Philosophical question about funds vs. stocks

[Finance Dave]

I realize there's no clear answer, but think this could provide some good discussion.

Let's say you believe that biotech stocks are the next hot area of the economy. Do you invest in a biotech sector fund or try to pick 1-2 biotech stocks?

If you invest in the sector, you are guaranteed both winners and losers within the sector...but (assuming biotech really DOES get hot), you're guaranteed at least some winners.

If you invest in individual firms, you could win big or lose it all.

What say you?

[pb4uski]

While it is true that the volatility of the individual stocks will likely exceed the volatility of the fund, the other important thing to consider is does one have the expertise and time to determine the 1-2 "best" biotech stocks?

While I have the time I would prefer to do other things, and I'm not sure that I necessarily have the expertise to pick the winners, so give me the sector fund.

Said by an avowed indexer.

P.S. Love the saying on your avatar.

[ziggy29]

I would say the same concept applies to the broader market as well, not just sector investing -- do you buy the "index" -- the whole market, the whole sector -- or try to pick specific winners within there? I'd also say the answer is pretty much the same as for the market as a whole -- someone who would buy the total market index would probably also want to buy the "index" of biotech or some biotech fund that diversified across the entire sector. And someone inclined to pick individual stocks in the broad market would likely do the same in a sector (unless they were "sector pickers" and not strictly stock pickers).

[LOL!]

Always an index fund. Never individual stocks. In general it is easy to pick the next hot area: It was the previous coldest area. And vice versa.

[ziggy29]

Quote:

Originally Posted by LOL! Always an index fund. Never individual stocks. In general it is easy to pick the next hot area: It was the previous coldest area. And vice versa.

I seem to recall an old Morningstar study about sector investing (and, well, "market timing") which noted that picking the sectors with the worst performance over the last three years tended to produce market-beating performance. In many ways, though, this is similar to the mean-reversion used by asset allocators and modern portfolio theorists.

[LOL!]

Yep, mean reversion is the story.

[ziggy29]

Quote:

Originally Posted by LOL! Yep, mean reversion is the story.

Of course, it's trickier with sectors because they can die over time as well as mean-revert. It wouldn't been a good idea to invest in the "beaten down" buggy whip sector in 1905...

[Midpack]

Depends on your risk tolerance no? I was 100% equities, only individual stock holdings until well into my 40's. And was fortunate lucky to do very well. Mid-forties I started adding funds and had phased out all individual holdings just to reduce volatility/risk within a few years. And I haven't bought individual shares since, and probably never will again. I do own VGENX (Energy Sector) and VEIEX (Emer Mkts), my only holdings more adventurous than index funds now.

Like you said, there is no right answer. I am sure people are successful investing in individual shares at any age...

[FinanceDude]

Go ETF, and get the best of both worlds........

[Texas Proud]

Quote:

Originally Posted by pb4uski While it is true that the volatility of the individual stocks will likely exceed the volatility of the fund, the other important thing to consider is does one have the expertise and time to determine the 1-2 "best" biotech stocks? While I have the time I would prefer to do other things, and I'm not sure that I necessarily have the expertise to pick the winners, so give me the sector fund. Said by an avowed indexer. P.S. Love the saying on your avatar.

I remember back when getting my MBA... we were doing portfolio analysis and someone brought up the question of 'beating the market' (at that time it meant the DOW industrials)... the prof said it is not as hard as people might think... look for a crappy company and then buy all the rest... If you chose one that was in the bottom 15, you beat the market...

So, you do not have to choose the best one or two, but get one or two that look better than the others...


The problem is that biotechs all look bad until they come out with the next wonder drug... then they skyrocket...

[Nords]

Quote:

Originally Posted by Finance Dave I realize there's no clear answer, but think this could provide some good discussion. Let's say you believe that biotech stocks are the next hot area of the economy. Do you invest in a biotech sector fund or try to pick 1-2 biotech stocks? If you invest in the sector, you are guaranteed both winners and losers within the sector...but (assuming biotech really DOES get hot), you're guaranteed at least some winners. If you invest in individual firms, you could win big or lose it all. What say you?

Is this another trick question?

In any case, the answer is: "diversification".

[jimnjana]

Quote:

Originally Posted by Finance Dave I realize there's no clear answer, but think this could provide some good discussion. Let's say you believe that biotech stocks are the next hot area of the economy. Do you invest in a biotech sector fund or try to pick 1-2 biotech stocks? If you invest in the sector, you are guaranteed both winners and losers within the sector...but (assuming biotech really DOES get hot), you're guaranteed at least some winners. If you invest in individual firms, you could win big or lose it all. What say you?

I say you pick one or two stocks, if you have the time to do the research and you understand what you are researching. Otherwise go with a fund.

[Onward]

Quote:

Originally Posted by Finance Dave What say you?

Funds. Never individual stocks.

And don't bet on sectors unless you're smarter than all the better-equipped PhD's who are betting against you.

Well, you asked.

[RetireBy90]

Quote:

Originally Posted by Finance Dave I realize there's no clear answer, but think this could provide some good discussion. Let's say you believe that biotech stocks are the next hot area of the economy. Do you invest in a biotech sector fund or try to pick 1-2 biotech stocks? If you invest in the sector, you are guaranteed both winners and losers within the sector...but (assuming biotech really DOES get hot), you're guaranteed at least some winners. If you invest in individual firms, you could win big or lose it all. What say you?

While I keep my retirement $$ in funds, I do have the account to purchase individual stocks. One advantage stock pickers have over the market is we can be focused on investing in good companies over the longer term. Those that make a living picking stocks for funds have a short term perspective. So I can get YUM or CAT and enjoy a slow 4-5% appreciation and 3-4% dividends, most fund managers can't.

I always believed if you want to play with the big boys that have tons of time and staff to research all the biotech stocks our there, you better have a plan to beat them. One way is to invest for 10-15 year timeframe.

FWIW

[Ed_The_Gypsy]

Funds--for example, Vanguard's VGHCX. It is not an index fund, but it is a good performing managed fund.

I once bought shares in a biotech company with a world-beating product, a dynamite cancer treatment. They lost a patent fight and disappeared.

Lesson to self: Do not buy a technology. If you do, you are only gambling.

Buy a business, one with a track record. Buy the balance sheet. Buy the cash flow. I want dividends these days. Even then, there are things I don't know about a stock. Except for a few small bets on certain companies in the industries in my experience, always a fund, mostly index funds.

[growing_older]

So if I'm buying an index, if I have a big enough stash, at some point doesn't it start to be less expensive to buy the stocks in the index directly? Maybe I have to grow into it by owning a representative sample of positions, but certainly at some point I can hold very similar stocks (in smaller quantities) as an index fund would hold. Does anybody do this?

[Col. Klink]

I bought the biotech ETF XBI about six months ago and sold it recently at a nice profit. I only buy what I understand, and I understood at time the sector had been beaten down. On the other hand, I would have no idea which individual company to buy. I look for trading opportunities in sectors using ETF's and +1 to the others on this forum that explained the diversification benefits of ETFs.

[frayne]

Like midpack I was a one stock wonder until in my forties. The stock was company stock of course and did very well. After reading some investment books I realized the errors of my ways and diversified by buying into index mutual funds, the bulk being an S&P index fund. The was 20 years ago and no regrets whatsoever. I have played around here and there buying some individual stocks but never had much luck. An index fund with low costs and diversification is a no brainer in my humble opinion.

[ronocnikral]

Quote:

Originally Posted by growing_older So if I'm buying an index, if I have a big enough stash, at some point doesn't it start to be less expensive to buy the stocks in the index directly? Maybe I have to grow into it by owning a representative sample of positions, but certainly at some point I can hold very similar stocks (in smaller quantities) as an index fund would hold. Does anybody do this?

wouldn't you have to take the time to manage all that as well? and have the accounting expertise and other expertises? not to mention, trading will incur costs as well.

seems like 0.1% is well worth to not have to deal with all that crap. jmo.

[Nords]

Quote:

Originally Posted by growing_older So if I'm buying an index, if I have a big enough stash, at some point doesn't it start to be less expensive to buy the stocks in the index directly? Maybe I have to grow into it by owning a representative sample of positions, but certainly at some point I can hold very similar stocks (in smaller quantities) as an index fund would hold. Does anybody do this?

You can do that, but you'd be working for minimum wage.

One problem is that you'd replicate the index by buying only 20-30 stocks (instead of 500) to reduce your costs. Yet the index's biggest gains would come from the half-dozen stocks that you wouldn't touch with a 10-foot pole. Indexes don't have to think about the quality of the stock, just its qualification criteria.

Note that even indexes have some annual turnover, so your index replication would drift over 10-20 years unless you did the appropriate selling & buying.

UncleMick has said it best over the years. Set aside 10-15% of your portfolio for testosterone-poisoned investing and let Vanguard's computers do the rest. If I was going to buy individual stocks again (in addition to Berkshire Hathaway) then I'd do it like the Dividend Growth Investor.