The default advice from many financial advisors is to invest in low-cost index funds, because most investment managers fail to beat the S&P 500 Index after costs over the long haul.
According to the most recent S&P Dow Jones Indices’ SPIVA studies, which compares the S&P 500 index versus active managers, only 12.2% of actively managed large-cap funds beat the S&P 500 over the past 15 years. That’s a shocking statistic, but the study has been going on for over 20 years and, though the numbers vary a bit year over year, the overall conclusion really hasn’t.
But what about buying top-performing funds? Welp. S&P also found that the odds of a top 25% performer in one period continuing to outperform were also lower than chance, suggesting that the outperforming fund was more lucky than skillful.
Taken at face value, the SPIVA study finds there’s no compelling reason to pay for investment advice and every reason to invest in a portfolio of index funds that balances the risk you are willing to take and the return you need to eventually do the things you want to do. But, that’s an oversimplification. There are still plenty of reasons to consider buying individual stocks.
First, funds don’t let you harvest tax losses in individual stocks, allowing you more control over your capital gain exposure. The SPIVA study can’t compare index performance against investors who manage for tax efficiency. Granted, most index funds, especially the S&P 500, have relatively low turnover, so there’s little exposure to short term capital gains distributions from the funds (conceivably there could be, though), but the sale of your index fund could trigger a capital gain unless it’s in a tax-deferred account.
Second, the fact that many do not outperform doesn’t negate the fact that some active managers actually do outperform. Though it’s hard to outperform the index, it’s possible, and that’s also true for individual investors. Individual investors are also able to buy stocks that large fund managers would have a tough time buying because they can’t take a large enough position of a stock without driving its price up. We’re not tied to the largest, most liquid stocks, nor do we have to only invest in a certain type of stock, such as large companies only or small companies only.
The third, and possibly most compelling, reason to own individual stocks is that stocks are just flat-out interesting. They motivate us to keep abreast of the huge trends that are driving our society, such as the oh-so-relevant topics of social media, artificial intelligence, robotics, space tourism…you get the idea. Before buying a stock, you research the company, you think about competitors, and you try to forecast what will happen in the future. Your stocks are very happy to tell you how right or wrong you are every second they trade. Talk about instant feedback.
So, yes, you can invest in funds and, for many investors, arguably even most, index funds are a terrific idea. But remain open to the idea that it is still possible to beat the market with individual stocks and, if you’re the right sort of person, it’s also an opportunity for both personal and financial growth.
Reference: SPIVA, S&P Dow Jones Indices: https://www.spglobal.com/spdji/en/research-insights/spiva/
Evan R. Guido is the Founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com. Read more of his insights at https://finance.heraldtribune.com/category/ask-guido/. Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through an Avantax affiliated insurance agency. 6260 Lake Osprey Dr. Lakewood Ranch, FL 34240. The views and opinions presented in this article are those of Evan R. Guido and not of Avantax Wealth ManagementSM or its subsidiaries. Past performance does not guarantee future results. The S&P 500 is an index of 500 major, large-cap U.S. corporations. Standard & Poor's is a corporation that rates stocks and corporate and municipal bonds according to risk profiles. The S&P 500 is an index of 500 major, large-cap U.S. corporations. You cannot invest directly in an index. An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund. CDs are FDIC insured and offer a fixed rate of return. They do not necessarily protect against a rising cost of living. The FDIC insurance on CDs applies in case of insolvency of the bank, but does not protect market value. Other investments are not insured and their principal and yield may fluctuate with market conditions. Investments are subject to market risks including the potential loss of principal invested. Neither diversification nor asset allocation assure or guarantee better performance and cannot eliminate the risk of investment losses.