075 | The Unfair Advantages of the Individual Investor | Brian Feroldi

This content may contain affiliate links through which we are compensated when you click on or are approved for offers from our partners. See our disclosures for more info.

Facebook
Google+
Twitter
LinkedIn
Pinterest
075 _ The Unfair Advantages of the Individual Investor _ Brian Feroldi (1)

Brian Feroldi talks through the advantages and disadvantages of individual investing, the realistic expectations for performance, and his strategies for beating Wall Street.

  • How did Brian find the FI community?
  • How did Brian start investing, and how has his strategy changed?
  • Brian still focuses his investments on index funds, but has found that well researched and intentional investment in individual stocks can be really successful.
  • Professional money managers operate under different parameters and mindsets than an individual investor.
  • Stockbrokers must make decisions based on short-term returns.
  • What other disadvantages do professional money managers face, in contrast to individual investors?
  • How do professional money managers truly spend their time and earn their money?
  • How much time will the average person commit to building a stock portfolio?
  • How many stocks should a beginner buy to start building their portfolio?
  • What information does Brian consider prior to purchasing a stock?
  • Keep an investing journal to record the reasons you want to invest, and then compare as returns come in, to ensure that those reasons remain true.
  • Don’t buy into any businesses you don’t understand.
  • Brian relies heavily on summaries from monthly Motley Fool newsletters, among other “outsourced” research sources.
  • Brian’s 7-year-old son just bought his first stocks – which one?
  • How does Brian make monthly decisions about the stocks in his portfolio, and what is the time frame he considers before purchasing?
  • What are some reasons to sell a stock?
  • Why don’t all your stocks have to be winners?
  • If someone purchased 10 stocks, a realistic goal for individual investing is to beat the market with 4 or 5, and hit a homerun with 1.
  • Brian talks about Priceline and Netflix as examples of how individual investors can beat out Wall Street.
  • What resources would Brian recommend to a newcomer to the stock market?
  • What steps should someone consider prior to getting started?
  • What makes a good company?

 

Resources mentioned in this episode:

Rich Dad Poor Dad

The Motley Fool Investment Guide

Warren Buffet and the Interpretation of Financial Statements

Motley Food Podcasts

Morgan Housel: The Collaborative Fund

Getting Rich: from Zero to Hero in One Blog Post

Facebook
Google+
Twitter
LinkedIn
Pinterest

27 thoughts on “075 | The Unfair Advantages of the Individual Investor | Brian Feroldi

  1. I wouldn’t touch individual stocks with a 20 foot pole.

    https://onlinelibrary.wiley.com/doi/full/10.1111/0022-1082.00226
    Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors
    Brad M. Barber Terrance Odean
    Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent. The average household earns an annual return of 16.4 percent, tilts its common stock investment toward high‐beta, small, value stocks, and turns over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.

    https://academic.oup.com/rfs/article-abstract/22/2/609/1595677
    Just How Much Do Individual Investors Lose by Trading?
    Brad M. Barber Yi-Tsung Lee Yu-Jane Liu Terrance Odean
    Individual investor trading results in systematic and economically large losses. Using a complete trading history of all investors in Taiwan, we document that the aggregate portfolio of individuals suffers an annual performance penalty of 3.8 percentage points. Individual investor losses are equivalent to 2.2% of Taiwan’s gross domestic product or 2.8% of the total personal income. Virtually all individual trading losses can be traced to their aggressive orders. In contrast, institutions enjoy an annual performance boost of 1.5 percentage points, and both the aggressive and passive trades of institutions are profitable. Foreign institutions garner nearly half of institutional profits.

    • Frugal Professor,

      You do realize that both of those links at pointing out why individual investors shouldn’t TRADE, right? I 100% agree! Trading is dumb, dumb, dumb, and is the direct opposite of what I propose (long-term investing.)

  2. I appreciate the effort you made to get on a guest to discuss active investing. Unfortunately, I felt this presentation was misleading in several ways that you may not have appreciated when you were putting it together.

    The first way it was misleading was in the description of the learning curve and time necessary to do this. Your guest suggested “2 hours a month”. If this was a paid solicitation, that would be a statement that could buy him a lawsuit, because I think he knows its untrue if he spends any time thinking about his actual personal experience. That’s like saying you can learn manage real estate investments on your own in 2 hours a week. (“With no money down . . .”).

    A better estimate would be “at least an hour a day” after about 200 hours of concentrated study to get you up to speed, and that’s for a modest portfolio. The point should be that if you want to do this, you’d better have a passion for it and want to put the time in to do it right either as a hobby or a career. I would guess that the guest probably spends 20-30 hours per week over and above what he does for his job. If you don’t want to spend your free time doing and reading about financial analysis, this is just not for you. BTW, Jim Collins made this point in spades on the Bigger Pockets podcast that also came out today.

    Moreover, you need to have the stomach for it. As the guest revealed, most of your individual investment are likely to underperform the market. In fact, the truth is that they

    The second way it was misleading was in the conflict of interest with Motley Fool. While I appreciate what Motley Fool does and enjoy listening to their podcast every week, what they offer is well known in the marketplace by marketplace professionals. Just taking their stuff off the shelf is not going to give you any particular advantages over index investing. Going back to point one, you can’t just farm this stuff out and expect to do significantly better than average.

    The third way it was misleading was that this investor does not appear to be seasoned through bad markets as well as good ones. It seemed like most of his investing occurred in the last 5 years. In fact, it was very easy to beat the market just buying the most popular stocks in that period. But it does not tell you anything about a 20-30 time horizon. His answer about how you can avoid Enrons — by just “studying the financials” — was revealing because it was wrong. You can’t avoid frauds by studying fraudulent materials. For a comparison with a person that knows what they are doing I would suggest listening to the interview of Jim Chanos that was on the Masters in Business podcast last Thursday. Chanos is a short seller since the 1980s who shorted Enron. You will learn that his process is complex and that you are unlikely to duplicate it on your own.

    The fourth way it was misleading is that the guest did not have exit strategies beyond “I’ll look at it later and maybe I’ll re-evaluate it if something has changed”. But this is the precise problem that most casual investors have — they have rules when to buy, but none when to sell. An experienced investor would tell you that you need hard and fast rules on the other end, even if its just “never sell”. I also did not understand why he would hold 80 different companies unless it was just for entertainment purposes. When you start holding that many, chances are that a number are in the same field and you might be better off simply holding the sector index.

    Now, that all being said, I do not in fact have anything against holding individual stocks and do hold a number of them. But I have a very specific list of the ones I would consider, and why, and in what circumstance I would buy or sell them.

    More importantly, I would never tell anyone, starting with my own children, that they ought to invest casually in individual stocks. Instead, I would tell them that if they have passion for it and want to put the time in, they should look into it and I would be happy to help them explore it. If they don’t want to put the time in, this is definitely not for them. 2 hours a week? Fuggedaboudit!

    • Whoops – I hit submit too soon. Where I said “2 hours per week” above, I meant “2 hours per month”.

      And here is the rest of this paragraph:

      Moreover, you need to have the stomach for it. As the guest revealed, most of your individual investmentd are likely to underperform the market. In fact, the truth is that they may underperform the market for one or more YEARS even with a strategy that is better than the market overall. So again, you’d better have a passion for stock picking if you want to do this.

  3. Hi Frank,

    Appreciate the great feedback — here’s my response:

    1) If I suggested that you could get started with “2 hours per month” then that was an unintentional mistake. Learning how to read financial statements & pick stocks takes time, especially up front. That comment was more about how much time it takes to TRACK your investments after you buy them, NOT how much time it takes to get started. Once you’ve done the work and know a company well, you can follow their results in much less time. My apologies to all if that was misleading, which was not my intention. Heck, just reading/understanding Warren Buffett and the Interpretation of Financial Statements (the book I recommended) alone should take more than 2 hours! I’d say that your estimate for 200 hours of work isn’t out of the ballpark at all.

    2) As I said multiple times on the podcast, if you do not have an interest in this stuff, then stick with Index funds and you’ll do great. Interest and a willingness to work/learn/be wrong are required up front.

    3) Yes, “having the stomach for it” is HUGELY important. The same goes for index funds, too. The almighty VTSAX fell ~50% from peak to trough in 2008. You need an iron stomach just to invest at all!

    4) I don’t see how this was “misleading” because of my affiliation with the Motley Fool. Brad stressed that “we don’t want this to be an advertisement for the Motley Fool.” So did I! However, I learned how to do this stuff as a member of the Fool. Also just because Wall Street follows what the Fool doesn’t mean that their advantage is gone.

    5) As for an “exit strategy”, my strategy is buy-and-hold UNTIL the story changes. I still hold many, many stocks today that I bought years ago. Selling is also a very complex issue that couldn’t be fully covered/explorer in this podcast. The point of this podcast was to talk about the advantages of being an individual investor….its not a “how to” guide on buying/selling stocks. I’d be happy to come back on to provide more details about my process, but that’s for Brad/Jonathan to decide. My colleague Brian Stoffel wrote an EXCELLENT article on this very topic recently: https://www.fool.com/investing/2018/04/14/how-to-know-when-to-sell-a-stock.aspx

    7) YES! You need a passion to do this! You can’t just pick it up casually and expect to do great! Underperforming FOR YEARS is part of the game — investing will test you like nothing else can!

    8) 100% disagree with your kids comment. My son is not interested in investing/the stock market because I allowed him to buy a few stocks that interested him. The goal isn’t to get him to make a killing — its to spark an interest in money/saving/investing in the first place!

    Again, I appreciate the thoughtful feedback.

  4. Sorry guys a rare misstep. Investing in individual stocks is gambling, nothing more. Many people carve out 5-10% of their portfolio for play money and this is seen in many instances at Bogleheads, but no one kids themselves to say that this is the secret path to FI.
    Multiple times through this episode there are clearly contradicting elements. It’s also too bad you let him get a free plug for his advertisement (similar to saying with all due respect…..then finishing your sentence).

    • I respectfully disagree, LA. Never, anywhere, did I suggest that stock picking is the “The secret path to FI”. That would be a silly assertation. It’s an alternative path to achieve the same thing — FI through saving hard and investing wisely. It’s just a slightly alternative path. The point of this episode was to highlight that it can be done and to push back against the dogma in the FI community that index funds are the only sane choice. They are an excellent choice for many (most!) but not the only choice.

      If you could be so kind as to highlight a few of the “clearly contradicting elements”, I’d be happy to address them here.

  5. I appreciate the episode. I think it is always good to get some diverse opinions that others may value. On the guest’s comment above (point number 3), I completely agree that you have to have a stomach for index investing just as much as individual stocks. I tend to be more conservative, so I invest in the permanent portfolio (PRPFX), but I do like to do a little speculation.

    I just want to remind everyone that this does not have to be an all-or-nothing game. You can take 10% of your investment portfolio and speculate on individual stocks. Even if you lose it all (which you probably won’t), it isn’t exactly devastating. And you could just as easily lose 10% in one day by index investing.

  6. Finally, the FI fog is starting to lift a bit on this topic. Brian, thank you for defending and making a solid argument for the advantages of the individual investor.

    What I have always found odd about the community’s view on index fund evangelism, and the scoffing at investing in individual companies, is that so many in the FI community invest in real estate, alternatives like prosper (P-to-P lending), and of course hacking the crap out of credit cards/discounts/taxes/etc. How does a genuine fascination and dedication to complex, time-consuming, and sometimes esoteric financial advantages jibe with not touching investing in companies? The FI community should be completely fascinated by this!

    Now, as to the advantages of individual investors:
    – You will learn more about the world around you – I read about 4-5 hours a night. Some of that is reading annual reports/10-q’s/investor decks. But a lot of it is learning about current events, politics, technology, history, and biographies. One thing that just about every investor does a lot of is read.

    – Low costs – When you buy shares, you pay one single fee at that moment. You never pay AUM fees along the way. There are many new platforms (and some old), that allow you to invest in fractional shares $100 at a time. I have a Folio account and pay a flat rate per year to invest in unlimited companies/trades. I can for example, invest in 15 companies every week, and still pay the same fee. I put the fee on a credit card and reap a signup bonus with it. This enables you to build a portfolio quickly.

    – It is way more fun – Why just be passively involved with one of the most important aspects of FI? Get involved with the companies you own, and learn more! It’s fun.

    – Anyone can be an investor – Experts are paid to underperform, because they have marketed investing as complicated and impossible for anyone to do. Read a few books, and just get started to learn. You will make many mistakes, but will find your comfort zone, and I feel that having a solid approach will provide you all you need to be successful.

    – Every investor has their own edge, and should keep with it. Whatever Brian’s edge is, yours is probably different. Find where you have your best chance at making big bets with confidence. You may have an edge in biotechnology, or you may instead understand real estate. Any of these can work if you stick to your knitting.

    – Most investors burn out and go with funds because they have a bad experience and give up. This is often because they bounce around a lot, putting little bits of money here, little bit there, and sell when they go down. It’s not how it is done. You spend a lot of time researching and learning about a company, and once you can understand how this company will thrive and beat competitors, return your capital over time, and stay relevant for a long time, you make a big bet on it and just sit back.

    – The main point that Brian has though, is that all of the evidence regarding active vs passive is based on looking at mutual funds vs index funds. Nobody is really looking at how individual investors are doing in aggregate, because it isn’t trackable. We don’t all publish our results (maybe we should!). Forget about actively managed mutual funds. Want to simply get the index’s returns? Buy the 20 largest companies in the SP500, and you will basically get that. The market cap of the top 5 alone is like 15% of the market. It’s all in perspective.

    – Really, if we are all going to put effort into life hacks, you all need to consider investing in businesses. Index funds are a solid foundation, and the ideal way to lay it. Once you have that, you can start to build your own unique house on top of it.

    • Hat tip to Josh — excellent points all around. Thanks for sharing, and its so great to hear that I’m not the only member of the FI community that feels this way!

    • Thanks for posting, RT:

      I did not listen to the episode, but I read the text.

      Counterpoints:

      +Buffett’s bet was very wise — but it was against hedge funds (in fact, fund of funds), NOT individual investors. As highlighted in the episode, fund managers are at a HUGE disadvantage when compared to individual investors. If it was the S&P 500 versus, say, David Gardner….I’d put my money on the latter (and do!).

      +(Never commit too much money to one stock.Devin thinks you should never invest more than 25% of your total portfolio should be in individual stocks, and no more than 5% of your total portfolio should be in one individual stock.) — Sound advice that I largely agree with. But, if you put 5% of your porfolio in a great company, and it GROWS to be, say, 15%…..are you breaking this rule? My personal comfortable level is much higher than his suggestions, but this number is different for everybody.

      +(Be careful about buying a stock that you already own. Compare what you’re thinking about buying with what is already held in your mutual funds or ETFs. You can use the Morningstar website to see what’s held in your portfolio.) — 100% agree

      +(Don’t pay attention to media that claims to give you hot stock tips – especially if they want you to pay for the information!) — 100% agree, ESPECIALLY if those offer the advice do not have a track record of success to point to.

      +(Stay with stocks whose market capitalization is more than $2 billion. This means that the value of all the outstanding shares is more than $2 billion.) — 100% disagree. This is an arbitrary number. Why limit your investing universe at all?

      +(Don’t fall for shares that pay high dividends. Some dividends can be good, but you have to understand how high dividend stocks are valued and what happens when the dividend changes.) — An excellent point. This a lesson that I learned the hard way (muliple times).

      +(Use objective research to pick your stocks. Some of the companies offering research aren’t completely objective, and their recommendations are tied to some sort of relationship with the company. Find a research company that doesn’t have a broker-dealer relationship.) — 100% agree.

      +(Figure out your exit strategy before you buy the stock. If you don’t have a sales strategy, you’re going to hold on to something too long. Selling is hard, so you have to get comfortable with the fact that you likely won’t sell at the very highest possible price.) — Sort of agree. To quote Buffett” when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” I vote that your “exit strategy” is to sell when 1) the business is no longer outstanding or 2) the management team is no longer outstanding. But yes, selling is super, super hard.

      • – Portion of the pie for stocks – I would say that what worked for me was to put around $10k into an index fund, and then to do individual stocks from there on out. This meant that I was mostly over-weighting various components of the index, and tilting it towards characteristics that I prefer. This is a better approach than say, sticking to percentages.

        – As you describe well, if a stock you own does exceptionally well and becomes a much larger portion of your pie, what do you do with that? Many mutual funds are forced to sell, in order to keep a targeted weighting. The individual can simply do nothing and will largely benefit from that approach. Instead of trimming, perhaps consider adding more to other portions of your portfolio until the weighting comes more in line. You may also want to add even more to that holding, depending on the price/value if attractive.

        – Research – I suggest sticking to company annual reports, and reading analyst calls. The calls will provide information on how management thinks about the company and its owners. The reports will show the figures, but also will show context. They are a great way to fall asleep as well! But you must read them. I also find a lot of value in reading short-form materials on businesses, such as magazine articles, survey data, Federal Reserve bank reports (each has their own webpage – start with the St Louis Fed: https://fred.stlouisfed.org.

        – Ignore analyst reports – Motley Fool not-withstanding of course (I am not a subscriber but have written for them a few times). The fool has some schlocky stuff that is sent to my junk mailbox daily and whatnot, but they really do put out some great information in an easily digestible format, and those articles are all free. You’ll gain insight and ideas that help narrow your search. As for other analyst reports, I would just ignore them. They are paid to figure out earnings projections and discounted cash flows, and cost of capital stuff. You should be doing that yourself if you are going to invest. What you want to seek out is industry info, competitor info, trend info, and so on.

        – I don’t like exit strategy as a concept – Unless you are practicing a very particular form of investing in say distressed debt (companies in bankruptcy or close), dying industries that are simply too cheap to ignore, merger arbitrage, and the like, don’t sweat the exit. Those strategies are like playing a great card game and betting when you have the odds highly in your favor, but you don’t want to even sit at that table unless you are a very special type of player.

        – My take on selling is that you only do it when you have something else to buy which offers a better return on your capital. So you may own shares in Bank of America, and see that its return on equity (ROE) is hovering around 10%, and hasn’t really budged in 5 years. Its competitor JP Morgan though, has seen its ROE rise from 9% to 13%. Both are trading for the same price relative to book value. Both pay the same dividend and have the same share buyback. In this scenario it is only rational to sell BOA and buy JPM. You are effectively trading $0.60 for dollars. Or you may find a totally different company with a ROE of 25, but only selling for a 50% higher price than these two. That is of course far superior.

        – If none of the above paragraph makes sense to you, then you need to start reading reports, and get a handle on accounting concepts before you start buying. Otherwise you don’t know what you are paying for.

        – Read “The intelligent Investor” chapters 8 and 20.

        • – Portion of the pie for stocks – Sounds logical to me!

          – I’m a fan of adding to winner and I only trim after the company has become a substantial portion of my portfolio (did so recently with AMZN after the huge run).

          – going to the companies themselves for data & listening to the calls is 100% part of my process.

          – Yes, the Fool marketing can be……uhh…..eccentric. It stinks that they have to do it, but since they are trying to reach people that need the most help (aka….investors who like that kind of marketing stuff), i understand why they do it. Their “premium” research is fantastic though.

          – I agree, my “exit strategy” is mostly to hold forever.

          – Yup, selling to buy companies you like better can make sense .

          – The intelligent Investor is a fantastic book

  7. I’m so glad you guys did this episode! SO GLAD!

    I’m relatively new to FI (~6 months). In that time I’ve gone overboard listening to podcasts and reading blogs on FI pretty much non-stop. I’ve changed my approach to tax management and personal finance. The one sticking point had been stocks. While I’m new to FI, I’ve been a Fool (Motley Fool member) for about 15 years. Over that time I’ve used several different Fool newsletters and have been very involved in individual stock investing.

    So as I’ve been reading and listening around your site as well as many others (jlcollins especially), I’ve been a little puzzled. All the content saying index funds are the way to go make sense. The logic, the history, the math. I totally want to buy in. Except… if I look at my personal returns over the past many many years, I fairly consistently beat the market. Sometimes by a percent or two, sometimes by upwards of 5-8% (per year). I’ve wrestled with this the past few months and just couldn’t rectify it. This podcast really helped me bring together these two worlds in a way that made sense and can help me have clarity moving forward.

    I love chooseFI and I love the Motley Fool. Up until this podcast it’s been like my parents were fighting and I was stuck in the middle. Thanks for not divorcing!

    Thanks for all the great podcasts!
    -Bill

  8. Thanks guys for putting this podcast together. There was lots of good information and presented to everyone a different viewpoint. That’s part of the problem with the FI community: We’re so caught up in “The One Way!” that we discovered, that we forget that the search is not over. That we need to keep looking for “the other ways”, and other ideas. We get so caught up in knowing, JUST KNOWING, that we’re right about everything that we forget that we’re occasionally (often) wrong. For example: You CAN invest (not speculate) in stocks and reliably do well, but it’s not for everyone.

    My only small point of disagreement is that I think individuals don’t really have that big of an advantage over mutual funds. I can’t imagine after a bad week, or month that funds have measurable outflows because of it. And there -are- funds that beat the markets over long periods of time by taking the long view, but they are indeed extremely rare. Michael Jordan was rare, but he existed too 🙂

    Thanks again to everyone for presenting ideas for us to think about and consider, instead of presenting and then crapping on them.

    • Great feedback Ron. You’re right that funds flows are not instantaneous — however, that IS an ever present “threat” that must be constantly considered. Wall Street stock pickers also have bosses that need to be reported to, so career risk is a real thing, even if fund flows do not occur right away after a bad week/month/quarter.

      And yes, SOME managers can beat the market consistently. What they tend to have in common is 1) a long-term focus 2) low turnover and 3) high active share (meaning that their portfolio looks very different than the index they are trying to beat) . Its rare though — if memory serves, something like 95% or so of funds underperform over the long-term (5+ years).

  9. No offense to Brian, but this episode rubbed me the wrong way. In earlier podcasts, it was pointed out that at least two highly respected FI personalities (JL Collins, episodes 19 & 34, and the Mad Fientist, episode 17) determined they couldn’t beat the market, and therefore recommended index investing as the most optimal approach. Are you suggesting that they were wrong to make that assertion, and if so, where is the evidence that individual stock picking beats indexing over the long haul for the time span that a FIRE investor is looking at (several decades)?

    Secondly, it is known that humans are irrational and prone to emotions (greed, fear) that can cause them to make the wrong decisions at the worst times. The best way to eliminate this factor is by not paying attention to what the market is doing, a.k.a. “set it and forget it” — a huge selling point for mutual/index funds. In one of the podcast episodes featuring JL Collins, it was mentioned that passive investors (dead people, or people who had forgotten the existence of their accounts) did better than any other groups of investors. This approach mentioned in this episode is antithetical to that idea, suggesting that investors spend several hours per month actively looking at their investments instead. If this were 2008, would you still advocate that approach (and trust that people can stomach their stock portfolios dropping 50% and still maintain the resolve to stay put in their positions) over index investors who don’t pay attention to market noise?

    This episode has done little to persuade me that active investing is superior to index investing over the long haul. Public reports paint an incomplete picture of the inner workings of a company, and cannot be relied on to accurately predict future earnings/performance (for example, they don’t tell investors what future products Apple is working on, and more importantly, whether they will be hits or duds). Few people saw industry giants like Blockbuster, Kodak, and Polaroid (all of whom employed tons of smart people) disappearing overnight thanks to emerging tech (or their reluctance to adopt them). No one has a crystal ball, and because of that I’m convinced it’s futile to try to predict the future. There is nothing wrong with getting market returns, which is more than adequate to do the job for a diligent saver/investor. Spending any time beyond that is not guaranteed to generate superior results over the long term, and may in fact result in sub par or disastrous results. I’m smart enough to know I’m not a better or smarter investor than anyone else, so buying the entire market via index funds makes the most sense for me, and for the vast majority of other people as well. It’s not only a disservice to tell people that they can control their returns, but potentially dangerous to lead people to think that they are smarter than the market. When it comes to investing, cost is the only factor we can fully control, and that is why index funds are so popular in the FI community.

  10. Hey KC,

    Appreciate you taking the time to give such great feedback. Here’s how I’d respond:

    – I HIGHLY respect JL Collins and the Mad Fientist and largely agree that index funds are “the most optimal approach” for the vast majority. However, the point of this episode was to show that 1) individual investors have a handful of advantages over professionals and 2) it is POSSIBLE (but not easy) to beat the market IF individual investors are willing to 1) develop a passion for learning how to invest properly, 2) develop and constantly refine their process for identify great businesses, 3) know and accept the odds of picking winners before they start investing, 4) can think and act like a business owner, which means staying focused on the long-term potential of the business, 5) can learn to become immune to short-term price fluctuations, 6) accept that they’ll be proven wrong often, 7) are willing to spend time each month monitoring their companies’ progress and research new investments, and 8) track their results against the index they are trying to beat.

    – You are right that humans are terrible at timing the market. That’s why I advocate dollar-cost averaging into the market with your stock picks. Its no “set it and forget it” like index funds, and it DOES require an investor to become immune to volatility (easier said that done). This isn’t for everybody (or even most) but some DO have the fortitude to do well. And yes, if this was 2008 all over again, I’d STILL advocate that approach. I’d personally love the chance to go back in time and buy my favorite businesses for next to nothing! Also, index investors ALSO lost 50%+ during the period, so idexers still need to have the fortitude to stick with their strategy when the world is going to hell.

    – “This episode has done little to persuade me that active investing is superior to index investing over the long haul.” — The goal wasn’t to persuade indexers to switch — it was to shed light on another style that might work for some.

    – “Public reports paint an incomplete picture of the inner workings of a company, and cannot be relied on to accurately predict future earnings/performance” — True, but I’m a firm believer that they give us enough information to make buy/sell/hold decisions. Amazon, for example, has a long history of innovating. Not everything they try will work (hello, fire phone) but they have a history of making smart bets that do (Prime, AWS, Alexa). I’d be willing to bet that they will continue to experiment and that some of them will work.

    – “Few people saw industry giants like Blockbuster, Kodak, and Polaroid.” — These businesses DID NOT collapse overnight. Its a slow decline and you CAN see them coming. For example, did you know that Sears and JC Penny are still publicly traded? I think these are dead companies walking, and they’ve been in decline for more than a decade. If/when they finally go belly-up, their investors would have been given YEARS to get out. The same is true for investors in Blockbuster, Kodak, and Polaroid.

    – “No one has a crystal ball, and because of that I’m convinced it’s futile to try to predict the future.” — Agreed! That’s why diversification is important. No business — no matter how strong — is a certainty. I own 80+ stocks. I’m not betting my future on just one of them working out.

    – “Spending any time beyond that is not guaranteed to generate superior results over the long term, and may in fact result in sub par or disastrous results.” — 100% true! Its a trade off and an extra risk, many think it is not worth it. However, I’m one of those freaks that enjoys this stuff, so for me it is worthwhile, and I’ve got the returns to show that I’m not wasting my time.

    Cheers!

    Brian

  11. Hi Brian,
    TSM index returns (2013 -2017) were reported on the podcast as 125% and your returns were 155% (as I recalled). You never mentioned taxes on those trades, and how that alone cuts down on your return. TSM index hardly ever trades, so the tax consequence is more efficient than your returns.

    You kept talking about long-term thinking, five years of returns is NOT long term. 15-20 years is long term.

    The ultimate price you pay for using your strategy is TIME, and that’s a huge price in itself. And those few folks who love what you had to say is that life is short, and it’s not worth 20% more in return. But even your 20% more in return is from past returns, and you cherry-picked stocks that you made a killing. Again, that’s real data but its the past. So its useless.

    Look, we only have today and the future, and your returns can never be replicated by anybody else. There are many instances of active investing beating the indexes BIG TIME. I get it. Gambling and luck are green too. And I get that also. But Gambling and luck are not long-term strategies. Index investing is highly predictable in that when the market goes up, portfolios go up, and when it goes down portfolios go down. With your 15 – 80 individual stocks who knows WHY they go up or down. You can do all of the researching you say you do, but it doesn’t reduce the incrediable risk you are taking. How much did you loss in the last two stock market crashes? I lost 70% in 2000-2002 so I know what I am talking about. You did not report any loses by taking such incrediable risks.

    Speaking of quality companies, PLEASE, the entire world does what you do (with the help of Motley Fool who would charge little old me $19 to join Motley Fool to get help choosing their stock recommendations). There is no way I can do that with an excellent program on my computer.

    Brain, you are an excellent sales person and very positive and I like all of that about you. I can see why MF hired you. You are great at what you do. But individual stock investing is what all of the others have commented and I would like to say again, it can never be replicated, even if I bought every individual stock you own right now, those companies, the market, the politics, the interest rates, the inflation rate, taxes, company management, board composition, their products, geopolitical issues and about 200 more variables will be different going forward from today than between 2013 to 2017 returns that your reported. BTW there is nothing wrong with 125%! and it investing in the TSM index which can be done and replicated with millions of investors.

    Lastly, your strategy is looking backward and not forward. Think like Elon Musk. He is a futuristic as you can get! He said that someday it will be illegal for human beings to drive automobiles because of our emotions, drinking, bad behavior and errors. Likewise, I hope it will be illegal for human beings to be financial advisers because robo investors will take the human and emotional element out of the decision making with investments. As we know emotions are all over money matters everywhere in our culture whether we like it or not.

    My father in law would love you, he spent his entire retirement years trading individual stocks, and did NOTHING else. HOW SAD! He died at 90 with $100,000 in taser stock! My spouse sold that stock in a flash and put it in a responsible investment, an index fund. Yeah, I know its cherry picking but investing in individual stocks is cherry picking by definition.

    have a great day,
    Steve

    • Hi Steve,

      Appreciate the detailed feedback — here’s my response:

      +My returns from Nov 15th, 2012 (day I switched brokers) to today are +193%. The TSM is115%, including dividends, over the same time period. I rarely sell, but it does happen. The TSM turnover ratio is about 3%. Mine is a bit higher for sure, but I ALWAYS optimize for taxes. My turnover ratio is about 10% or so on average, so its still incredibly tax efficient. In fact, from 2012 – 2015, I ONLY SOLD MY LOSERS, so my “tax bill” from picking my own stocks was negative! However, this flipped last year because I decided to use some of my gains to pay off my mortgage, so that was a bit of an anomaly and it did result in a rather large tax hit. The total tax hit when compared to the overall value of my overall portfolio was still less than 3%. Does it hamper my returns? Sure, a little bit. But nowhere close to offset the alpha that I’ve earned. Having said that, taxes are something to ALWAYS consider and are a major plus in the column for why index funds are the way to go.

      + “You kept talking about long-term thinking, five years of returns is NOT long term. 15-20 years is long term.” — I’d say that “long-term” means different things to different people. I always buy stocks WITH THE INTENTION of holding them “forever.” However, I do sell if the story changes, or if I think there’s a better place for my money. Having said that, I’ve been a shareholder of GOOGL, AAPL, and BKNG (formerly PCLN since 2009) — does that qualify me a “long-term investor” in your mind, even though I haven’t hit 15 years yet?

      + “The ultimate price you pay for using your strategy is TIME, and that’s a huge price in itself.” –100% true. By picking your own stocks you’re trading time for the potential to earn higher returns. I personally just LOVE talking/thinking about the market…. it’s just how I’m wired. The same goes for many other Fools that I know, and its pretty clear that Buffett is the same way. I think of building a portfolio as the ultimate mind exercise — there’s so much to consider and the rules are constantly changing. Learning to navigate it all is far more complicated and time consuming that just buying the index. I completly understand why others would find it boring and choose not to try, the tradeoff just isn’t worth it for them. For those folks, I strongly recommend index funds. However, I truly get joy out of the process. I’d imagine its the same way that Brad gets joy out of researching credit cards, or MMM gets joy out of carpentry. They do it because they LOVE the process. I’m the same way with investing.

      +”There are many instances of active investing beating the indexes BIG TIME. I get it. Gambling and luck are green too. And I get that also. But Gambling and luck are not long-term strategies. Index investing is highly predictable in that when the market goes up, portfolios go up, and when it goes down portfolios go down. With your 15 – 80 individual stocks who knows WHY they go up or down. ” — I understand where you are coming from, but this is flat out false. The companies that I own move up over time because they are increasing their revenue/profits/cash flow over time — that’s it. Over a long time frame, profits and stock prices are 100% correlated (look at Berkshire Hathaway’s growth in book value and growth in stock price over the last 50+ years — they are nearly identical). Over a short time frame, they are not! Stock movements in the short term (say, less than 3 years) are mostly a matter of luck. Over a longer time period, they are a matter of growth in profits. With true gambling, its ALL luck ALL of the time…there’s no distinction between the short-term and long-term and there is no “value” created by the game you are playing. It’s different with stocks — the companies behind those stocks either create or destroy value in the long term. The ones that create it go higher. The ones that don’t go lower. That’s the difference.

      +”Speaking of quality companies, PLEASE, the entire world does what you do (with the help of Motley Fool who would charge little old me $19 to join Motley Fool to get help choosing their stock recommendations). There is no way I can do that with an excellent program on my computer.” — If its “easy” to pick great companies, then why don’t most professional money managers beat the market? I could point to dozens of articles over the last decade that would explain in detail why you would be CRAZY to buy Amazon/Netflix/Salesforce.com or dozens of other stocks that I consider to be high quality. Good business selection is part art and part science. Its the marriage of left and right brain thinking. The Fool has a wonderful track record of doing so and they have helped me to beat the market. Having said that, I stated numerous time that “I don’t want this to be viewed as a sales pitch for joining the Fool” as did Jonathan & Brad.

      +”Brain, you are an excellent sales person and very positive and I like all of that about you. I can see why MF hired you. You are great at what you do. But individual stock investing is what all of the others have commented and I would like to say again, it can never be replicated, even if I bought every individual stock you own right now, those companies, the market, the politics, the interest rates, the inflation rate, taxes, company management, board composition, their products, geopolitical issues and about 200 more variables will be different going forward from today than between 2013 to 2017 returns that your reported. BTW there is nothing wrong with 125%! and it investing in the TSM index which can be done and replicated with millions of investors.” — MF didn’t hire me as a salesman — they hired me as a writer to help educate readers. Their mission is “to help the world invest. Better!” — That’s why I love to do and it is what I’m passionate about. You are right that the last 5+ years cannot be replicated — nor can any other 5 year period. However, I’m a firm believer that the principles that helped me outperform — buy great companies, hold them for the long-term, learn to control your emotions, look for great leaders and innovators, avoid companies with debt, find businesses with durable competitive advantages……etc — will continue to produce outperformance over the long term. However, I fully expect that my strategy will also produce underperformance for extended periods of time in the short term — sometimes even a few years! That’s a hard fact to accept, but I’m mentally prepared for it. I was investing in mutual funds from 2007 – 2009 and I saw my portfolio fall by more than 50%! Man did that suck, and it is going to suck WHEN — not if — that happens again. I’m also a growth-focused investor, so my portfolio is likely to fall MORE than the TSM. That’s the price that you pay for long-term outperformance — it is emotionally very, very difficult. However, I have high conviction in many, many stocks that I own. I would be a happy buyer of many of them as their prices fall along with the rest of the market.

      +”Lastly, your strategy is looking backward and not forward. Think like Elon Musk. He is a futuristic as you can get! He said that someday it will be illegal for human beings to drive automobiles because of our emotions, drinking, bad behavior and errors. Likewise, I hope it will be illegal for human beings to be financial advisers because robo investors will take the human and emotional element out of the decision making with investments. As we know emotions are all over money matters everywhere in our culture whether we like it or not.” — Actually, I’d argue that my strategy is far more forward-looking than indexing. Why? Some of biggest companies in the index — which is where the bulk of the assets are concentrated — are ripe for disruption. I’d much, much, much rather bet on the innovators of tomorrow than on the old, stodgey companies that dominated for so long. I’d rather bet on Tesla (a stock I own) than GM (a stock I dont’). I rather bet on Amazon (a stock I own) than Walmart (a stock I don’t). I’d rather bet on Whole Foods (a stock I used to own until Amazon bought them) than Krogers/Pepsi/Coca-cola/General Mills/Kraft (stocks I don’t). Since I’m in control of what goes into my portfolio I can make those bets as I see fit. Often, I’ll be wrong. Sometimes, I’ll be right. And if I’m really right, a few of my big winners will more than offset the losses from ALL of my losers (my gains on Netflix alone prove this out). As for robo-adviors, I think they are a GOOD things. However, they will not help with price discovery. If most people are indexing and buying without any regards to price, that creates OPPORTUNITY for people who pick stocks.

      +”My father in law would love you, he spent his entire retirement years trading individual stocks, and did NOTHING else. HOW SAD! He died at 90 with $100,000 in taser stock! My spouse sold that stock in a flash and put it in a responsible investment, an index fund. Yeah, I know its cherry picking but investing in individual stocks is cherry picking by definition.” — I agree that devoting your life to stock picking and “nothing else” would be very, very, very sad. I love to travel, go hiking, hang out with friends, coach my kid’s soccer team, volunteer at my kid’s school, visit family and friends, and live a healthy, active life! While I love to read & learn about stocks, i fill my life with far more fulfilling activities. Having said that, outperforming the market have allowed my finances to flourish, which afford me the luxury of choosing a job that I love (writing about the stock market) instead of being in the daily grind every day. Picking my own stocks has made my life better, no doubt. However, I recognize that doing so is not for everybody (not even for most people!) But I think that sharing this idea with Choose FI’s audience is perfect! These are people who are passionate about money and have their financial lives in order. The people in this group travel hack (I do too!) — at its core, isn’t that just trading time for a little extra money? The trade-off sounds very similar to me as taking the time to study business and pick your own stocks.

      – Brian

Leave a Comment