Let’s kick this off by saying that I like shares, ALOT. If you choose the rights ones they are like little geese that continuously lay golden eggs. Brilliant! Contrary to the popular belief that they are little squiggly lines on a stock exchange website, shares are actually little pieces of companies; many of them run by responsible CEO’s and MD’s that will work tirelessly (or more so work their employees tirelessly) in order to provide returns to their shareholders. Therein lies the magic my friends, when you own shares, you effectively become one of the many bosses of the board of the company that you own the shares in. This is the reason why in the long run shares are said to outperform all other asset classes. Because companies will generally strive to provide returns to their shareholders in order to compensate them for the risk that they have taken to become owners of the company.
Choosing your own shares – advantages and disadvantages
Advantages
- Full customization – you can have what you want, when you want, for as long or as short as you want
- Relatively cheap buy in costs – online share trading costs around $20.00 per trade which is cheap and easy
- No ongoing management expenses
- Higher returns if done right or the investor gets lucky
Disadvantages
- Choosing the shares can be time consuming
- Often produce lower returns than managed funds
- Lack of diversification when compared with managed funds
- Susceptible to human behavioural biases
Why managed funds work for the FFE house
Let me start this section by saying that during my university years and first few years of work my portfolio was made up of a basket of individual shares that I selected myself. It was a really fun experience and it allowed me to learn a lot about companies, markets and investment decision making. It also revealed to me the behavioural factors that play a part in determining investors’ portfolio returns.
Currently we invest the vast majority of our funds with Dimensional Fund Advisors and Vanguard through the financial advice company that the wife works for. Here are some of the reasons why we invest this way.
Lack of Time
It is hugely time consuming to put together a share portfolio that can provide higher returns than an index fund over 5, 10 or 20 years. At the FFE house we prefer spend our time, and energy, figuring out things like which countries we want to visit next year or how we can spend more time with our friends. Constantly searching and working to maintain our investment portfolio is not really something we have the time to spend time doing.
Human behavioural biases
There is a huge body of research that shows individual investors are their own worst enemy when it comes to their own portfolio returns. Investors regularly do things like:
- Use the past returns to predict future returns for a stock or asset class – you may have heard statements like “Australian property never goes down” or “buy dot com stocks they’ve been running hard so you’ll surely make money”
- Attributing positive returns to investor skill and negative returns to uncontrollable market factors
- Selling the stocks that have gone up in order to “bank the return” whilst holding on to all the stocks that have gone down, triggering taxation as well whilst having a portfolio of stock that produce low returns
- Waiting for the market to “stabilize” before buying
“Average” return is actually pretty good
Over the long run the S&P 500 and ASX200 have returned around 9%, including dividends, which is actually a pretty good return. There are many other articles on this blog and online that show what effect this has over 10 or 20 years of consistent investing. Our modelling shows that we have a good chance at achieving financial independence in 10 years by investing in this manner so why take on additional risk if we know that we can achieve our goals in a satisfactory time frame on the market return?
Further to this there is much research to show that low cost index funds beat the majority of actively managed funds after fees so my money is with the majority. The question I would pose is that if most professional fund managers, people with teams of researchers and all manner of the latest research tools and materials are unable to beat the market what chance do mum and dad investors have with google and some homemade spreadsheets? The odds are stacked against.
So how is your money invested? Managed funds, individual shares, property or combination?
Engineer your freedom