Archives for February 2007

Apparently the S&P 500 dropped 3.5% yesterday. Not bad for one day!

Let’s see what I haven’t done yet:

1. I haven’t logged into Vanguard.com, where all my IRAs are.
2. I haven’t logged into Fidelity.com, where my 401(k) is.
3. I haven’t logged into Scottrade, where… oh wait, I don’t have any individual stocks right now.

Why don’t I care? Because not only do I not have any control over the numbers, but there is also nothing I am going to do in response to what I see. I won’t be relieved, nor will I get depressed.

Remember, for every trade there is a buyer and a seller. The buyer thinks he’s getting a good deal. The seller think she’s getting a good deal. Both can’t be right. So now you must ask, how much do you want to bet that you are smarter then the next person? Many of us are competitive people, and it’s hard to admit that you’re average. This pervasive human tendency to overestimate one?s achievements and capabilities in relation to others is sometimes referred to as the Lake Wobegon effect (where all the children are above average).

For example, do you think you are an above-average driver? During one such survey, 80% of respondents rated themselves in the top 30% of all drivers. Hmm…

On top of that, you are going against the headwind of trade commissions, the bid-ask spread, and taxes on generated capital gains.

By essentially investing in every publicly-traded company out there (although not on a perfect market-cap weighted basis), I am able to take a different, non-competitive view of things. The way I see it, every single day millions of people are waking up and going to work in order to create value. They are thinking up new ideas, making better widgets and services, and selling those widgets and services to new people. And then they go to sleep, and people on the other side of the world wake up and do the same thing. It doesn’t matter if they are working for Ford or GM, Intel or AMD, Sirius or XM Radio. As a whole, value will be created using my money, and I sleep well at night.

I just finished watching my first episode of Deal or No Deal, a new game show on NBC. I personally thought it was amazingly dull, but it did remind me of a good parallel to investing that I read in the book The Coffeehouse Investor (Yes, I know. Who’s the dull one?). If you’ve never seen it, that’s okay, this is a simplified version which I will explain. (You can also play an online version if you’d like.)

Let’s say you have ten open suitcases, each with a different amount of money in them:

Obviously, if you had a choice you’d pick the one with $10,000 in it. But the Banker then closes the suitcases and mixes them all up. Next, he reveals the $8,000 suitcase. You can still choose any of the suitcases to take home. Which one would you pick?

Added: It’s interactive now! Click on a suitcase if you want to gamble.

This is similar to the situation that you are faced with when picking an active vs. passive mutual fund. Over extended periods, approximately 75-85% of actively managed mutual funds fail to match the total market average. Yes, you could pick the $9,000 or $10,000 suitcase, but do you want to take that risk? We should all the take $8,000 happily.

Knowing the $8,000 suitcase is readily available is another analogy to knowing about index funds. Otherwise, you might be walking around with the $6,000 or $7,000 suitcase thinking you got lucky… Remember, even picking the active mutual funds with the best 10-year historical returns doesn’t work! For example, the top 35 mutual funds from 1978 to 1987 cumulatively under-performed the stock market average by 7 percent annually the next ten years (data also taken from The Coffeehouse Investor.)