This Will Make You Not Want To Stock Pick (Historical DJIA Components)

[TripleB]

I have been thinking of handpicking about 30 stocks to hold individually as a large part of my PP rather than an index for reasons I've previously posted about (preferring directly holding the security rather than through an intermediary of a mutual fund manager and avoid stocks I absolutely do not want to own like Facebook are the two big reasons).

I decided to do some research on the DJIA which represents the 30 biggest stocks in the US economy. My idea behind my 30-portfolio holding would not be to replicate the DJIA but to create my own "index" of sorts that provides good diversification across sectors using stocks I want to own.

I looked into the historical DJIA components because I wanted to see how often they change and how they change. From looking at them, clearly my idea of just picking 30 strong companies and forgetting about them will not work, otherwise I'll be holding things like Woolworths, Sears, and Loews Cinema.

Back in the 1940's Loews was a huge thing, presumably due to the new movie format, and was actually on the DJIA. It was probably like the Apple of it's day. Personally, I can't imagine Apple will still be on the DJIA in 10 or 15 years.

If you look at names like DuPoint, they've been on the DJIA for almost 100 years. Presumably because they are a materials dealer and don't deal in things to the direct public to the extend that Apple does, and could maintain their leadership position longer.

Check it out - it's an interesting review:

http://en.wikipedia.org/wiki/Historical ... al_Average

[hpowders]

Over the years, I just followed what Ben Stein said to do. He picks index funds because he says he is a terrible stock picker. He's an economist and admits he can't pick individual issues with repeatable success. That's good enough advice for me.

[AgAuMoney]

Over the years, I just followed what Ben Stein said to do. He picks index funds because he says he is a terrible stock picker. He's an economist and admits he can't pick individual issues with repeatable success. That's good enough advice for me.

Ben sounds like another one that would just as soon not see behind the curtain.  From people that like plastic covers under the hood to cover their engine, to those who really do not want to know what is in their breakfast sausage, the world seems to be evolving faster and faster into people who know more and more about less and less.

A human being should be able to change a diaper, plan an invasion, butcher a hog, conn a ship, design a building, write a sonnet, balance accounts, build a wall, set a bone, comfort the dying, take orders, give orders, cooperate, act alone, solve equations, analyze a new problem, pitch manure, program a computer, cook a tasty meal, fight efficiently, die gallantly. Specialization is for insects.

(I'm still working on the change a diaper thing, much to the chagrin of my wife.  And some of the others I haven't had much chance to practice, but it seems a worthy list and an admirable approach to life.)

So let's peek behind the curtain...

The DJIA (and other Dow indices) and the S&P 500 are really just handpicked stocks selected very subjectively from the universe they have traditionally drawn from.

Even VTI as a "whole stock market" has a selection process (IIRC its quite mechanical/objective) to limit the stocks actually held which supposedly represent "the whole market."

And after looking at a few dozen non-US "index" funds available on the U.S. exchanges, I found they were all handpicked with at least the subjectivity of the S&P 500.  Perhaps there is something like a VTI for some other country(s) where the selection is mechanical, but 8-10 years ago I didn't find it.

In the final assessment there is not a single index that meets the standard Ben apparently set for himself so obviously they cannot pick stocks either, which is why they make changes.  (Which changes cause the fund(s) tracking the index some amount of grief and friction loss as they sell off the losers and buy the winners.  The actual index doesn't have that loss, because they calculate the swap at par.)

Now beginning my 3rd decade as a stock investor I still use some specialized index funds, but the vast majority of my stock allocation is in individual stocks.  And I make changes when I need to.  For me selecting individual stocks allows me to matche my objective better than any index fund or funds, and as a bonus the last 10 years or so my portfolio has also out performed the index.

[hpowders]

Over 10 years you may beat an index, but I wouldn't confuse luck with skill.

Let's agree to meet here after 20 more years and compare results. I'll choose the unmanaged, S&P 500 SPY ETF, completely untraded. You trade to your heart's content with your individual stocks.

[AgAuMoney]

Over 10 years you may beat an index, but your odds diminish over the next 10 and the 10 years after that. Luck is not skill.

Right.  So?  Where I wrote "and as a bonus" it has meaning.  I didn't put it there by a mistaken copy and paste.

[hpowders]

See you in 20 years. We'll meet right under the advertisement over this post.

[TripleB]

See you in 20 years. We'll meet right under the advertisement over this post.

This place won't be here in 20 years. Within the next year or two, every possible question about the PP will have been asked and answered 10x over, so we can just shut the forum down and turn it into an archive

[AgAuMoney]

See you in 20 years. We'll meet right under the advertisement over this post.

What part of "individual stocks match my objectives better than the index" can you not read?  (Yes, I know originally I made a typo writing "matche".  Sorry to confuse you so.)

To be explicit about it:

Beating the index is not and has never been my objective.  Beating the index (trouncing it, really) the past 10 years was a nice bonus.

I'm using webster's definition of "bonus":  something in addition to what is expected

So if you want to meet, let's not wait 20 years.  I'll buy you a burger.  I'd even take you someplace other than McDonalds, even though I'm long McD's and it has exceeded my expectations in every regard.

[MediumTex]

See you in 20 years. We'll meet right under the advertisement over this post.

This place won't be here in 20 years. Within the next year or two, every possible question about the PP will have been asked and answered 10x over, so we can just shut the forum down and turn it into an archive

I would have thought that two and a half years ago when this thing started.

As long as there are humans involved, the theoretical framework of the PP will continue to throw off questions.  The way it exposes so many Wall Street folkways as little more than treasured delusions can't help but generate discussion.  Fielding the same questions over and over and over at the Bogleheads site has taught me this.

The average investor who thinks of himself as sophisticated is bothered by the PP.  It's like a cat struggling with a hairball--you can't decide whether you want to swallow it, spit it out, or just make dissonant sounds while trying to figure out what to do next.

[melveyr]

My simple reason for indexing is that net alpha equals zero. Yes, there are some inefficiencies in the market that at times allow some to generate alpha, but that is that expense of another trader, a trader who experienced negative alpha.

This makes it a zero sum game, which immediately makes it less attractive to me. Next, participating in this zero sum game costs money and time. Why should I spend my money and time to play a zero sum game? There are so many better uses of money and time.

[MediumTex]

See you in 20 years. We'll meet right under the advertisement over this post.

What part of "individual stocks match my objectives better than the index" can you not read?  (Yes, I know originally I made a typo writing "matche".  Sorry to confuse you so.)

To be explicit about it:

Beating the index is not and has never been my objective.  Beating the index (trouncing it, really) the past 10 years was a nice bonus.

I'm using webster's definition of "bonus":  something in addition to what is expected

So if you want to meet, let's not wait 20 years.  I'll buy you a burger.  I'd even take you someplace other than McDonalds, even though I'm long McD's and it has exceeded my expectations in every regard.

I appreciate that there may be people like AgAuMoney who are able to achieve better returns than an average investor due to a combination of skill, experience and a bunch of other subtle factors.

From my perspective, though, even if a skill set like this exists (and I'm willing to say that it may for purposes of this discussion), I still don't know how it helps another investor who doesn't have that skill set and who is looking for a safe and simple way to invest.

In other words, it's like a person watching an illusionist and realizing that it doesn't matter whether it's real magic or just illusion, the skills of the magician are not easily duplicated by the average magic show attendee in any case.

[hpowders]

See you in 20 years. We'll meet right under the advertisement over this post.

This place won't be here in 20 years. Within the next year or two, every possible question about the PP will have been asked and answered 10x over, so we can just shut the forum down and turn it into an archive

I would have thought that two and a half years ago when this thing started.

As long as there are humans involved, the theoretical framework of the PP will continue to throw off questions.  The way it exposes so many Wall Street folkways as little more than treasured delusions can't help but generate discussion.  Fielding the same questions over and over and over at the Bogleheads site has taught me this.

The average investor who thinks of himself as sophisticated is bothered by the PP.  It's like a cat struggling with a hairball--you can't decide whether you want to swallow it, spit it out, or just make dissonant sounds while trying to figure out what to do next.

No matter how many books are written with sophisticated studies proving that trading and market timing will not beat a simple, passive buy and hold of a benchmark stock market index over time, folks never seem to give up the urge to try-a combination of ego and boredom, I guess. Many of them are aware of these studies. The Mt. Everest complex?

[AgAuMoney]

Beating the index is not and has never been my objective.  Beating the index (trouncing it, really) the past 10 years was a nice bonus.

I'm using webster's definition of "bonus":  something in addition to what is expected

I appreciate that there may be people like AgAuMoney who are able to achieve better returns than an average investor due to a combination of skill, experience and a bunch of other subtle factors.

Again, better returns is not my objective...


The biggest problem most investors have is psychological.

I suspect this is because they do not have a well defined and realistic goal that they have internalized along with how they will reach that goal and how the progress will look towards meeting that goal.

"Accumulating [$X] pot of money by retirement" is not a well defined or realistic goal if you depend on market returns.

"Each year I expect to increase my portfolio at the historical average of [X%]" is not how progress toward your goal will look if you depend on market returns.

A plan to "Add [$X] to my investments every year" will not have measurable results in any reasonable timeframe for positive feedback on meeting your goal if you depend on market returns.


Any goal which depends on market returns either in amount or sequence will not have regular progress and will frighten you to death because market returns are totally uncontrollable by anyone (with the possible exception of the gov't) so cannot be counted on or planned for.  Depending on return amounts can be averaged out if you have a long enough future in front of you.  You might, or you might not have that future because in depending on market returns you also always depend on sequence of those returns.

Depending on sequence means a down year can be ignored if you are just starting to invest, or that same down year can destroy your entire plan if you are about to retire.  Yes, that means that losing 50% or more (like in 2008-2009) will hurt you more the nearer you are to retirement and will cause any sane person to question their goal and their plan to reach that goal.  Unlike conventional wisdom, research has proven that the longer you are in the market depending on market returns, the HIGHER your risk becomes.  (Because the longer you are in the market, the probability of a downturn increases, the amount of damage any particular downturn will cause to you increases, thus the risk to you increases.)


My goal is orthogonal to market returns and has no dependence or concern with them.  (I keep repeating that, and people don't seem to get it...)

In fact, down markets like 2008 are beneficial to meeting my goal and accelerate my progress.  A booming market (like 1998-2000) slows me down, but does not stop my progress.  This allows me to mute and even invert the typical investor response to the market.


My goal is to reach a certain amount of dividend income.  My progress is measured by increasing income every year.  My plan is to invest in companies which increase their dividends every year.

My goal, my plan and the progress are all either under my direct control or the direct control of the companies in which I invest (which I directly control).  No stock market or random walk has any direct involvement.


I expect to meet my goal before 20 years no matter what the stock market does.  If we get another 2007-2008 that works as well for me as the last time (doubtful) I could meet my goal in 5 years.  Another 2000-2002 and I could meet my goal in 10 years.  The only way I would not meet my goal within 20 years is if over 400 companies with globally diverse operations and income were to suddenly stop raising dividends even though they individually have been raising dividends for most of the past decade for the least of them, or over 50 years for some of them.


I set this goal over 10 years ago after reviewing what worked the previous 10+ years and what failed.  So far I have over 10 years now of executing my plan with the result of meeting or exceeding my expected progress every year (yes, every year increased dividend income even in 2007-2009).  (That's vastly different than the results after my first 10 years of investing.)

Getting better than market returns the past 10 years was a bonus.  Meaning it was not expected nor needed in order to meet my goal and the intervening progress toward that goal.

[MediumTex]

No matter how many books are written with sophisticated studies proving that trading and market timing will not beat a simple, passive buy and hold of a benchmark stock market index over time, folks never seem to give up the urge to try-a combination of ego and boredom, I guess. Many of them are aware of these studies. The Mt. Everest complex?

How about The Las Vegas Complex?

[AgAuMoney]

No matter how many books are written with sophisticated studies proving that trading and market timing will not beat a simple, passive buy and hold of a benchmark stock market index over time,

You keep setting up this STUPID false dichotomy.

I'm not doing any trading or market timing.

In fact I do less of that than the S&P 500 or the DJI.

[MediumTex]

Beating the index is not and has never been my objective.  Beating the index (trouncing it, really) the past 10 years was a nice bonus.

I'm using webster's definition of "bonus":  something in addition to what is expected

I appreciate that there may be people like AgAuMoney who are able to achieve better returns than an average investor due to a combination of skill, experience and a bunch of other subtle factors.

Again, better returns is not my objective...

The biggest problem most investors have is psychological.

I suspect this is because they do not have a well defined and realistic goal that they have internalized along with how they will reach that goal and how the progress will look towards meeting that goal.

...

My goal is orthogonal to market returns and has no dependence or concern with them.  (I keep repeating that, and people don't seem to get it...)

Okay, so you are not saying that you think you can consistently beat a market index when you consider overall returns (dividends + capital gains), which means that sometimes you will outperform a market index and sometimes you will underperform it. 

What I'm not understanding is how you are adding value through your stock picking efforts if you concede that you aren't gaining any advantage over a passive index for your efforts.

If you are saying that you are able to provide some additional returns through your stock picking when compared to a passive index, that gets back to the matter of how such an advantage could be durable over time, considering how people who do nothing but sit around picking stocks can't seem to get it right consistently.

The core of your argument seems to be that stocks are the best asset for the long term, and you like a certain type of dividend paying stock the best.  The problem is, though, sometimes stocks aren't the best asset for the period of a single investor's investment career (see Japan).  How do you deal with this risk that something unprecedented (but entirely conceivable) could happen to any stock portfolio?

***

The other issue that I keep thinking about as I read about your approach is how someone else might be able to replicate your success if the success is a result of your own idiosyncratic approach to stock picking?  I'm not saying that it doesn't work for you (and I understand that "work" doesn't mean that it will consistently beat an index), but of what value would your strategy be to someone else if no one else could replicate it?  If someone could replicate it, wouldn't any advantage you enjoy from your orthogonal approach compared to market indices be quickly arbitraged away?

In other words, if you believe you have created some advantage for yourself (even though this advantage is not necessarily measured through beating an index), why has the market not figured out the same thing you have?

Perhaps what you are really saying is just that you are comfortable taking more risk and can live with more volatility, and you understand that your increased exposure to risk could expose you to losses that a PP investor is unlikely to be faced with.

[MachineGhost]

http://en.wikipedia.org/wiki/Historical ... al_Average

Dow Jones isn't a cap-weighted index, i.e. it is not momentum.  By definition, a momentum index is going to be very hard to beat.  That is the only reason why passive indexing "works", because it is momentum investing without the effort.  Otherwise, investing would be a massive failure as I posted in the other thread about how 75% of stocks lose money.  Nowadays the market exhibits 6-month momentum, so if you invest in any stock that has lower momentum for the past 6-months, you are already underperforming.

[MediumTex]

No matter how many books are written with sophisticated studies proving that trading and market timing will not beat a simple, passive buy and hold of a benchmark stock market index over time,

You keep setting up this STUPID false dichotomy.

I'm not doing any trading or market timing.

In fact I do less of that than the S&P 500 or the DJI.

I'm trying to follow what you are getting at, but it seems if you are picking stocks based upon your own personalized stock metrics, isn't that active portfolio management (even if your portfolio has low turnover)?  Hasn't such active management been shown not to provide any advantage over indexing?  

I think hpowders is touching on a legitimate point.  You can say that you don't care what an index does, but I don't believe that.  If a passive index outperformed your strategy significantly every single year with lower volatility I have to think that at some point it would cause you to reassess your strategy, right?

[hpowders]

No matter how many books are written with sophisticated studies proving that trading and market timing will not beat a simple, passive buy and hold of a benchmark stock market index over time,

You keep setting up this STUPID false dichotomy.

I'm not doing any trading or market timing.

In fact I do less of that than the S&P 500 or the DJI.

I'm trying to follow what you are getting at, but it seems if you are picking stocks based upon your own personalized stock metrics, isn't that active portfolio management (even if your portfolio has low turnover)?  Hasn't such active management been shown not to provide any advantage over indexing?  

I think hpowders is touching on a legitimate point.  You can say that you don't care what an index does, but I don't believe that.  If a passive index outperformed your strategy significantly every single year with lower volatility I have to think that at some point it would cause you to reassess your strategy, right?

Holding a relatively small portfolio of stocks with low turnover is reckless, IMO. You are not privy to inside company information. Any of those stocks can go down 50% or more any time. It's a crap shoot. Holding a passive index fund consisting of 500 or 3000 stocks may be boring, but will hardly affect you if any one stock goes down 50% one day. It's simply prudent portfolio management.

I don't care who put the index together. It's the diversification I care about.

[D1984]

I'm trying to follow what you are getting at, but it seems if you are picking stocks based upon your own personalized stock metrics, isn't that active portfolio management (even if your portfolio has low turnover)?  Hasn't such active management been shown not to provide any advantage over indexing?  

I think hpowders is touching on a legitimate point.  You can say that you don't care what an index does, but I don't believe that.  If a passive index outperformed your strategy significantly every single year with lower volatility I have to think that at some point it would cause you to reassess your strategy, right?

I don't think with dividend growth investing that the point is whether your capital value outperforms the index. The point is that you are getting a (hopefully) ever increasing income stream. The actual sellable capital value of your assets (stocks) is basically a moot point. In its purest form, dividend growth investing would not even care if the stocks went to zero (unlikely as that is) if the income stayed the same or increased…in fact, stock prices falling are a boon to such an investor (at least as long as dividends stay the same, rise, or at least don’t fall as fast as prices do) because it means that dividends can be reinvested to buy more shares at cheaper prices.

A purely dividend growth focused investor simply looks at stocks as quasi-perpetual annuities that pay him/her an increasing income every year (reinvesting dividends compounds the income even quicker).  In essence, he/she has surrendered his money for an income stream so who cares what the current value of what his/her money bought is (what’s important is how much the income stream is)? The fact that said stocks do have a market value (which will fluctuate) is almost beside the point because income is what matters to such an investor; capital gains are nice icing on the cake but the income is what he/she is after.

With that said, I’m not sure exactly how one integrates such a strategy with the PP which is after all focused on capturing capital gains in various highly uncorrelated asset classes (including stocks) through rebalancing

[MediumTex]

I'm trying to follow what you are getting at, but it seems if you are picking stocks based upon your own personalized stock metrics, isn't that active portfolio management (even if your portfolio has low turnover)?  Hasn't such active management been shown not to provide any advantage over indexing?  

I think hpowders is touching on a legitimate point.  You can say that you don't care what an index does, but I don't believe that.  If a passive index outperformed your strategy significantly every single year with lower volatility I have to think that at some point it would cause you to reassess your strategy, right?

I don't think with dividend growth investing that the point is whether your capital value outperforms the index. The point is that you are getting a (hopefully) ever increasing income stream. The actual sellable capital value of your assets (stocks) is basically a moot point. In its purest form, dividend growth investing would not even care if the stocks went to zero (unlikely as that is) if the income stayed the same or increased…in fact, stock prices falling are a boon to such an investor (at least as long as dividends stay the same, rise, or at least don’t fall as fast as prices do) because it means that dividends can be reinvested to buy more shares at cheaper prices.

But dividends don't occur in a vacuum.  Ask investors in GE, the whole financial sector, the auto companies, etc. 

Lots of historically strong dividend paying companies can fall on hard times and the dividend will be cut during these hard times as well.

You're still in a position of having to guess which companies will continue paying nice dividends going forward, and needing a methodology to get out of those companies before their fortunes go into terminal decline.

I'm sure that in their days, GM, Polaroid, Montgomery Ward and Xerox paid nice dividends...until they didn't.

If someone says "Oh, I will just get out if that happens" in the same breath that they are saying "If the market tanks I will just buy more of the companies I like", that sounds to me like a recipe for trouble.

[D1984]

But dividends don't occur in a vacuum.  Ask investors in GE, the whole financial sector, the auto companies, etc.  

Lots of historically strong dividend paying companies can fall on hard times and the dividend will be cut during these hard times as well.

You're still in a position of having to guess which companies will continue paying nice dividends going forward, and needing a methodology to get out of those companies before their fortunes go into terminal decline.

I'm sure that in their days, GM, Polaroid, Montgomery Ward and Xerox paid nice dividends...until they didn't.

If someone says "Oh, I will just get out if that happens" in the same breath that they are saying "If the market tanks I will just buy more of the companies I like", that sounds to me like a recipe for trouble.

i don't know what method AgAuMoney is using and I don't presume to speak for him but the typical method to get rid of stocks like GM, Polaroid, Montgomery Ward, etc is to kick a stock out of your portfolio and replace it with another when said stock either:

A. Cuts its dividend,

or,

B. Fails to raise its dividend after four quarters when it normally should have.

That would have got you out of GM, Montgomery Ward, Polaroid and such years before they went under and would even have got you out of most of the financials in the fall of 2008 before most of the carnage really started.

Plus, being diversified helps; a dividend growth investor should own stocks from every sector and not just financials, utilities, consumer staples, industrials, etc. That way if one stock or sector does poorly the others will still provide some protection.

[D1984]

Montgomery Ward

Actually, come to think of it, wasn't Montgomery Ward acquired by Mobil in 1976? That would have either left you with cash to buy a different stock, or (if it was an al-stock deal) you'd now own XOM shares, which with reinvested dividends from 1976 to the present would mean you'd be doing OK.

[Pointedstick]

It seems like with dividend growth investing, you're basically treating stocks almost like adjustable rate, callable bonds. I'm no expert, but if income is the goal, wouldn't real bonds be a lot safer, and might they even provide a better return if you're willing to endure the risks inherent to investing your money with a private sector corporation? There are Verizon bonds that are returning 7% right now!

[ngcpa]

It seems like with dividend growth investing, you're basically treating stocks almost like adjustable rate, callable bonds. I'm no expert, but if income is the goal, wouldn't real bonds be a lot safer, and might they even provide a better return if you're willing to endure the risks inherent to investing your money with a private sector corporation? There are Verizon bonds that are returning 7% right now!

There is absolutely no growth in bond income.  How is this going to be an improvement over AgAuMoney's strategy.  I can understand AgAuMoney's frustration.  When I discussed using a 3x3 PP (no cash component) and using individual stocks instead of an index, I also met a lot of resisitance.  Resistance is one thing, but a lot of you are not very open minded about anything but a 4x4 PP.  It is obvious to me that a lot of you have not taken the time to actually carefully read and think about what AgAuMoney is suggesting.  If I were a lot younger (I am 67), I would strongly consider doing the same thing.  It makes a lot of sense.
Norm