Often, I get asked a question along the lines of
“What stock should I buy?”
In my opinion, that is the wrong question to ask. I think a more relevant question would be “What type of investor are you?”
When you are trying to figure this out, you will come across three categories of investors.
- Automatic/No-Activity Investor: You are in this category if you don’t enjoy investing. You just see investing as something that you have to do. You do not like/ or do not want to understand how the stock market works. You just want to make sure that you are earning more than the inflation. You have no interest in keeping up the stock market.
- Passive/Low-Activity Investor: You are in this category if you want to earn market returns, you want to follow the stock market and like to own steady holdings that do fluctuate wildly and you are investing for the purpose of capital preservation. You are generally a buy and hold investor and not worried about short-term movements of the market.
- Active Investor: You are in this category if you enjoy following the stock market, like to read about exciting innovations in different industries. You are able to spend several hours each month doing research on your investments. You like to buy individual stocks and continually verify your thesis for holding those individual stocks every year. You want to own select companies and want to earn more than market returns. You are able to withstand volatility and are not afraid of losing money to earn those extra returns.
Here’s what I would recommend for each of these three categories.
|Type of Investor||Expected Returns||Volatility||Suggested Investment Vehicle|
|Automatic/No-Activity||8-10%||Low||Target Dated Funds|
|Passive/Low-Activity||10-12%||Medium||S&P 500 Index Fund (FXAIX) or a Total Stock Market Fund (VTSAX) or both|
|Active Investor||> 12%*||High||Combination of index funds and individual stocks|
This table gives you an idea of what to expect from each category and how you can achieve these returns. For the Automatic and Passive investor categories, these returns are the average returns of the past 100 years, so if you stick with these investments for a minimum of three years, you are reasonably likely to see these returns or even higher. You really don’t need a financial advisor to achieve these returns. You can achieve these returns on your own. I share the process of buying index funds in this article. A financial advisor will charge you anywhere between 0.75% to 1.5% to get the same returns. You might think that it is a small price to pay but over a period of 30 years, but even a 1% return could cost you hundreds of thousands of dollars. If you don’t believe me, watch the first half of this video.
For the active investor returns, I put an asterisk on greater than 12% number, because this really depends on your temperament and if you are willing to do the work. If you do consider yourself an active investor, your goal should be to exceed the returns provided by index funds because if you are not exceeding that threshold, you are better off just investing in index funds. To do this, you must score yourself and keep good records of your brokerage statements so that you can find out your annual returns. Don’t score yourself over just one year. Try to find if you can beat this number consistently. If you do decide to invest in individual stocks, maintain an investment journal and be ready to spend the time learning about your holdings. It is not a good idea to invest in a stock because you received a hot tip about a stock or if a stock is below $10. Be ready to do research yourself by reading the annual report of the company on their investor relations page. I have been investing in index funds for 14 years and in individual stocks for 9 years. Here’s how I have done
|Year||Index Fund Return||Individual Stock Returns|
I left the column for individual stock returns blank for the first few years because I did not keep those records and switched brokerages and never had the mentality to track myself. As you can see, the index funds portion part of the portfolio has kept steady growth. During these nine years there were several times, when my performance was negative during the year (March 2020, for example), but if you dollar-cost average each paycheck into these index funds, you can still end up with positive returns. I left the 2020 blank for individual stock returns because 2020 was an exceptional year and I don’t like to brag and I am not sure if we will ever see anything like it. I will just say that it was the highest per year return that I have ever experienced.
I would like to mention here that if you are using a financial advisor/planner for a few years, track your returns as compared to the index fund returns. If your advisor is able to earn returns higher than index funds, then it is totally worth paying 1% or even 1.5% to your advisor for achieving those returns but if your advisor is just investing in the index funds on your behalf and charging you close to 1%, then you can do it yourself and save a lot of money in the process.
Another point I would like to make here is that an individual or a family can be different types of investors in different accounts. For example, our 401Ks, 529 plan and HSA account are maintained like a passive/low-activity investor (only index funds), whereas our taxable brokerage accounts and Roth IRAs are maintained like an active investor (individual stocks and ETFs). So you don’t have to pick one or the other.
If you are not sure what type of investor you are, this is something that I can help you with. I have helped a number of individuals get started investing, help them open different accounts for investing and making sure that they are optimizing their finances. I can walk through your benefits from your employer and make sure that you are signed up for the right benefits. This is how you can book an appointment with me.
If you have read so far, what type of investor are you? Do you agree with my definitions? If you are an active investor, do you score yourself consistently? Are you beating the market? Let me know by commenting below