The Lazy Investor

A lazy investor relying on his lazy portfolio.

 

How Much Do You Really Need To Know About Investing?

 

Investing can be a hobby.  Some people find it fun.  Some almost make it sport and come to live and die by every little blip in the market.  For a lot of us, investing is one of those things we may know a few things about, but if pressed would have to admit still have much more to learn.  Or do we?

 

The Bell Curve

 

As is true for most things, the investors of the world can be described by a bell curve (See Figure 1).

 

An investing bell curve.

Figure 1: A bell curve for investor trading.

 

On the left end of the curve you have those who never invest or who only invest on an infrequent basis.  In the middle, you have your average investor who buys and sells steadily over the years.  On the right end of the curve you have those who invest and trade all the time—these would be professionals or day traders for the most part.

 

 

Lazy Investors

 

Near the left end, just beyond those who never invest is a subsection of the investing world who have come to consider “active investing”, meaning active trading of stocks, bonds, funds, options, commodities, etc. as a pointless exercise in futility.  Why?  Because as you look into it, no matter what kind of investment is hot today there’s a different investment that will be hot tomorrow and it’s almost impossible to predict it.  To these investors, the idea of trying to outguess the market is more a matter of luck as not.  Now, though I call these “the lazy investors”, please don’t assume the term lazy implies they are somehow unsuccessful or bad.

 

Up and Down

 

One of the main reasons mutual funds and exchange traded funds (ETFs) go up and down so regularly is because they contain a basket of investments that happen to be hot one day, week, month, or year, and not the next.  I’m sure some would argue that certain fund managers (meaning the people managing these funds) are practiced at their craft and do a reasonable job picking winners or shedding the losers year after year.  However, the argument ignores the hundreds or thousands of other fund managers who only get it right some of the time, or in many cases, those who rarely get it right at all.

 

What Are Investors To Do?

 

Where does that leave the average investor?  I’d say, mostly confused about picking a good fund! After all, if a majority of professionals can’t pick a winning hand of stocks or bonds on a consistent basis, then how should those who have less understanding of the market fair any better?  Or to make it more personal, how do we pick a good stock or fund, one that won’t take a nosedive the minute we put our money into it?

 

A Dirty Little Secret

 

Thankfully, the lazy investors have figured out something most stock brokers would prefer you didn’t know.  You could call it the broker’s “dirty little secret”.  It’s a dirty secret in the sense that if everyone bought into the idea, then there would be a lot less money spent on commissions.  If your business is selling stocks that’s not good!  In other words, lazy investors choose to opt out of the game of chasing returns, and in doing so pay far less on commissions.  That’s totally unlike average investors who trade in and out of stocks or funds all the time.

 

To get an idea why the frequency of trading matters consider this: Some of the best brokerages offer trades as low as $4 to $8 a pop, so if you were a fairly active investor and made 100 trades a year you’d be spending:

 

$4 or $8 per trade

times 100 trades per year

= $400 to $800 on commissions each year!

 

Add that up over a lifetime of investing, say 40 years, and we’re talking $16,000 to $32,000 for the total cost of your commissions, not including whatever return on investment you give up on by handing this money over to the broker.  That’s worth thinking about because if you compound $32,000 monthly at say a 4% annual return over 40 years, you’re suddenly talking almost $80,000.  Get a 6% return and suddenly you’re talking over $135,000! Bottom line: there’s a huge hidden cost to active trading.

 

There’s Logic Behind The Lazy Approach

 

Lazy investors have come to the following conclusions:

 

1) They can’t guess the direction that prices of individual stocks or funds will take with any degree of accuracy.

2) They therefore can’t predict the direction of the market.

3) Leaving all their money in cash risks losing some portion of it through inflation, or of losing the opportunity to make more money by being fully invested.

4) The safest way to invest is to buy well-diversified mutual funds or exchange traded funds and hold them for the long haul.

5) Buying in and out of investments on a frequent basis really cuts into returns (as we’ve just demonstrated in our math above).

 

The Lazy Portfolios

 

So what do the lazy investors do?  In terms of trading, not much at all, other than buy and then hold a so-called “Lazy Investment Portfolio”.

 

It turns out there are a number of Lazy Portfolios that have a pretty decent track record over the long haul.  These portfolios have been given names like The Coffeehouse Portfolio, 2nd Grader’s Starter, Aronson Family Taxable, etc.  Most lazy portfolios are typically made up of indexed mutual or exchange traded funds.  Some, of course, have fared better than others, but now that the market has recovered from its low a couple years ago, they’re all chugging along nicely.

 

Figure 2, below, shows the performance of one Lazy Portfolio that my good friend “Carlos” reminded me of the other day (which incidentally was the inspiration for this post).  Now, since Carlos is a Vanguard fan, the fact that some of the most famous Lazy Portfolios take advantage of Vanguard index funds doesn’t bother him a bit.  In truth, Vanguard has a great reputation for running low cost mutual and exchange traded funds, though with a bit of online sleuthing investors should be able to find several other low cost fund companies who offer similar products.

 

A "Lazy Portfolio"

Figure 2: The Margaritaville Portfolio and sample returns. (Click to expand)

 

More Portfolios

 

Our numbers in Figure 2 for the Margaritaville Portfolio came from Paul Farrell at Market Watch who regularly tracks the progress of 8 lazy portfolios. You can see the results for the rest of the portfolios he tracks, the funds they’re composed of, and how they stack up here: Total Returns For 8 Lazy Portfolios.   Another person who tracks “lazy” portfolios is Paul Boyer at MadMoneyMachine.com.  He includes several other lazy portfolios, including two we mentioned in our post Diversification: A Safe Money Machine (i.e. Harry Browne’s Permanent Portfolio and a mutual fund that happens to have the same name—i.e. “The Permanent Portfolio”.  Be advised that as far as “lazy portfolios” are concerned, these two are considered fairly unique and are arguably more or less risky as they include gold as one of their basic components.

 

Better Or Worse

 

In a given year, any fund may perform better or worse than the S&P 500 (which is a common benchmark used to track 500 large-cap common stocks in the U.S.).  That’s why it’s best to consider how a fund stacks up to this index over time.  For example, the last time I checked, investors putting their money in an “index fund” tracking the S&P 500 over the last year would have beat out all the lazy portfolios with a return of nearly 26%.  However, if you compare 3, 5, and 10 returns, the 8 lazy portfolios beat the S&P 500 in all cases, except for the 3 year number on the Margaritaville Portfolio.  Even so, the Margaritaville Portfolio returned nearly 5% over 10 years, beating the S&P by just over 3% overall.  Please remember, that on any given day a portfolio will be up or down so it’s much better to look at returns for various periods of time as you go about comparing them.

 

Make Your Own

 

You can also make your own lazy portfolio as you develop a better feel for the market by combining various mutual or exchange traded funds.  If you’re interested in making your own fund read this post from Market Watch, which offers 6 suggestions worth heeding.

 

Our Ideas For Picking Funds

 

We have a few other items worth consideration as you look to start building your portfolio.  Our list should only be considered as a starting point as you make your first foray into investing.  As you proceed, you’ll find a number of terms that may not be familiar.  Don’t despair!  Most fund companies and brokerages have a wealth of additional information to help as you go, and most are extremely helpful if you have questions as they want to earn your business.

 

In the meantime, here’s our list of 10 items worth consideration for picking out and investing in a mutual or exchange traded fund.

 

(1) Look at a fund’s year in and year out performance. Seek those funds whose 1, 3, 5, and 10 year overall return is consistent year in and year out.  If your goal is long term investing, ignore funds who may offer spectacular returns in one year but can’t seem to generate those same results on a consistent basis.

 

(2) Look for funds with stable management. Some funds are managed by teams so it’s hard to tell how long the people involved have been there or who is in charge.  Others have managers who have been at the helm a number of years. Long tenure is generally considered a good thing when it comes to fund management.  Also, be aware that many (though not all) ETFs and some mutual funds are based on a market index (or market segment index) so management expertise in these funds will play less of a role in determining the fund’s investment choices.  Bottom line: Unless you’re zeroing in on an index fund, find out how a potential fund is run, and where possible, target those who have a good track record and lots of experience at the helm.

 

(3) Don’t consider return alone when looking at a fund. Return is important, but it’s closely tied to risk.  This means you need to consider the risk you’ll have in holding the fund’s investments.  In other words, before you buy a fund, find out how volatile the fund is, and then ask yourself if owning it will make a difference in whether you can sleep at night.  If the answer is no, pay attention!  For example, prices for some sector funds (like energy or commodities) may vary substantially more on a day-to-day basis than a broader market stock or bond fund.  Look at past performance to see if the fund price is up significantly one week, down just as much the next, and then up or down again as much the week after that.  For less risk, seek out less volatile funds—those where the share price fluctuates within a consistent range of its ongoing trend.  Also, when looking at an ETF, pick a fund with higher daily trade volumes (meaning those trading at least 250,000 shares a day, though a million is better).  Too little volume and you may pay more to get in a fund or have a harder time getting out when you need to.

 

(4) See how the fund stacks up against the S&P 500. If it doesn’t beat the S&P 500 on a consistent basis, why buy it?  Also look at any other index that is a better measure for the investments held within the fund.  When an actively managed fund can’t even match the returns of an index you need to question why you’d ever consider owing it.

 

(5) Compare other funds in the same category. Are there any other funds with better overall records of return in the same category or sector?  Is management more stable at one fund?  Are fees the same or different? Check into the details.  Also, companies like “Morningstar”  compare funds and rate them based on a number of different factors.  Take advantage of this information as you compare various funds.

 

(6) Look for funds with the lowest management fees. If two funds track the same index or have roughly the same investments, find out which one costs less to run.  Even fractions of a percent add up over time so make sure you aren’t paying more to manage the fund than you need to.

(7) For mutual funds, look for no-load funds, meaning there’s no “extra” charge to buy into them.  Don’t start in the hole with a load fund, unless you’re absolutely convinced the performance can’t be matched by another fund.  This would be rare.  For more on fund fees click here.

 

(8) Make sure the fund is open to investors and then “dollar cost averageyour way into it—this means splitting your investment capital into chunks and buying in at regular intervals.  Dollar cost averaging is a great tool which avoids the need to try and time the market.  Click the link on dollar cost averaging to learn more.

 

(9) Re-balance your portfolio regularly. No matter your ultimate choices in picking funds, you’ll want to re-balance your portfolio at regular intervals and/or any time you add more money to your funds.  Otherwise, you can end up with the stock, cash, or bond percentages shrinking or growing in ways you didn’t intend.  For more information on re-balancing see our post Diversification: A Safe Money Machine.

 

(10) Check the fund’s prospectus which is often available online.  This will have much more detailed information about the fund than you’ll find in a fund summary at most financial websites.

 

Discipline

 

There’s no doubt that timing plays a role in investing.  If you buy into the market when stocks are high and sell at the bottom of a crash you can lose a substantial portion of your fortune.  If you’re lucky enough to buy low and sell high, your returns can be huge.  The trouble is there’s no way to predict it.  That’s why lazy investors stay focused and consistently add to their investments in good times and bad.  That way they end up buying  in at a better overall cost (see the link on dollar cost averaging above).

 

The biggest issue most investors have with any investment strategy is sticking to it.  If the markets start plummeting the first thought is almost always, “Maybe I should bail out of my funds until this is over.”  The trouble with bailing, however, is knowing when to get back in.  That’s why lazy investors go along for the ride.  When they look at the big picture, they know that every time the markets go down they inevitably come back up.  The key for any investor is therefore to pick a strategy for investing and stick with it.  If you find, you can’t stick with a strategy it’s a good sign you are uncomfortable with the risks involved.  That could mean you need to reconsider the mix of stocks, bonds or other investments in your portfolio.

 

Invest Wisely

 

Since we are not investment counselors or advisers we do not recommend any one strategy of investing over another.  Our point in today’s post is to present you with investing options for your consideration.  It’s up to you to decide whether those ideas fit with your overall tolerance for risk or your personal wealth building strategy.

When it comes to investing it’s important to understand the risks involved.  If you haven’t read it yet, our recent post “Collecting Rich Dividends” describes the risk factors involved in owning stocks and may be worth a read.  Also, please understand that past portfolio or fund results are no guarantee of future performance.  As a potential investor, please research any potential investment and consult with trusted friends and financial advisers before risking your hard earned cash.

 

Finally, if you’re planning to invest in an ETF instead of a mutual fund, make sure you understand the differences first.  From the outside the two types seem similar, but there are some significant distinctions which may make one or the other more attractive to you.  Plus, some funds which may first appear to be ETFs are actually exchange traded notes (ETNs) or master limited partnerships (MLPs), instead.  Either might have more risk or complicate your income tax situation, so make sure you know what you’re getting into.

 
If investing is still too stressful, check out Javabird’s Adventures in Investing next.
 

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