Avoiding Mediocrity

A fool and his money are soon parted, or so the proverb goes. I can’t think of anyone that has not heard some version of it and yet it surprises me still when I stumble across someone proposing to take you by the hand, leading you from the frying pan into the fire. And so it was that this past week I ran across two post within a day of each other, one advising you that you ain’t got what it takes to pick a stock so buy ETFs, and the other presenting a keeping-it-simple how-to.

When Canadians say “I’m sorry”, it’s followed by the word “asshole” in a pitch only other Canadians can hear — @lloydrang

In engaging the author of the first post, in typical Canadian fashion, I chose to tread softly, agreeing mostly, except where I didn’t. Of course I was spanked down; silly me I stepped up again, because, you know, I think we kinda deserve to make money. Wrong approach again, because, you see, studies have shown that the individual investors will make mistakes, so stop trying and eat your ETFs. Fine, says I; you have your studies and I have my 12% CAGR over 17 years! Nope, apparently I’m still wrong because, you see, “ETFs are still superior, as you could simply buy and hold Vanguard small-cap value ETF and Vanguard High Yield Large Cap ETF without having to adjust the portfolio every year”. And that’s when I backed away, mumbling my apologies … Of course, one of us has multiple thousands of followers, the other has you. My mission is unchanged: I will continue to advocate selection of stocks by the simplest method I have stumbled upon  – read: not because I am an analyst of great renown, not because I have developed the killer stock selection app, not because my PhD in quantitative analysis guides my decisions – and will do so over any and all mutual funds.

Common stocks vs ETFs

The universe of stocks available to the individual investor is vast. In the US you will find more than 5,900 issues on the Big Board (NYSE), 3,200 on the NASDAQ, and for those of us playing north of the border the Toronto Exchange (TSX) provides around 1600 or so issues to choose from. Want more? There’s the Canadian Venture Exchange with 2,400 “smaller, mostly unknown companies” to take your money and of course the OTCBB featuring gems like $CYNK. Sounds dangerous, doesn’t it? Are things any better with ETFs then? Perhaps yes, but your choices still number in the hundreds, well over 1,500 if you go cross-border shopping. And what kind of ETF are you looking for now? Maybe you didn’t see the vast landscape of ETF’s and you settled on a simple proxy, $SPY, the ETF that tracks the S&P 500 index rather efficiently. Or, perhaps, you fancy yourself a bit of a geek and choose a proxy for the NASDAQ 100, $QQQQ. A good play until you realise that Apple makes up approximately 15% of the portfolio over Microsoft’s 8%, and IBM’s not there at all. Is that what you thought you bought? You don’t even like Apple!

Common mistakes of the Individual Investor (me)

1. Buy high, sell low – you have no idea how often I have succumbed to this idiocy. You do your research, you understand the market, you’ve looked at executive management and you decide to pull the trigger. You are perfectly aware that the stock is trading at a 52 week high, but, you’ve done the homework. The market starts to trend down, and your pick with it. Six weeks pass and all is still trending down, and you’re out 25%. Do you buy more at this price, this stock so carefully selected? Hell no! Madness of the masses drives you now and you bail before you lose more. Thinking back, perhaps $AAPL at under $100 pre-split looks good.
2. Falling in love with your pick – You did your research, “organics | solar | wind” is the wave of the future. 5 years later your investment has been decimated and yet it still clutters your portfolio, because it can’t go down any further, right? Riiight …
3. Relying on the abilities of others – you’re new at this so you buy into a newsletter/blog/twitterfeed, better yet, your neighbour/colleague. Stop right there! These publications percolate in bubble times and all but disappear during the downdrafts. “My picks are up 150% over the last 5 years!!” Amazing until you see that the broader market is up 175% in the same timeframe and our marketer is in fact touting underperformance. And your neighbour? Really?? And, based on my own experiences, my final big bonehead move is:
4. Investing without a plan – do you know the stocks you own? Do you know why you own them? Do you know when to sell? Do you have a plan for portfolio construction, or do you think you need one? Now, if you’ve read my updates, you’ll know why I own the vast bulk of my stocks: I applied a filter, one that guarantees a degree of safety, if not performance. It has served me well for almost two decades so I have a great deal of faith in it, and IT is my plan. I have a set of rules that I apply to the rest – 20% – of my portfolio and it is much newer and therefore more requiring of my diligence. That said, have a plan, and follow it; a plan not followed is simply empty self-gratification. Stop it.

Ahh then, ETF’s are for me, you say – just like the NASDAQ Qubes mentioned above, ETF’s come in a variety of flavours. You know for a fact that “health care” is the demographic that will bear fruit, but you don’t won’t to lose your shirt like you did on “organics | solar | wind”. You’re not sure if you should go for the Health Care REIT (HCP), the insurer (UNH), or the device manufacturer (SYK). Fine then, an ETF it is, but which one?? Count them: 25! There’s Vanguard, SPDRs, iShares and PowerShares, likely all names you know. Which one?? Pick wrong and you’ll see a 40% difference in appreciation over 5 years. So, to be safe, you opt for the S&P500 index-tracking ETF’s, in a word, mediocrity. It’s a reasonable place to be until you establish your plan. Backtest it, build a model and track it. Then, when you are satisfied and you understand the possible places you will falter: Do It™. We can beat the average! Stay tuned!