I have a confession to make: I own a stock – Netflix. I’m confessing because I’ve come to the conclusion that investing in individual stocks is a bad idea for most people. Let me back up a step.
About 12 years ago I started learning about investing. I quickly became interested in the subject and read everything I could find on it from books by Peter Lynch and Ben Graham to periodicals like the Wall Street Journal and Investor Business Daily. I became active on the Motley Fool community and even joined the company. Over time I found myself spending hours and hours researching stocks in my spare time and making investment decisions. I had some spectacular winners such as Starbucks and Celera and some equally spectacular losers such as @Home.
About 3 years ago I forced myself to answer a tough question: am I any good at this? To be clear, I’ve never been a trader or bought anything without learning everything I can about the company. Based on discussions with other people over the past decade I’ve concluded that I know much more than most people on the subject. But facts are facts, and I decided the only way to answer this question was to go through the painful exercise of calculating my returns relative to the S&P 500.
The answer? No, I am not. Well, at least as compared to a monkey picking random stocks from the newspaper. I suppose compared to most investors I’m actually doing well: the net result of my 7-8 years of investing in stocks got me a return equal to the S&P 500 Index over that period. That’s a lot of work for no “Alpha” as we say in the financial world, but at least I’m faring better than the day-traders and most mutual fund buyers.
As a result of this exercise I decided to shift to an asset-allocation strategy using ETFs. I’ll try to cover more of my current approach in a later post, but the point of this discussion is that my current strategy dictates that I no longer invest in stocks.
Today I read another brilliant article by William Bernstein that confirms my observations and validates my decision. In his usual, eloquent style Bernstein explains why you probably shouldn’t be buying stocks either. Don’t fell badly, though. He also makes a pretty strong case that 99% of the “pros” on Wall Street should join us.
If you want some great information on what we should probably be doing, I suggest Bernstein’s books – particularly the Intelligent Asset Allocator – or David Jackson’s ETF Investing Guide.
I suppose you’re going to make me publicly explain why I’m ignoring my own cold, hard, factual history and answer your question: “Why are you investing in Netflix?” My answer is that I invest a LOT of time studying the stock and company. I read about it daily, research the industry, and talk to everyone I can find about it. Netflix also has a very transparent, consumer-facing service, so evaluating their product offerings is relatively easy. The net result of this exercise is that I feel comfortable with a small % stake in the company.
Only time will tell if this was a profitable decision, but I’ll sleep easy knowing that my downside is minimal and that I knew the risks in advance.
{ 4 comments… read them below or add one }
Kevin,
We’ve come to the same conclusion independently. Of course we share that common experience of the Motley Fool and the roller coaster ride of Celera and other biotechnology stocks.
-Greg
As a follow up to the previous message, I thought it would be good to put what made me decide to go with asset allocation over individual stocks. Largely, it has been the findings of DFA as outlined by Scott Burns. For example, see his article (and awesome website):
http://assetbuilder.com/?p=143
Basically, they’ve shown this:
Decades of research show that there are only two consistent sources of higher returns in the stock market: small-cap stocks and “value” stocks — those with low price-to-book-value ratios. Those are the areas for fundamental indexing to pursue.
That, along with the realization that I could outperform the S&P500 with massive diversification, convinced me to pursue a widely diversified portfolio with a moderate % weighting in small-cap and value stocks. These days, this can be done with low-cost ETFs.
If you think of it as the amount of return divided by (in proportion) to risk (which is at its lowest with massive diversification), it really can’t get much better. You might get lucky, or maybe perhaps you’re that good, but how do you know before you’ve taken the risk of (very likely) being wrong? Any manageable number of stocks willl fall so short of being truly widely diversified that the risk increase would be huge in proportion to the potential gain.
Not sure if that’s clear…but it’s worth a shot trying to explain.
As a Fool convert as well, I too have seen the light. In fact, I own a fee-only firm now, and I use ETFs almost exclusively for my clients.
If you want another great book about the benefits of diversification, look at Roger Gibson’s book on Asset Allocation. I use examples from his studies all the time for clients.
I’ve always followed the model that no matter how good your stock picking “ship” is, none of it matters if there’s no wind in the sails. So, buy when people are putting alot of money in for their IRAs and 401ks. Then buy the stocks you love. Once that wind is done around June, get out and stay out till the wind comes back.