A discussion about personal finances can be a polite, congenial affair. Few people come to blows over insurance or budgeting. But some topics inflame financial passions, and one of them is investing. Fellow GRS e-scribe William Cowie encountered this a couple weeks ago when he advocated for investing in individual stocks in certain situations. I thought I would pass along a few thoughts of my own, given that 1) William cited the success he's had with a newsletter from The Motley Fool (my employer for the past 15-plus years), and 2) my own portfolio has big holdings in index funds but also some actively managed funds and individual stocks. This is a huge topic, with enough books written about the subject to create an entire wall of books. But for today's post, I'll question one of the main arguments against individual stocks, then conclude with a few parting thoughts. And as my posts have traditionally been sprinkled with cat pictures, I'm including this cool "peace" cat just for fun. We'll see how it goes!
People aren't actively managed funds
The evidence is clear: Most actively managed funds underperform similarly invested index funds. The Standard & Poor's Index vs. Active (SPIVA) mid-2014 report says that more than 70 percent of actively managed funds lost to their respective benchmarks over the previous five years. The cheerleaders of index funds have plenty of hard evidence to power their pom-poms. This leads some to argue that if fancy-pants Wall Street fund managers can't beat an index fund, then the average Josephine doesn't have a chance. However, fund managers have to overcome hurdles that individual investors don't. First off, fund companies take money from your account to pay for running the business and buying fancy pants. The fees charged by index funds are much lower than those charged by actively managed funds, which gives the former group a head start, so to speak. According to the SPIVA report, the S&P 1500 index (a more comprehensive measure of the U.S. stock market than the S&P 500) earned an annualized 19.18 percent over the five years ending June 30, 2014; the average actively managed fund made 17.95 percent -- a difference of 1.23 percent. Not coincidentally, that is just about the average fund's expense ratio -- i.e., the percentage of your account value a fund company extracts. In other words, higher costs are one of the reasons active funds lag index funds.