The 5 Reasons Why I am Gradually Moving More of My Money to Exchange Traded Funds

In the recent months I have begun moving more and more of my money to index funds/exchange traded funds. Below I list the 5 main reasons why I have chosen to do this.

1. Picking Stocks Takes Time

I love researching and picking my own stocks, especially when they turn out to be big winners. However, in order to pick the right stocks it takes time and patience.

When I pick stocks I am very meticulous in my research. I only pick stocks that appear to be a great companies at a good value.

Finding these stocks takes time.

In order to free up time for my other ventures, I have begun investing more and more into exchange traded funds, also known as ETF’s.

2. My Chances of Beating the Market are Slim

I know that the chance of me beating the market as a whole is slim. While I love researching and picking stocks, it is highly likely that my returns will be subpar, or right at the market at best.

Instead of hoping to match the market and maybe beat it, I have instead chosen to invest my money into the very funds I am trying to beat.

This goes hand in hand with #1 listed above. Why spend so much time matching the market when I can buy an ETF in the market?

3. Diversification is Simpler

Trying to diversify a portfolio with many stocks can prove to be a difficult challenge. This is another reason I have chosen to invest more in ETF’s.

Consider this: I have one Total Stock Market ETF and on Total Bond Market ETF. It is much easier for me to balance this portfolio than if I am juggling with 20 different stocks and bonds in my portfolio all at one time.

4. Keeping Track of Stocks Takes Time

I noted above that picking stocks takes time, but tracking your own stocks takes even more time.

In order to maintain your portfolio, you need to have some idea of how your stock positions are performing.

So you need to stay updated on the stock’s news and know when a good exit point for you will be.

I have lost out in some instances where I waited too long to sell a stock. As a result, I am still holding some stocks that have proven to be losers which brings me to #5.

5. It’s Hard to Cut Losses

With individual stocks it is hard to cut losses and move on. This is something that I have struggled with.

I currently own some stock in 3D Technology (DDD) which has dropped 39% since I bought in about a year ago.

What is holding me back?

If I had to guess, it would be the loss aversion theory in action. I wrote a post about loss aversion which you can check out here.

Do you pick your own stocks or do you opt to invest in an exchange traded fund instead? Why did you choose one over the other? 

Six Reasons Why You Shouldn’t Pick Your Own Stocks

When I first started investing, it was an overwhelming experience. I didn’t know where to get started and figured that I could just start investing in individual stocks.

I didn’t have a real strategy behind why I was doing what I was doing. I just picked a company that looked like it would be a good investment, and bought into it.

It wasn’t until I started to do some actual research and read up on books that had to do with investing in the market that I realized that I was probably better off not picking individual stocks.

As a matter of fact, practically everyone is better off investing in an index fund or ETF instead of picking their own stocks.

In this article you will discover six reasons why you are better off not picking your own individual stocks.

1. You don’t have the expertise to pick stocks

Picking stocks can be a difficult challenge. It takes a considerable amount of time to understand the market and to learn how to read a company’s financial statements.

Not only do you have to analyze a company’s financial statements, you also have to have a good understanding of a company’s behavior and how it affects the bottom line.

In addition, there are many schools of thought on how to pick stocks. Choosing between these various methodologies can be difficult and overwhelming. Not only that, but some of these methodologies just flat out don’t work.

2. You don’t have time to pick your own stocks.

I know you lead a busy life. If you want to pick your own stocks it will only add to the daily tasks that you to do.

It takes a significant amount of time to manage your own investments. You always need to keep an eye on your individual stocks in the event that something unusual does happen.

You also have to keep track of earnings announcements and other press releases by the company to make sure they are staying on the right track.

Most people don’t have the time or simply don’t want to take this much time with their investments.

3. You want to get rich quick.

Investing in the stock market won’t make you a millionaire overnight. Sure, some people became millionaires during the internet boom of the late 90s, but these people are the exception to the rule.

There were also many people who lost a ton of money in the 90s following the same strategies. They just ended up on the wrong side of the coin.

4. You don’t have the patience

In order to invest in individual stocks, you need to be extremely patient.

You have to be careful with your investment because it is easy to panic if your stock starts to plummet out of nowhere.

Investing in the stock market takes years of patience and discipline. If you aren’t willing to put in that time and effort, don’t pick your own stocks.

5. You don’t enjoy picking stocks

This one seems fairly obvious but if you don’t enjoy picking stocks, don’t pick your own stocks.

However, a lot of people don’t know if they enjoy picking stocks until after they have bought their first stocks. They realize how much time and stress is involved but by the time they realize it, it is too late.

One thing I would recommend is to use a stock market simulator game for a few weeks or even a few month.

Practice picking stocks and tracking companies in your free time. If you actually enjoy finding stocks and tracking them, maybe you are fit to pick your own stocks.

If you don’t enjoy this process, then don’t even think about picking your own stocks.

6. You want to beat the market

Let’s just clarify one thing: you will not beat the market. Many people don’t beat the market.

Professional money managers rarely beat the market. If they can’t do it, what makes you think you can?

According to Brad Barber of UC Davis and Terrance Odean of UC Berkeley, only 1% of active traders beat the market. They concluded that the more frequently people trade, the worse they ended up doing.

Sure it’s fun to imagine being the next Warren Buffett or Peter Lynch, but chances are you won’t be one of those guys.

What should you do instead?

If you aren’t picking your own stocks, what should you do with your money?

My recommendation for those investors is to invest in a total market ETF. My personal favorite is the Vanguard Total Stock Market ETF (VTI).

By investing in this ETF you will have a diversified portfolio which also has extremely low fees compared to other mutual funds.

The Importance of Low Fees

Picking a fund with low fees is important to me and it should be important to you too.

Many actively manage funds have high fees. This means you will have to pay more money which will end up eating into your return on investment.

The kicker is this: most managed funds don’t beat the market.

Remember what I said above about beating the market? Most fund managers fail to beat the market consistently. Why pay more fees for something that’s not even going to give you a higher rate of return.

Why do you benefit from investing in a Total Stock Market Fund?

By investing in a total stock market fund, you experience a couple of benefits.

First, there is much less management on your part. All you have to do is put your money into this fund and sit back and let the stock market do the work.

You don’t have to spend a bunch of time analyzing individual stocks and tracking your portfolio.

Second, there is much less stress by investing in a total market fund. Because your investments are diversified, you don’t have to worry about a single company destroying your investment portfolio.

But what if I really want to pick my own stocks?

Now you know that you shouldn’t pick your own stocks. But what if you still have an itch to pick some individual stocks. What should you do?

One thing that you could do is invest a large percentage of your portfolio in the total stock market fund, and use the remainder to pick your own individual stocks.

This is a strategy that I personally use. I enjoy picking stocks but I don’t like the stress that comes with putting all of my eggs in only one or two baskets.

What I do is invest 60% of my portfolio in the total stock market fund (along with some bond funds) and I use the remainder to invest in individual stocks.

I still get the enjoyment of picking my own stocks, but I don’t have to deal with the risk of having all of my money investing in only a few companies.

Do you pick your own stocks or invest in a market fund? 

Your Fear of Losing Will End Up Costing You Big Time

I was discussing the stock market with one of my co-workers the other day, and we were talking about how stocks are generally overvalued and how the market will have to come back down eventually.

He said “This is why I don’t want to invest in the market right now. Everything is just too high and it’s going to fall eventually. I would rather wait for things to come down to get started.”

I don’t blame him for not wanted to invest everything in stocks right now, but he could invest a small portion of his money in stocks and put the other portion into other forms of investments. Keep in mind, he didn’t invest in the market when it was high in 2007, but he also didn’t invest in 2009 when it hit rock bottom.

It’s not unusual for first time investors to have this mentality

Many first time investors hesitate when it comes to investing. Personally, I spent a couple of years dreaming of investing but never took the leap of faith. What was holding me back those two years is the same thing that holds back many first time investors: loss aversion.

The loss aversion theory explains why many people are afraid to get started. People will make excuses as to why they don’t want to invest in the stock market because they are scared of losing money.

But, this begs the question, when exactly do you plan on investing in the market?

What I saw with my co-worker was a classic example of the loss aversion theory in action. He was so afraid of losing money in the market. As a result, he has not investing in the stock market at all in the past 8 years.

So you may be wondering “What exactly is the loss aversion theory?”

The theory states that people have a tendency to value gains and losses differently. So if something is presented in terms of gains and losses, people are more likely to pick the item based off the gains presentation.

Why do we value gains and losses differently?

This is due to the fact that people strongly prefer to avoid losses rather than acquiring gains of the same amount. In some studies, they have showed that the pain of losing is almost twice as strong as the pain of gaining.

In one example, people were given the option of risking $5,000 to make $10,000 on a flip of a coin. Many people would forgo the gain just so that they didn’t lose any money.

Think about that one for a second. If you could flip a coin and make $10,000 or lose $5,000, would you take that chance? Truth is, you really should take that chance. 50% of the time your will come out ahead with $10,000. What do you think you would do in this situation? Why?

How can you apply loss aversion theory to investing?

The thing about loss aversion is this: it causes people to stay in stagnant positions just so that they don’t have to risk losing any money. Due to the fact that people are so afraid of losing, they will stay in a position that is worse in the long run.

For example, some individuals would stick with losing investments over a long period of time because they don’t want to realize losses. As a result, they will ride down with a sinking ship so that they don’t have to experience the pain of losing…until it is too late of course.

To make matters worse, some people will actually invest more money into a losing stock to average out the cost of their investment. This makes it seem as though the stock hasn’t lost as much value.

How can you avoid the loss aversion bias?

Above I have illustrated two situations in investing that are subject to the loss aversion bias.

The first one being new investors who just don’t get started because they are afraid to lose money.

The second one being experienced investors who hold on to losing stock positions because they do not want to realize losses, which would turn paper losses into actual money losses.

How can new investors avoid the loss aversion bias?

For new investors, it is important to realize that there is some risk to investing in the stock market. You need to understand that your investments may lose value in the short term.

What you also need to know is that the market has been upward trending for the past 130 years and more. You can’t let your fear of losses hold you back from investing.

Another way to hedge your losses is to make sure your portfolio is well diversified. Make sure you have your money invested across a range of stock indexes, bonds, and other investment types. This will help limit your losses over the long haul and make you less likely to lose your money.

Finally, you need to stop worrying and accept the fact that you could lose money. You need to grow comfortable with the fact that your portfolio will have extremely high days and extremely lows days. The most important thing is to weather the storm and not panic on those bad days.

How can experienced investors avoid the loss aversion bias?

My advice for experienced investors is quite different from new investors. New investors are afraid of losing money from the get go whereas experienced investors are afraid of realizing losses on certain investments.

For experienced investors, you need to maintain a long term view of investments. It is important for you to understand how a loss will impact your portfolio as a whole.

One way you can avoid holding on to a losing stock for too long is to place a stop loss order on that stock. This will force you to sell your stock once it hits a certain low point.

Another good thing to remember is that selling investments at a loss will actually help you. When you sell at a loss, you will be able to offset any short term and long term taxable gains.

Final word to experienced investors

Do not hold onto a stock longer than you should. If there are legitimate, solid indications of a sign to sell your stock now, you should absolutely sell.

Now, this doesn’t mean every time a tv pundit tells you a stock is a sell that you should sell it. However, if a company is going through turmoil and revenues and profits are way down, then you should probably sell before it is too late.

You don’t want to hold on to a stock just because you hope it will go up in value. You shouldn’t buy a stock which you hope goes up in value, so why would you have that mentality for a stock you currently own?

What do you think?

What do you think about the loss aversion theory? Have there been times where you didn’t do something because you were afraid of losing? Can you apply this theory to other areas of your life?

I made 59% on one stock in nine months, here’s what I learned

Yesterday when I was checking my stocks, I was pleasantly surprised when I saw one of my stocks was up nearly 20% for the day. Not only that, but the stock had climbed nearly 60% since I initially bought it in September of 2013.

The stock that I’m referring to is Williams Company (WMB). When I bought the stock on September 5, 2013 I paid $35.10 for 15 shares. Yesterday (June 18, 2014) I had sold the 15 shares at $55.90 per share. This resulted in a 59.3% return on this stock in only nine months!

Lesson learned

Why did I buy WMB in the first place?

When I bought the stock in the first place, I was looking for a high dividend paying stock. When I found WMB it was paying out dividends around 4.5%.

In addition, the stock seemed to be trading at a low price at the time. It seemed like a no brainer to buy this stock. My thinking was flawed, which I will get to in a minute. Regardless, I bought 15 shares at $35.10 and watched the stocks grow over the coming months.

Why did I sell WMB yesterday?

I sold WMB for a number of reasons, the most important being to lock in my gains.

I made over $310 or about 59% on my investment, and I didn’t want to lose out on locking in that money for good.

Currently, WMB seems to be overvalued. The stock has a PE ratio around 96, which is ridiculously high when compared to similar companies in its industry. Now seemed to be a good time to get rid of a stock which will probably drop off in a matter of time.

The flaw in my thinking

When I bought WMB I was under the impression that I was getting the stock at a reasonable price. The stock was trading close to its 52 week low. Truth is, the stock wasn’t really that cheap when looking at its PE ratio.

While the PE ratio was on par with other companies in WMB’s industry, that was not really a sign that it was a stock to buy. I didn’t do much research before jumping into this stock. Honestly, I got lucky that it shot up the way it did.

I held on and reaped the benefits and got out on my own terms

I had actually though about selling WMB on multiple occasions. The reason I held on was because the stock’s value was continually increasing.

I realized that I needed to sell the moment the stock jumped 20% in one day and I made over 50% in less than a year. Sure, the stock could keep going up but I don’t want to take that risk.

Take home message

When it comes to investing you need to recognize when you are lucky and when you were actually skilled. Too many people think they have the secret formula to making money in the stock market.

At the end of the day it’s safe to say that I got lucky with this stock. I invested on a flawed premised and I am grateful that I made the money that I did, but I don’t feel like it was because of some skillful move.

 

What grocery shopping can teach you about picking stocks

Imagine your average trip to the grocery store. You go through the ads and various coupons and figure out what items are on sale. If there are products that you have a preference for, you will go ahead and buy them for a bargain. It makes sense. When you like a product and see it selling at a lower price than usual, you will buy it. That begs this question: why should the approach the stock market any different?

When buying stocks, the first thing you want to do is identify companies that you like. Good companies can be defined in any ways. This depends on personal preference, but for me, a good company is one with good management in place. In addition, it is a company that has had steady growth over the years. Companies that have historically paid dividends are also another plus in my book. Finally, invest in what you know. Peter Lynch advises this in his book “One Up on Wall Street” which provides great insight on how he made 29% a year over the span of 20 years.

I suggest that you make a list of good companies that you like based on the criteria above. It doesn’t have to be a long list, be it should be long enough so that it gives you options in investing. Track of these companies over time. When these companies become “cheap” buy as much stock as you are comfortable buying. Cheap can be defined in any number of ways. I personally view cheap companies as one that have a low PE ratio. A low PE ratio has historically been one that is under 15. I use this as a base for deciding the value of a company. I also compare their PE ratio to the historical PE ratio of the company as well as the average PE ratio for other companies in their industry. You can also use price-to-book ratio and price-to-sales ratio when valuing a company.

When you combine you knowledge of great companies with the valuation metrics, you will greatly increase your chance of succeeding in the stock market. As Warren Buffett once said: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”