Comments on: Why does an Indexer pick Stocks?

By: Weekly Dividend Investing Roundup - December 21, 2007 Edition » The Dividend Guy Blog

Fri, 21 Dec 2007 15:43:58 +0000

[...] and research done concerning passive investing. Canadian Capitalist addresses the question, Why does an Indexer pick Stocks? His response is great and I agree with his [...]

By: Dave

Dave — Fri, 21 Dec 2007 01:05:44 +0000

If your trading costs are less than an index ETFs per year, you have greater than 50% odds of beating an index.

By: laketrout

laketrout — Thu, 20 Dec 2007 22:38:03 +0000

BTW… You’ll have to excuse me. I have a mild case of the flu and can’t type very coherently.

By: laketrout

laketrout — Thu, 20 Dec 2007 22:35:28 +0000

I plan to follow a very similar plan.

My employer has a savings plan that where I can deposit up to 10% of my in a money market fund and they’ll match 3%. With four free withdrawals a year I plan to make four ETF index purchases a year inside my RRSP. Then, using Preet’s idea of using your tax return in an efficient manner, I plan to use my tax return to purchase individual Canadian dividend paying stocks to be held outside my RRSP.

By: Canadian Capitalist

Canadian Capitalist — Thu, 20 Dec 2007 22:25:32 +0000

Michael: There is some evidence for your comment. I thumbed through Four Pillars of Investing and Bernstein cites a study (Page 100 if you have the book). The study looked at 1000 random portfolios of 15, 30 and 60 stocks and found that the 50th percentile achieved the market return in all instances. So, it appears that you do have an even chance of beating the market with a random portfolio.

By: Michael James

Michael James — Thu, 20 Dec 2007 20:09:23 +0000

CC, I completely agree with you about the uncertainty with the outcome on any one stock in a given year. Over the course of many years and many picks, I think it is likely that my performance will not differ much from that of the index in the same way that random picks should not differ much from the index over the long term.

If it turns out that I have any talent at stock picking, it will only show after many years of data gives statistically significant results.

By: moneygardener

moneygardener — Thu, 20 Dec 2007 20:05:29 +0000

It is much easier to be a semi successful stock picker if you stick to some simple rules:

1. Only invest in companies that raise their dividend every year.

2. Only invest in companies with a long history of consistent EPS growth

3. Only invest in comapnies with Return on Equity over 15%

By: Canadian Capitalist

Canadian Capitalist — Thu, 20 Dec 2007 19:02:50 +0000

Michael: Assuming we are talking about a broad-based capitalization-weighted index, it’s tough to say what the odds are than one stock will outperform the index because it will be all over the map. If a handful of large caps posted great gains, the odds are small that a random stock will outperform the index. On the other hand, if large caps are suffering and small caps performing well, the odds are better than even that a random stock will outperform. In a given year, who knows which scenario will play out and to what degree?

By: moneygardener

moneygardener — Thu, 20 Dec 2007 16:26:02 +0000

CC, I think that is a great response to that question.

By: Michael James

Michael James — Thu, 20 Dec 2007 16:00:54 +0000

I too am a big fan of indexing, but I like to pick some stocks as well.

You said that in your stock picking “the odds are against outperforming the index.” If the index represents the market as a whole, and you keep trading to a minimum, and we treat your stock picks as random, wouldn’t the odds of doing better than the index be roughly even money? Maybe you meant that the odds of significantly outperforming the index are low, which I agree with.

I hold out the hope that I’m actually a slightly better stock picker than average, but I don’t put enough time into it to justify building my entire portfolio with my small number of picks. So, I just have a fraction of my money in my own picks.

Michael James