Wednesday, July 7, 2010

Relief by Indexing

My transition from being an active stock-picker to investing in low-cost index ETFs is mostly complete, and I’d have to say that it has been a relief. While I enjoy thinking about investing topics, having to track a basket of stocks can be a chore when I’d rather be doing something else.

I used to own between 10 and 20 individual stocks at any one time, and it takes time to keep up with them. For many investors, “keeping up with stocks” means watching their prices. However, to have any hope of success, stock pickers have to do much more than just stare at price graphs. They need to read company information and try to sniff out signs of changes in the odds of future company success. And they have to do this better than other investors.

To reduce my burden I could have tried to find a financial advisor and hand over my money, but then I'd be left worrying whether I’d chosen the right advisor. Overall, I expect better performance from indexing than from an advisor because of the lower fees.

I haven’t completely sworn off individual stocks, though. I still own some Bank of Montreal (BMO) and Berkshire Hathaway (BRK). (Disclaimer: I do not recommend any particular individual investments. Buyer beware.) I'm hoping that tracking just two companies will be manageable and enjoyable. They also represent only a small fraction of my portfolio and are quite stable companies (not that that is any guarantee: think Nortel). I may yet decide to eliminate individual stocks altogether.

I don’t consider these two stocks to represent “play money”. I don’t believe in wasting a fraction of my money on poor investments. If I didn’t believe that these two companies would perform well, I’d sell them.

I’m looking forward to simpler income tax returns and the knowledge that my returns will roughly match the widely-reported stock indexes whether I watch my investments or ignore them.

13 comments:

  1. Congrats, Michael. Discovering your blog less than a year ago was probably what introduced me to the idea of indexing. I've since done lots more research and am fully convinced that passive low-cost indexing is the way to go.

    My wife and I have parted ways with our advisor and have just recently completed the conversion to a fully indexed portfolio.

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  2. Interesting post. You are on the right path. You are saving a tremendous amount by doing it yourself both in time and $s. I try to get people where you are after a year.
    In terms of individual stocks I recommend they be kept to less than 20% of total investable assets and any single name be less than 5%. You never know when you'll run into a BP!

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  3. @Anthony: I wish you the best of luck with your new path, but you probably won't need luck as long as you can keep your head the next time the market drops.

    @DIY Investor: You're right about the possibility of a company failing altogether. Today's dominant technology can be tomorrow's buggy whips.

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  4. I've gone this route as well. I won't deny that I'm occasionally tempted to buy an individual stock or two but the feeling eventually passes.

    The point about simpler income tax returns is a very good one. It's much easier at tax time when all you do is buy a basket of index funds and very rarely sell anything.

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  5. @CC: I think my number of individual stocks is on a one-way path toward zero. I'm at 2 right now with no plans to add new ones. Over time, I suspect I'll sell one or both and then stop thinking about individual stocks altogether.

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  6. I like the way you are heading with your portfolio Michael. By transitioning to stocks that you merely hold for long periods of time you save money on commissions as well. However, I hate getting hit with the 'low activity fee' from I-trade when I don't make a trade in a quarter ... any way to avoid these fees?

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  7. @Chris: From my read of I-trade's fees, you can avoid the low activity fee by having a total of $10,000 in your combined accounts:

    https://www.scotiaitrade.com/pages/home/fees3.shtml

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  8. @Chris: I had the same problem. If you don't have $10k, you can transfer your holdings to a TFSA (assuming you have room). There is no inactivity fee on registered accounts.

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  9. @Patrick: That's an excellent suggestion for Chris. However, be careful not to run afoul of the TFSA contribution/withdrawal rules if you are thinking of using it like a regular savings account.

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  10. I enjoy stock picking, and I think it can be lucrative, so it's disappointing to see an intelligent person like yourself leave the stockpicking club.

    I wouldn't ordinarily say anything, but there's just too much of a group-think attitude that believes that indexing is the path to investment success. I feel like I should be the one dissenting voice here.

    Warren Buffett has said why would he buy a piece of every business in town, when he could choose just the best ones. He also says most people should not pick stocks, but simply own low-cost index funds, so I guess I can't really argue with you there.

    I think if I were an indexer, I would stop following financial news. I initially thought this would be bad, because I find financial news interesting, but it's almost 100% noise and 0% signal, so it probably wouldn't be a huge loss financially. Hardly ever do I make an investing decision based on financial news.

    I'd wish you luck in your investments, but by indexing, you've removed most of the luck out of investing.

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  11. @Gene: I haven't completely stopped picking individual stocks, but I have come close. I may yet need some luck -- most index investors manage to underperform the index because of failed attempts at market timing. Despite the fact that picking stocks is sometimes fun (and tracking them sometimes a burden), my decision is based on my belief that this approach will increase my expected returns and reduce my risk.

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  12. Wow, only 2 stocks left. I'm surprised but I can also see why you're doing it Michael. Just, there are so many great Canadian dividend-payers - no reservations about missing dividends?

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  13. @Financial Cents: I have nothing against dividends -- the index ETFs pay them, but I'd rather pay lower taxes on capital gains.

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