Any reason to hold large group of stocks instead of index fund?

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rshocka
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Any reason to hold large group of stocks instead of index fund?

Post by rshocka »

Was meeting with some extended family fee only wealth advisors recently, and they were talking through their firm's strategy. Not the bond / fixed income side, but for their stock asset allocation, it's essentially a selection of about 40 stocks that they use (revolving around eliminating some risks by running it through a series of filters (top 1000 largest companies, A+ rating on average for financial strength, stronger cash flow. Obviously, all of those stocks are household names, but their thinking was it allows them to control the taxes more effectively while getting very similar returns as the S&P500.

Would there be any validity to structuring an account like that?

I recognize that you'd have to factor in total expenses as well given they are closer to ~70 basis points with no fees on the stockholdings/tradings vs. the low costs of index funds. I'd rather focus less on the expenses / costs associated with the decision and more hear from the Boglehead community on if they even would agree with logic around this.

Thanks!
Retired Bill
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Re: Any reason to hold large group of stocks instead of index fund?

Post by Retired Bill »

None I can think of for your benefit.

That 1/2% or more in fees, could well be giving up $1million over your investing life.

Unlikely the advisor can overcome that, and 40 stocks amps up the risk vs a total market index ETF.

With 40 stocks, the advisor will eventually sell completely a position and have reportable gains. Broad based indexed ETF's have ways of seeing those gains do not show up on your 1099 besides tax loss harvesting a 40 stock portfolio can do.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by MrJedi »

There is a strategy called direct indexing which can suitable for very large portfolios for tax management.

What you are describing with 40 different stocks just sounds like an active fund manager. I doubt that is enough to closely track the SP500. You might win, you might lose. You do pay extra fees either way.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by Metsfan91 »

rshocka wrote: Thu Sep 23, 2021 9:21 pm Any reason to hold large group of stocks instead of index fund?
Nope. No reason to hold large group of stocks instead of index fund. Keep it simple; buy the index fund.

Seems to me, the fee only adviser was trying to steer you toward his/her company.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by roth evangelist »

Investing in VTI or VTSAX will be much cheaper and very likely to outperform this group of stocks.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by 000 »

Passively managed individual stocks may make sense or even be effectively necessary for some tax situations, but what you are describing is semi-active management towards some kind of quality factor. This may be a reasonable thing to do for the more risk averse (especially if it's an emotional issue about the small and volatile corners of the market) although the idiosyncratic risk of just having 40 stocks may cancel it out. The tax management case has some merit too but also comes with risk, namely that dividend low-payers may be relatively overvalued compared to dividend high-payers.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by exodusNH »

rshocka wrote: Thu Sep 23, 2021 9:21 pm Was meeting with some extended family fee only wealth advisors recently, and they were talking through their firm's strategy. Not the bond / fixed income side, but for their stock asset allocation, it's essentially a selection of about 40 stocks that they use (revolving around eliminating some risks by running it through a series of filters (top 1000 largest companies, A+ rating on average for financial strength, stronger cash flow. Obviously, all of those stocks are household names, but their thinking was it allows them to control the taxes more effectively while getting very similar returns as the S&P500.

Would there be any validity to structuring an account like that?

I recognize that you'd have to factor in total expenses as well given they are closer to ~70 basis points with no fees on the stockholdings/tradings vs. the low costs of index funds. I'd rather focus less on the expenses / costs associated with the decision and more hear from the Boglehead community on if they even would agree with logic around this.

Thanks!
With only 40 stocks, it's a way to trap you with them by giving you an unnecessarily complicated portfolio.

40 stocks isn't enough to simulate the whole market. You'd need around 100 carefully selected stocks.

Stick with low-cost index funds offered by Schwab, Fidelity (though above the zero expense ones in taxable), or Vanguard.

Tax loss harvesting isn't as great of a tool as people think. You wind up lowering your basis; capital gains taxes will wind up higher. Yes, you can offset up to $3K of income, so you'll save on the difference between your capital gains rate and ordinary income rate, but that's $450 of tax vs $660-750 for most people with the hassle of a more complicated portfolio.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by retired@50 »

The 70 basis points in fees would devour the potential tax advantage of the additional TLH.
I wouldn't go near this idea with a 10-foot pole.

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Re: Any reason to hold large group of stocks instead of index fund?

Post by cflannagan »

rshocka wrote: Thu Sep 23, 2021 9:21 pm
Would there be any validity to structuring an account like that?
Not that I can see.
rshocka wrote: Thu Sep 23, 2021 9:21 pm
I'd rather focus less on the expenses / costs associated with the decision and more hear from the Boglehead community on if they even would agree with logic around this.

Thanks!
Well, our (Boglehead) logic here is very much about the expenses/costs associated with going with 40-stock "actively" managed portfolio with higher expense ratio. As for tax efficiency, VTSAX, VTI, etc are already tax efficient, will give you similar returns as S&P500 for much lower expense ratio.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by nisiprius »

No.

And, an aside, there are no advantages in letting an advisory firm pick stocks versus choosing a actively-managed mutual fund or ETF that follows a similar selection strategy. The mutual fund or ETF has a highly visible track record, transparency, professional managers who are likely to be at least as good as the people running the advisory firm, and the investor protections of the Investment Company Act of 1940. If you want a collection of fifty or a hundred personally-chosen stocks, there is no compelling advantage, and several obvious disadvantages, to having it be done by an advisory firm instead of just buying a suitable mutual fund or ETF. Of course, you do not want to pay an advisory firm 1% in order to have them buy a mutual fund with a 1% expense ratio for you.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by livesoft »

If you want to blame someone for underperforming the market after fees, then that is a good reason to hire someone like this to hold a group of individual stocks for you. As noted elsewhere, some people really need someone else to blame and fear making their own decisions or even having a robo advisor make decisions for them. Blaming a robo advisor or blaming oneself are just not good for the psyche.

However, if you really need someone to blame, then I certainly give you permission to blame me.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by sureshoe »

rshocka wrote: Thu Sep 23, 2021 9:21 pm Was meeting with some extended family fee only wealth advisors recently, and they were talking through their firm's strategy.
Most wealthy advisors are successful because they are good at sales, not stock picking.
rshocka wrote: Thu Sep 23, 2021 9:21 pm Not the bond / fixed income side, but for their stock asset allocation, it's essentially a selection of about 40 stocks that they use (revolving around eliminating some risks by running it through a series of filters (top 1000 largest companies, A+ rating on average for financial strength, stronger cash flow. Obviously, all of those stocks are household names, but their thinking was it allows them to control the taxes more effectively while getting very similar returns as the S&P500.
If there was such a "filter" that would allow you to pick "the best", lots of other people would have it and drive the prices up of those "best" stocks. In fact, their approach sounds stale. More advance companies are running complex AI algorithms trying to outsmart the market. I don't know if any of them are successful, and if I did know of them - they would get copied and have their advantage negated. Let me assure you - there is no shortage of salespeople/advisors out there who claim to have a proprietary computer "system" for picking stocks.

This is just "technical analysis", and it doesn't work. But like I said > good advisors are salespeople, not stock pickers.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by sureshoe »

MrJedi wrote: Thu Sep 23, 2021 9:46 pm There is a strategy called direct indexing which can suitable for very large portfolios for tax management.

What you are describing with 40 different stocks just sounds like an active fund manager. I doubt that is enough to closely track the SP500. You might win, you might lose. You do pay extra fees either way.
If you owned 40 stocks that are in the top 100-200 of the S&P, I think you'd probably get very close. There is some analysis of how 7 stocks get you diversity... I can't recall the details. But owning the top 10 gets you something like 30% of the market, right?

But either way, I agree, it just seems a complicated way to mirror the S&P unless you're going to be actively tax loss harvesting individual stock constantly. Even then, I wonder if that pays for anything.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by senex »

I agree with most of the above, esp Nisiprius’s comment on the ICA.

Individual stocks does have some potential real advantages: tax loss harvesting in the first few years, and if you donate to charity, donating the big winners (in-kind) is more tax efficient than donating an equiv amount from an etf.

I personally would not pay 0.7% for those advantages. I once bought a similar number of individual stocks myself (didn’t pay anyone). Returns were similar to the market, and I got the larger charitable donation benefit. Not sure if it was worth the trouble. The beauty of 3 fund is its supreme simplicity.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by alex_686 »

MrJedi wrote: Thu Sep 23, 2021 9:46 pm There is a strategy called direct indexing which can suitable for very large portfolios for tax management.

What you are describing with 40 different stocks just sounds like an active fund manager. I doubt that is enough to closely track the SP500. You might win, you might lose. You do pay extra fees either way.
I was involved with this 30 years ago. The lower bound back then was 30 stocks. But that was a different tine. Taxes were higher. Our clients had issues with low costs basis concentrated positions. etc.

To the OP, parts of the tax alpha strategy you are laying out is valid. Complex and expensive, but valid. The stock screeners are active management. I am a modest proponent of active management but not this kind. Its not going to add much value. Maybe some if there is a tilt towards the quality and low volatility factor. This is not worth 70 bps.

I am a modest proponent of advisors. Not everyone is a DIY type of person. Some people need or like personal advice from a real person. Quality advice like this is expensive.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by dbr »

It is surely valid to feel good paying someone to do something special for you and for you only to beat index investing. It is good to be a winner. The people involved are indeed knowledgeable.

The result might be that you will end up wealthier than you would have otherwise, or it might be you will not accomplish that. At least you will have contributed to someone's livelihood.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by afan »

To be clear- tax loss harvesting itself is a valid thing to do. Whether it is worth paying someone to do for you is another matter. The benefits are small and decline with time. If you pay for it, the fee must be very low to justify the service. I would not pay as much as 0.1% for this. 0.7% is vastly too much and will wipe out any profit from doing it.
As others have noted, holding 40 stocks and actively managing them is simply foolish. There are abundant studies showing that this is a losing proposition. Ignore whatever they may tell you about their past results. Even if they are giving you the full returns to every portfolio they managed, as independently audited, calculated and and publicly reported, this is a tiny sample of the universe of active management. Performance of active managers does not persist. Picking someone who has done well in the past does not provide any reason to expect them to do well in the future.

If you want to have someone tax loss harvest a portfolio that otherwise comprises the entire S&P 500, there are companies that will do this for much less than 0.7%. Again, I would not hire them to do it at all. But if you really want TLH, go with a 500 stock portfolio, passively managed and at the lowest cost you can find.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by arcticpineapplecorp. »

rshocka wrote: Thu Sep 23, 2021 9:21 pm but their thinking was it allows them to control the taxes more effectively while getting very similar returns as the S&P500.
very similar is not "the same as".

therefore, it sounds like it's going to underperform the S&P500.

I mean, if it was similar but in the opposite direction, they'd be touting it will outperform the S&P500.

Since they're at least not claiming that but stating "similar" returns that either means same or less.

Is it same?

If it was, shouldn't they have said same instead of similar?

If it's not same and it's not going to outperform, it's less than.

now ask yourself why you'd want to invest in something that is similar (but probably less than) the S&P500 when you can just invest in the S&P500 and get that return?

The issue of tax efficiency I think is a red herring. Why?

The S&P500 or total stock market index fund is already highly tax efficient.

Both (S&P500 and total stock) also allow for tax loss harvesting too.

I think they're making the claim they can tax loss harvest more because of the individual positions where some might incur losses even though the overall portfolio or S&P500 does not have losses due to other holdings with gains.

possibly. but it's still dancing around the edges likely and you can't get rid of the higher fees because that's how they get paid.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by illumination »

The "reason" in part is to make a financial advisor look like what they are doing is extremely complicated and no way could an "Average Joe" juggle all of these securities and keep up with all the companies.

It also makes it harder for a retail investor to just pick things up and move. It appears daunting to have a complicated portfolio like this "on your own".

If advisors say just had a 3 fund portfolio, an average person would pick up pretty quickly they could do that also and not pay their guy a lot of money.

I'd love to see how this equity approach worked next to a benchmark like VTI.
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rshocka
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Re: Any reason to hold large group of stocks instead of index fund?

Post by rshocka »

Thanks everyone for the feedback. I'm aware that paying a financial advisor a % of AUM is not a popular item around here, and it's unlikely I would end up in that camp as well (in fact trying to get out of current situation because of that now); however, I was interested in hearing everyone's philosophical and analytical feedback regarding their proposed strategy. This is a great community and always come away learning something from reading those replies!
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Re: Any reason to hold large group of stocks instead of index fund?

Post by 1789 »

Building up a portfolio of 40-50 stocks is pure nonsense. A successful stock picker don't need more than 2-3 stocks.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by Northern Flicker »

A portfolio of 40 stocks is not sufficiently diversified to eliminate all unsystematic risk.This is uncompensated risk. My own view is that this rises to the level of a reason to fire the advisor.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by nisiprius »

Northern Flicker wrote: Sat Sep 25, 2021 2:28 am A portfolio of 40 stocks is not sufficiently diversified to eliminate all unsystematic risk.This is uncompensated risk. My own view is that this rises to the level of a reason to fire the advisor.
"How many stocks is sufficiently diversified" is an interesting question. I don't feel that I need to decide it, because I am happy with a total market strategy and I can buy 3,980 stocks in VTSAX at an expense of 0.03%/year.

I tend to believe William J. Bernstein's answer--I don't know if he's refined his thinking since this essay from twenty years ago, The 15-Stock Diversification Myth
One of the most dangerous investment chestnuts is the idea that you can successfully diversify your portfolio with a relatively small number of stocks, the magic number usually being about 15.

...if you think that you can do an adequate job of minimizing portfolio risk with 15 or 30 stocks, then you are imperiling your financial future and the future of those who depend on you. The reason is simple: There are critically important dimensions of portfolio risk beyond standard deviation. The most important is so-called Terminal Wealth Dispersion (TWD). In other words, it is quite possible (in fact, as we shall soon see, quite easy) to put together a 15-stock or 30-stock portfolio with a very low SD, but whose lousy returns will put you in the poorhouse....

The reason is simple: [in his study] a grossly disproportionate fraction of the total return came from a very few "superstocks" like Dell Computer, which increased in value over 550 times. If you didn’t have one of the half-dozen or so of these in your portfolio, then you badly lagged the market. (The odds of owing one of the 10 superstocks are approximately one in six.) Of course, by owning only 15 stocks you also increase your chances of becoming fabulously rich. But unfortunately, in investing, it is all too often true that the same things that maximize your chances of getting rich also maximize your chances of getting poor.

...So, yes... you can eliminate nonsytematic portfolio risk, as defined by Modern Portfolio Theory, with a relatively few stocks. It’s just that nonsystematic risk is only a small part of the puzzle. Fifteen stocks is not enough. Thirty is not enough. Even 200 is not enough. The only way to truly minimize the risks of stock ownership is by owning the whole market.
This seems confirmed by a more recent study: Do Stocks Outperform Treasury Bills?
our out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages.
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Re: Any reason to hold large group of stocks instead of index fund?

Post by Parkinglotracer »

rshocka wrote: Thu Sep 23, 2021 9:21 pm Was meeting with some extended family fee only wealth advisors recently, and they were talking through their firm's strategy. Not the bond / fixed income side, but for their stock asset allocation, it's essentially a selection of about 40 stocks that they use (revolving around eliminating some risks by running it through a series of filters (top 1000 largest companies, A+ rating on average for financial strength, stronger cash flow. Obviously, all of those stocks are household names, but their thinking was it allows them to control the taxes more effectively while getting very similar returns as the S&P500.

Would there be any validity to structuring an account like that?

I recognize that you'd have to factor in total expenses as well given they are closer to ~70 basis points with no fees on the stockholdings/tradings vs. the low costs of index funds. I'd rather focus less on the expenses / costs associated with the decision and more hear from the Boglehead community on if they even would agree with logic around this.

Thanks!
I think the main reason this is done is to justify the advisor’s fees.
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