While indexing offers an inexpensive way to beat most professionally managed funds over time, picking stocks is fun.Feodora Chiosea/iStockPhoto / Getty Images
One of the great benefits of writing for this newsletter is the feedback I receive from you.
A recent standout: Your overwhelming response to an article I wrote in late August, addressing why I combine index investing – which entails tracking entire indexes with mutual funds or exchange-traded funds – with individual stock picking.
Turns out, what I thought was an eccentricity is an approach that many of you also follow, and for similar reasons.
While indexing offers an inexpensive way to beat most professionally managed funds over time and delivers instant diversification, picking stocks is fun.
It also offers a way to focus on a key strategy, such as buying stocks with big dividends that might get watered down in a broadly diversified index fund.
“Couldn’t agree with you more,” one reader told me in an e-mail. “I own both index funds such as the S&P 500 index and individual stocks such as Enbridge, and have done well over the years following this approach.”
Another reader prefers indexing for one part of his portfolio, and stock picking for another.
“For Canadian equity, I’m 100 per cent individual stocks for the reasons you list. Can’t talk about ETFs with friends! For U.S. and international equity, I’m 100 per cent ETFs for convenience and simplicity,” the reader said.
Not everyone embraces indexing, where an investor holds all the stocks in an index and therefore matches the performance of, say, the S&P 500 or the S&P/TSX 60 Index, to name two examples that are popular with Canadian investors.
What’s interesting, though, is that the readers who prefer to own individual stocks aren’t necessarily driven to outdo benchmarks with savvy trading.
Some stock pickers preferred the transparency of individual stocks: “I like that the dividends drop, untouched by human hands, into my account. That I can anticipate what I will get. Index funds are opaque,” one reader said.
Can’t argue with that.
Another wondered if the large amounts of money now flowing into indexes can create market distortions, raising an issue that has alarmed some observers in recent years.
Three particularly large U.S.-traded index ETFs – the Vanguard S&P 500 ETF, the iShares Core S&P 500 ETF and the SPDR S&P 500 ETF Trust – manage a combined US$2.1-trillion, which is a lot of passive money that could inflate the valuations of the most expensive stocks.
“I’ve come to believe that ultimately index funds contribute to asset bubbles, and on the whole are a net negative for a capitalist society. At the very least, they certainly don’t contribute any information to the market,” a reader said.
Fair enough.
It is also worth pointing out that index investing can be complicated, given the vast number of funds to choose from.
The S&P 500 has an equal-weighted version, where each stock has the same sway and gives investors a way to sidestep the current infatuation with expensive tech stocks. Is that still indexing?
There are also growth indexes, value indexes, high-yield dividend indexes, emerging market indexes, sector-specific indexes and even indexes of indexes that combine various country and regional equity benchmarks with bond funds.
The difference between index investing and holding individual stocks, in other words, can get a little blurry at times. No wonder so many of us are okay when we stray from one approach to another.
My question for you this week: Are you worried that an equity bubble may be forming? If so, what are you doing about it? You can reach me at dberman@globeandmail.com
Chart of the day
Analysis: Why these three Canadian cities top the U.S. in housing inflation
Today’s financial tool
If you’ve ever fiddled around with guesstimates of how much money you can generate in retirement – note to self – perhaps it’s time to sit down with a few financial statements to get a clearer view. This tool from the Government of Canada website is a good place to start.