didn't ask the question correctly. It has nothing to do with stocks vs index fund picking. It is about picking index funds. You buy a index fund for certain reasons. That index fund is comprised of stocks. The charateristics of the index remains fairlly constant but the stocks change. Ergo, small cap growth stocks would not be growth stocks if they didn't grow into mid or large cap. (G)
As far as a broad portfolio of stocks vs indexes; I'd submit with owning 15 to 30 stocks you can own 75 to 85% of the market.
Bob
I didn't ask the question correctly. It has nothing to do with stocks vs index fund picking. It is about picking index funds. You buy a index fund for certain reasons. That index fund is comprised of stocks. The characteristics of the index remains fairlly constant but the stocks change. Ergo, small cap growth stocks would not be growth stocks if they didn't grow into mid or large cap. (G)
When I select index funds, I do it in a way the covers most of the world stock market. I pay zero attention to the individual stocks that make up any index fund. On occasion I will look through the stocks in the VTV (or IVE) index as that is where most of the "sin stocks" reside.
I buy a particular ETF to cover a certain asset class. The reason for taking this approach is based on the research by Ibbotson & Associates as well as other studies. The research shows that Asset Allocation is more important than market timing or picking individual stocks. That runs counter to intuition, but I prefer not to let my intuition stand in the way of facts - at least the facts as we now know them. Information does change and if I come across new information, I will adapt.
Yes, the index ETFs are made up of a basket of stocks, and that basket will take on a slightly different look from year to year. Even if the stocks within an index change, I do not change ownership in the ETF. I will likely always hold shares in the "Big Six" U.S. asset classes.
Bernstein would certainly differ. My answer would be - maybe and maybe not. I would be concerned about not owning that 15% to 25% of the market. If one does not hold international investment one is opting out of 50% of the market. When I was picking individual stocks to populate the portfolio, I was incompetent when it came to selecting international and emerging market stocks. International bonds and international REITs were even further out of my expertise. [and I use the word 'expertise' with caution. (g)] Most stock pickers shun the international market or view holdings in big-cap companies with international business to be sufficient.
If I may return to a worn out adage - Track your own portfolio using the TLH spreadsheet and compare the results vs. the VTSMX index and a customized benchmark. I don't know of any better method of answering the question of performance. The TLH SS also provides a first step toward portfolio diversification.
Lowell Herr
On occasion I will look through the stocks in the VTV (or IVE) index as that is where most of the "sin stocks" reside.
Any idea how this helps or hurts a portfolio?
In other words, DFA does not have to own all of the stocks fitting its criteria, only those that can be bought without incurring significant transactional costs."
Buy the market, keep fees and transaction costs low, spread risks. Let the market growth be your friend.
I am no longer able to find the message, but I recall reading an entry where the argument was made that by investing in 12-15 stocks, one was able to create a well-diversified portfolio. In reading further in Bernstein's book, I came across this study by Ron Surz. Surz constructed 1,000 random portfolios each containing 15 stocks, and then followed their performance for 30 years. Portfolios at the 95th percentile (top 5%) or better, returned 2.5 times the return of the broad market, whereas those portfolios in the 5th percentile returned only 40% of the broad market.
The study I remember said you could have a well diversified portfolio with 12-15 stocks up to about 30 stocks. After 30 stock any safety of diversification had marginal impact. I suspect the 5% or 3 SD portfolio's were not very diversified. It does show luck plays a role in investing.
True, most 15 stock portfolios are not well diversified. Bernstein would argue that most 30 stock portfolios are also not all that well diversified.
If I took 30 stocks and distributed them to match the percentage's found in the S&P 500, would I be diversified for US equities? If not, why? If I took all 500 stocks and distributed them to match the percentage's found in the S&P 500, would I be diversified? Why or why not? Is it a matter of risk or a matter of return? If it is because there are only US stocks and no other assets, then that is another issue.
Diversity is the primary motivator to reduce risk. I'm of the opinion that if one is careful in how the different asset classes are selected, it is possible to out-perform indexes such as the S&P 500 (VFINX) or an even tougher standard, the VTSMX.
With the value of international stocks now 73% and the US 27% this would reinforce the view the S&P 500 is no longer a good benchmark to utilize.
I have seen studies that show a portfolio of 12 stocks can provide diversification and also studies suggesting 100 stocks are needed to provide diversification. I tend to lean toward the higher number.
The key seems to be the correlation of the various selected asset classes. With a worldwide economy and an Internet connected world I believe the correlations will continue to converge. However I do believe demographics will result in varying correlations. For example a country with a population with the majority of people in the working age of 20 - 60 will tend to do better than one with a high percentage of retired people. Of course a stable free government is also essential to allow a country to grow.
Today is the 20th anniversary of the fall of the Berlin Wall. Prior to that time only about 1/5 of the world's population was free to enhance their position in life. Today it is closer to 4/5 anxious to work and improve their position and grow their wealth. This provides a lot of countries with a hungry (Anxious to work) population wanting to work hard and improve their position in life. I think the availability of world wide communications has allowed many of these people to see how the rest of the world lives and they want to emulate this for their lives. Thus I think it is necessary to have a portfolio that includes these young growing nations that will likely out perform the developed nations for the foreseeable future.
Dan
