One aspect of buy-and-hold investing in low-cost index funds that has always attracted me is that there is an extremely low time cost. Once you have the initial investments in place, there is virtually no time cost at all. All you have to do is invest maybe half an hour a year rebalancing the investments - and that’s it.
That strategy pretty much matches the stock market. In fact, if you choose to just invest in the Vanguard 500, it almost exactly matches the ups and downs of the S&P 500 stock index.
Let’s look at the other side of the coin. Let’s say you’re following normal stock picking advice. You have a portfolio of 20 individual stocks (so that no piece of your portfolio is more than 5% of your total investment - diversification, after all). You devote an hour a week to studying each stock in detail, so you know what’s going on with that company. You also devote five hours a week to finding new, worthwhile companies to invest in, potentially replacing the slots in your portfolio.
You’re able to invest $10,000 a year - and we’re not worried about brokerage fees at all. What’s your earnings per hour doing all that research?
Let’s say all that work manages to beat the Vanguard 500 by 1% per year. Historically, VFINX has returned 9.56% per year since its inception (remember, that number includes dividends and stock price increases and decreases, and it does include 2008), so we’ll use that number as an annual return baseline.
Over a ten year period, VFINX would turn your $10,000 a year into a sum total of $170,968.66. Meanwhile, that portfolio that beats the S&P 500 by 1% would turn $10,000 a year into a sum total of $181,005.77. Your extra effort of 25 hours a week for ten years has earned you $10,037.11 during that period - an hourly wage of $0.77. Ouch.
“Come on!” you say. “Stocks are a long term investment!” So let’s look at the thirty year mark. Over a thirty year period, VFINX would turn your $10,000 a year into a sum total of $1,061,590.42. Similarly, your 1% better investment portfolio, with 25 hours a week over ten years invested in it, will turn that annual $10,000 into $1,347,885.59. Your extra effort of 25 hours a week for thirty years has earned you $286,295.18 - an hourly wage of $7.34. Congratulations, your investing expertise has earned you minimum wage.
“Come on!” you say. “I can do better than 1% over the S&P 500 every year for thirty years!” (Of course, if you actually believe that, I have a bridge to sell you.) So let’s make it 2% - you beat the S&P 500 by 2% every year for thirty years. Your extra effort for 25 hours a week for thirty years earns you an hourly wage of $16.60.
If you have the intellectual ability to do enough rigorous analysis to beat the market by 2% year in and year out, you can most certainly be earning more than $16.60 an hour with your time.
But what if you can invest more than $10,000 a year? If you’re in that group, where you’re able to invest significantly more than $10,000 a year in whatever you want and you’re sure you can beat the market consistently over the long haul, by all means, choose the route that’s right for you. However, I argue the statement above still holds - with those kinds of resources and intellectual acumen, you likely have better ways to earn money.
Here’s the take-home message: individual stock investing, done with adequate research, is a lot of work. Unless you have a very large amount to invest, the extra work is simply not worth it in terms of the extra income per hour.
Now, that’s not to say that you shouldn’t dabble in individual stock investing. I see nothing wrong with taking a sliver of your investments and playing the market, so to speak. However, recognize that such investments are largely a gamble unless you do adequate research. And, if you do adequate research, you have to blow away the overall market to make it worth your time.
My conclusion is simple. If you’re an individual investor without a ton of money to invest, it’s simply not worth your time to chase individual stocks. The time that’s required to adequately study individual stocks and build a truly diverse portfolio will make the gains small enough per hour of your work that you might as well do something else with your time, like build your skill set for your career, improve your health, or start your own side business.
Instead, just invest in a very broad index fund and ride the market at a low price with little time investment of your own. Better yet, do it with a balanced portfolio - don’t put it all into stocks, so that you can ride through the down markets with less worry and smaller losses.
The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com