{"id":438,"date":"2013-06-10T17:51:15","date_gmt":"2013-06-10T17:51:15","guid":{"rendered":"http:\/\/www.wallstreetandkstreet.com\/?p=438"},"modified":"2013-06-10T17:51:15","modified_gmt":"2013-06-10T17:51:15","slug":"create-your-own-conglomerate","status":"publish","type":"post","link":"https:\/\/www.wallstreetandkstreet.com\/?p=438","title":{"rendered":"Create Your Own Conglomerate"},"content":{"rendered":"

Short-take:<\/strong>\u00a0 Index funds are inexpensive but they are riskier than they appear, and individuals tend to dump them during panics because they don\u2019t know what they own.\u00a0 Superior after-tax returns are achieved by working with an investment advisor to create a diversified \u201cconglomerate\u201d of stocks you actually understand.\u00a0 Hang on as long as they are doing well; sell the losers not the winners.<\/p>\n

The Trouble with Index Funds<\/strong><\/p>\n

The Wall Street Journal<\/b> carried a sad story about how active portfolio managers are losing share to passively managed funds, which are cheaper.\u00a0 It is actually a big mistake for individual investors to flock to index funds, for two reasons.<\/p>\n

Index funds are less \u201cpassive\u201d than they appear.\u00a0 An S&P 500 Fund is risky because the index is managed to be \u201crepresentative\u201d of the market, which means S&P adds stocks in excessively popular sectors that may eventually crash<\/b>.\u00a0 Between 1990 and 2003 the number of tech stocks increased from 44 to 83; in the late 1990s S&P added many \u201chot\u201d tech stocks after<\/b> they had soared in price.\u00a0 So investors got the downside but not the upside<\/b>.\u00a0 Similarly, because of numerous mergers and new names being added, the financial sector\u2019s weight soared from 7% of market cap in 1990 to 21% in 2004, making index investors highly vulnerable to the financial crisis.<\/p>\n

Second, index fund investors tend to think of their holdings as a single asset class, rather than individual enterprises that pay dividends every quarter and can deal with adversity. When the whole world is bearish at the bottom of bear markets, individuals tend to sell, and fail to get back in until stocks have recovered.\u00a0 Consequently they vastly under-perform the market averages<\/b>, as Dalbar has demonstrated through extensive research into the returns of mutual fund holders.\u00a0 For example, ICI data shows that individuals were aggressively selling, not buying, equity mutual funds during the huge bull market of the past four years.<\/p>\n

So in the real world index funds are a very expensive way to save on fees<\/b>.\u00a0 Individuals are likely to achieve superior long-term after-tax returns if they team up with a knowledgeable investment advisor to assemble a group of companies they understand<\/b>.\u00a0 To channel New York Yankee catcher Yogi Berra (\u201cNinety percent of this game is half-mental.\u201d), 80% of investing is 100% mental; the other 20% is emotion. If you know what you own you are less likely to panic at the bottom.\u00a0 Think of your stocks not as a \u201cportfolio\u201d to be traded, but rather as divisions of a \u201cconglomerate.\u201d\u00a0 Buy shares of 20-40 strong, high quality companies with good growth prospects. They should be \u201cleaders in their field\u201d but usually not \u201chot stocks\u201d that everyone is talking about. Most of them should pay decent dividends, but include a few smaller growth stocks without payouts.\u00a0 It is important to diversify across the major sectors (consumer, tech, healthcare, energy, industrials, utilities \/ telecom), finance) because:<\/p>\n