Saturday, September 23, 2006

picking stocks versus enhanced frugality

Jeff has a great post on this topic here. The key point is that most people with a smaller amount of investment capital would do better focussing on reduced spending and placing their money in index funds rather than picking their own stocks in an attempt to beat the market.

Actually, after thinking about it, I actually recommend the following priorities:

1. increase income - if you're under 40 this should be a priority - it governs what you can save
2. reduce debt - as Jeff pointed out - you'll probably beat the market on comparable returns
3. reduce spending - harder to calculate, but great savings
4. invest in index funds - you may not have alot, but an index fund at 0.12 - 0.45% expense ratio is alot cheaper than 1.2% for the average mutual fund.

Keep in mind Jeff recommends this approach for people with investible assets under $50k. My thoughts are that this a better approach for people with investible assets under $1M.

Think of it this way:

1. the return on time for someone with < $1MM assets may be far better spent increasing earnings and savings compared to the time spent trying to increase returns.
2. transaction costs can become expensive as a ratio to assets traded.
3. most investment money is likely to be in retirement accounts. pairing capital gains with losses for tax benefits only works for taxable trading accounts, but why go there if you can put your money in a retirement account?
4. asset allocation models are much simpler with a few index mutual funds. plus you get the rebalancing benefit of buying low and selling high.
5. it's alot cheaper to dollar cost average with mutual funds than with individual stocks, though sharebuilder makes it easier, however you're still paying monthly fees or $4 per share - that can be quite a bit with smaller volumes.

What are your thoughts?



Medicated Money said...

Very interesting points! I agree with your assessments made in the first 4 points.

We currently are trying to do all 4 of these points since we are in our late 20's. We figure that our positioning will greatly change once we are out of debt, own a house, and able to save in both tax-deferred and taxable investment accounts.


fin_indie said...

Agree that keeping it simple is the way to go for people with minimal investable capital, but only indexing with less than $1M may be extreme. It really depends on the person's tolerance for risk, age, etc. For larger returns, some stock picking is ok, given the person has the right investing mindset and has done their research. I personally own individual stocks, but they're not the bedrock of my portfolio... and I tend to trade them on fundamentals vs. on a technical basis. People have to figure this one out for themselves...

On the topic of increasing income and reducing spending: sure, I don't think you can argue with that. :)

mOOm said...

I learnt a lot through my early attempts at investing. If you want to learn it is worthwhile otherwise not. The reason to invest in non-retirement accounts is if you have other goals than retiring at 59 1/2 ish plus.