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Indexing or Active approach?
Old 10-10-2012, 01:23 PM   #1
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Indexing or Active approach?

Hello All...

I've been reading the boards for awhile and thought I'd post a couple questions I have related to my portfolio.

First some background....I'm currently married and both my wife and I are in our mid 30s. We have very good incomes and have saved a decent amount (about $350K in retirement accounts and $550K in taxable accounts). The retirement accounts are invested about 70% stocks / 30% bonds, mostly in index funds available through each of our employers. The taxable accounts are mostly in cash except for about $140K in some bonds ($100K) and individual stocks ($40K). I have no debt and are currently house hunting (so I will need some of the $550K for a downpayment).

My question is more related to the taxable accounts -

1) First, what are your thoughts on a pure indexing versus active approach (active meaning some individual stock selection, sector funds, etc.....not market timing). I consider myself a pretty experienced investor with a business background. I enjoy researching / following the markets, but at the same time know about all the studies that say you can't beat the market over the long term. Just curious what people's experiences have been with this? Do you purely index or mix in some active investing?

2) The taxable balance has grown quite rapidly over the past few years. As a result, I find myself with a LOT of cash, which I know makes no sense in my situation (won't need the money for a long time, I continue to save a lot each month, no debts). How would you approach puting the money back to work? All at once? Spread over time and if so, what time period? I know it probably makes sense just to invest it immediatly based on my desired AA, but don't want to end up top ticking the market.

thanks for the help in advance
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Old 10-10-2012, 01:41 PM   #2
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First, I would follow the advice of "LOL!'s Market Timing Newsletter". The approach there is to use passively-managed tax-efficient low-expense ratio index funds in a taxable account. That way you don't pay taxes on unrealized gains and you get a tax-break from tax-loss harvesting activities.

Second, if you want to use actively managed funds, then do so only in tax-advantaged accounts, but try to not to lose money because you cannot deduct your losses there. Bond funds are good in tax-deferred accounts and not in taxable accounts.

Other than that, are you asking about dollar-cost averaging versus lump-sum investing?

See also www.bogleheads.org and Getting Started there.
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Old 10-10-2012, 01:52 PM   #3
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Thanks LOL

My question was more related to how people feel about the whole all in or all out approach to passive portfolios. For instance, if you read the Bogleheads forum, most believe in a very simple allocation, for example 50% SPY, 25% EFA and 25% AGG (they'll obviously use Vanguard funds but you get the point).

My question is are most of the portfolios of the people on this forum that simple, or do they mix in individual stocks, sector ETFs, etc?

On the second question....yes, basically what are your thoughts regarding lump sum investing versus DCA when you have a lot of cash today?
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Old 10-10-2012, 01:59 PM   #4
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I don't know what folks on the forum do, but for me: No individual stocks. I suggest limit "sector" funds to REIT and TIPs. One can tilt to small-cap and value by owning VBR or IJS, VSS or SCZ+DGS, or VTV.

I would not LS, but would DCA despite what anybody else says. Invest 50% now and the remaining at 5% to 10% per month no matter what. If market tanks be sure to accelerate the DCA part.

As for bogleheads, most do not believe in the 3-fund portfolio, but in the last month there are many posts about that, so it might appear to be so.
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Old 10-10-2012, 01:59 PM   #5
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I choose the indexing together with the Dollar Cost Averaging (DCA) route for three reasons.

1) As mentioned, studies show that you can't beat the market over a long term

2) Makes it a simple process as since my money is just following the the market. I invest in funds and don't have to decide if the fund manger is competent or if the fund grows too big to manage, as examples.

3) By DCA'ing, this takes my emotions and tempation to market time out of the equation.

I think if you decide to not put all the investment in at once, then decide what timeframe you want, then go with it. For example, if you have $100K to invest and don't want to throw the entire amount in at once, decide say, 10 months (at 10K each month) or 20 months (at 5K each month) or whatever timeframe you decide and go with that schedule. Simple as 1-2-3.
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Old 10-10-2012, 02:25 PM   #6
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Quote:
Originally Posted by sox2012 View Post
what are your thoughts on a pure indexing versus active approach
For me, pure indexing, or as pure as possible. US & intl stocks (small, mid, and large), US & intl bonds, US & intl REITs, a bit of commodities & p2p loans.
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Old 10-10-2012, 02:32 PM   #7
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When I first started investing, I assumed I'd always be actively managing my accounts well past retirement. Now that I'm older, I find that I'm lazy and find investing to be too much like work. So now I'll be converting the majority of my portfolio into index funds and just manage my asset allocation. I'll likely keep some of my individual stocks as I was converting to an income producing portfolio and I'll likely do some playing when bored.
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Old 10-10-2012, 03:49 PM   #8
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Originally Posted by sox2012 View Post

My question is more related to the taxable accounts -

1) First, what are your thoughts on a pure indexing versus active approach (active meaning some individual stock selection, sector funds, etc.....not market timing). I consider myself a pretty experienced investor with a business background. I enjoy researching / following the markets, but at the same time know about all the studies that say you can't beat the market over the long term. Just curious what people's experiences have been with this? Do you purely index or mix in some active investing?

2) The taxable balance has grown quite rapidly over the past few years. As a result, I find myself with a LOT of cash, which I know makes no sense in my situation (won't need the money for a long time, I continue to save a lot each month, no debts). How would you approach puting the money back to work? All at once? Spread over time and if so, what time period? I know it probably makes sense just to invest it immediatly based on my desired AA, but don't want to end up top ticking the market.

thanks for the help in advance
Capital gains aren't too inefficient in taxable funds. Certainly no reason to stay in cash.

I mix active and passive/indexed investing. I use index funds when I can't find anything I like better. They're a safe choice when they have low fees.

I'm also active in terms of raising some additional cash when the portfolio is above my retirement needs and then reinvesting it when the market is down 20% or more. I've been at 30% to 1% cash at times.

Also I'm happy to purchase additional shares at a 10% or more discount to my existing shares and sell the higher priced shares when they break even. I even have a few funds now where I have sold some shares at recent highs and I'm hoping to repurchase them at a 10% discount in the future. In addition to rebalancing of course. Most of this is with just 5% or so of the portfolio in total, so mostly just keeping busy.

In an average market I'd just pop extra cash all in at once and not worry about it. However, I feel stongly that the global debt problems will (eventually) cause the market to drop. And we're not far off recent market peaks just now. So a DCA or value averaging might be more appealing. Or try waiting until what you want to buy is 10% lower than now. 10% off is not bad, and you might not feel as bad if things dropped another 10% as if you had bought now. I think I'd go with a combo of DCA and adding extra if the market is down a specific percentage over a period of at least a year. A simple written plan that involves no other judgements, only mechanical implementation. Just some ideas. You have to choose something that eventually gets you into the market but doesn't discourage you too much if the market just goes up or just goes down for the next several years.
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Old 10-10-2012, 03:50 PM   #9
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You answered your own question, the odds are higher of a portfolio performing better through indexing. This seems to be a struggle for so many people but the facts are the facts; I look at it as anything I can use to improve my results I totally embrace. DCA provides some peace of mind and consistant with the findings that people deal a lot better with not making as much as they could have than they do with dealing with losing money.
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Old 10-10-2012, 05:00 PM   #10
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I have a significant amount in actively-managed funds because when I started investing in my early 20s, that's all there were (and honestly, lots of people back then said I was crazy for buying into funds at all, individual stocks were all the rage). Most in taxable accounts, which unfortunately have such a low cost basis now that selling just to get out of the fund is impractical due to taxes. Some are in IRAs (back from when IRAs were first created) and I've just been lazy about converting them to other funds, mostly because my father steered me to some terrific funds that have very low expenses and excellent long-term results - so no real reason to change.

I have steered my kids to index and target-date funds as they start out on their investments in their Roth IRAs. I would do the same if I were starting out now.
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Old 10-10-2012, 05:20 PM   #11
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The short answer is active management fails to produce returns superior to indexing. My own portfolio has fallen short of the s&p 500 in half the years, but produces more dividend income...its ~70% DVY, VNQ and VEA.

According to the numbers, not only does active management fail to beat a common index, it appears that the more active the management, the weaker the results and the lower the likelihood that a fund manager will put in successive years beating an index.

Whats really wacky is that according to statistics, a monkey with a copy of the WSJ tacked to a dartboard would produce better numbers than our apt fund managers. Magellan and Bill Miller are the only ones with a decent length 'beating the index' record, and both of those fell on their heads after a while. With absolutely random fund management, we should have dozens of 'market beating' funds and fund managers, but we don't. We should have thousands of Warren Buffets, but we don't.
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Old 10-10-2012, 05:27 PM   #12
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Everyone has an opinion, so let me add my experience. I find it hard to believe that I can't do as we'll as the market. It is true, but I still cling to a belief that this time will be different ;-) so, I kept about 10% in a separate account that I use to buy individual stocks.

I have most of my investments in index funds, with a couple active managed that I got from an advisor before I left. Once they fall below the index Ill move them. I keep it simple, use
large stocks,
mid/small cap,
international stocks,
cash,
us bonds, and
international bonds.

I check my AA each month (supposed to do each qtr) and rebalance once a year or more often if I'm off by 5% or more. Also have a rental house.

FWIW just how I do it, and I'm happy with it. You need to find a balance between theory and what you will sleep well with, and what you can live with. Like keep some separate for individual stocks.

Good luck and congrats on doing dang well
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Old 10-10-2012, 05:31 PM   #13
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im as lazy an investor as you can get. i use my newsletter i have been getting for 25 years that caters to fidelity funds and i give things no thought .

i can easily put my own mixes together but i like the newsletter taking the burdeon of making the decisions and not having me 2nd guess myself.

who knows if left to my own devices i would have bailed and ran at some point in the down turn.

my wife and find it so comforting not to have to debate with each other the next steps. we spend our time thinking about everything else and leave the driving to someone else.

its not that their picks are so great, they are not , but the portfolios blend well together and the fact you stick to the plan makes everything just great in the end.
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Old 10-10-2012, 06:02 PM   #14
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Passive indexing
Value Cost Average not Dollar Cost Average
This where you put in a set amount and expect it to return some set amount every interval...if at that time it has returned more, you lessen the set amount put in by that amount over, if it is down, you put in more than your set amount by the amount needed to make up for the deficit. Puts more in when things are down and less when they are up.
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Old 10-10-2012, 06:43 PM   #15
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I am all index funds because I don't believe that I could necessarily pick the funds that will outperform the indices and I believe there is an advantage to lower costs. Mostly Vanguard Total Stock Market Index, Total International Stock Index, FTSE All-World ex-US Index, Short Term Investment Grade, Intermediate Investment Grade, High Yield Corporate and GNMA. The ER for my entire portfolio is 0.16% so out of the gate I think I am at least 50 bps ahead of even a 50/50 mix of index/managed funds.

I used to do individual stocks long ago. While I have a strong business background (MBA/CPA) I never felt that i would have the time and interest in doing the research and diligence needed to pick stocks intelligently. It was boring enough reading all the financial information that I needed to do my work - I certainly didn't want to do more of it on my leisure time!

With respect to getting in, I'm a strong advocate of value averaging. It is similar to DCA but the mechanics of the approach lead one to buy more when prices are relatively low and buy less when prices are relatively high. Value averaging is a bit different from dollar cost averaging. DCA is investing a set amount each month - say $10k a month for a year if you had $120k to invest. Value averaging differs in that if relates to the balance in relation to the planned balance. So if the initial 10k is worth 11k at the end of the first month then the second month investment would only be 9k, but if the initial 10k was worth only 9k at the end of the first month then the second month investment would be 11k. You can google and find out more about the mechanics, but what happens is you invest less when the market is relatively high and more when the market is relatively low. IIRC studies have found that it is slightly better than DCA over long periods of time.
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Old 10-10-2012, 09:04 PM   #16
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Let's see. After 25 years of goofing around with individual stocks, active managed funds, and indexes, I've decided to focus on index funds from here on out. Most of my stock picks have been terrible, although a few good picks got me near even. I'm done with stocks.

I still have a few sector type funds that I'll be drawing down to convert to more broad indexes, using the value averaging approach.

As a matter of fact, I learned about the value averaging here on this board from my first posts (I see it mentioned above twice), and it sounds like a really good approach. I'm going to try it, with plans to invest every 2 months for the next two years (12 purchases) to a broad equity index. It will be interesting to see how this works out.
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Old 10-10-2012, 09:27 PM   #17
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Quote:
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I enjoy researching / following the markets, but at the same time know about all the studies that say you can't beat the market over the long term. Just curious what people's experiences have been with this?
If you have a mountain of evidence in front of you, why would you ignore it? Unless you have a very good reason for thinking the studies are (A) flawed or (B) not applicable, it would be irrational to ignore the evidence.

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Originally Posted by sox2012 View Post
Do you purely index or mix in some active investing?
I always prefer to use a low cost index fund but will buy an active fund when necessary (because no other fund is available) to meet my AA goals. I still try to make sure that the active fund is index like (i.e., low cost, low turnover).
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Old 10-11-2012, 02:39 AM   #18
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one thing to be careful about with index funds is whats now called the tax torpedo.

because they spin off little in taxable gains the day of reckoning if you change strategy and sell can be painful.

if you used good planning your equities should be in a taxable account where they get special capital gains treatment, can write off losses , and pass totally tax free to heirs.

that can create a tax burdeon if you sell from all the decades of accumulated gains and little taxes along the way..

one person we know didnt realize just how large his indexing tax bill would create and he tripped the amt tax when the gains brought his income up to the right level.

that can be pretty painful.

the few times we hit the amt because of large capital gains putting us in amt territory it ends up nailing us 2 years in a row.

it hits us the first year on the gains and because our state and local taxes are so high it hits us again the following year on the state and local tax deductions for the payment .

that was a double whammy.
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Old 10-11-2012, 09:39 AM   #19
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Originally Posted by sox2012 View Post
...(snip)...
1) First, what are your thoughts on a pure indexing versus active approach (active meaning some individual stock selection, sector funds, etc.....not market timing). I consider myself a pretty experienced investor with a business background. I enjoy researching / following the markets, but at the same time know about all the studies that say you can't beat the market over the long term. Just curious what people's experiences have been with this? Do you purely index or mix in some active investing?
...
After years of investing I favor an all index portfolio. I have a few active bond funds.

If you are young, married, getting a house, maybe having children and then the normal things happen in life, you may not have time to really devote to investing beyond a well constructed indexed portfolio. If you think you can do better, then carve out something like 10% and swing for the fences. Give this experiment at least 10 years before making too many conclusions. Just some thoughts.
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Old 10-11-2012, 09:57 AM   #20
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Quote:
Originally Posted by sox2012 View Post

1) First, what are your thoughts on a pure indexing versus active approach (active meaning some individual stock selection, sector funds, etc.....not market timing). I consider myself a pretty experienced investor with a business background. I enjoy researching / following the markets, but at the same time know about all the studies that say you can't beat the market over the long term. Just curious what people's experiences have been with this? Do you purely index or mix in some active investing?

2) The taxable balance has grown quite rapidly over the past few years. As a result, I find myself with a LOT of cash, which I know makes no sense in my situation (won't need the money for a long time, I continue to save a lot each month, no debts). How would you approach puting the money back to work? All at once? Spread over time and if so, what time period? I know it probably makes sense just to invest it immediatly based on my desired AA, but don't want to end up top ticking the market.

thanks for the help in advance
Be careful of this. Investing isn't a hobby. Certainly the researching will help, as it's better to constantly follow than to invest in individual stocks and then lose interest and hold them longer than you should, but it's really easy to overestimate your knowledge. If you want, maybe leave 5-10% to invest in a small number of stocks.

I used to primarily buy individual stocks, but didn't like the risk so I started putting more in index funds, especially as I liquidated my company stock options. Recently I compared my individual brokerage account (which was down to around 10% of my holdings) vs. my Vanguard account which is almost entirely index funds. I did a lot better with the Vanguard account, so I've sold off nearly all but one of my individual stocks (due to a big gain I don't want to take this year) and put the funds in Vanguard (all at once, to answer your second question). Maybe you are one of the few that can beat the market, but it's worth looking at.

I would also plug the sales into Turbo Tax (last year's is probably good enough) and see if you trigger AMT. If so, you might want to sell off the winners over the next 2-3 years to spread them out and hopefully not hit AMT.
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