Stocks, Mutual Funds, and Exchange Traded Funds (ETFs)
I own almost no stocks. I don’t have the patience to do the ‘due diligence’ to really truly understand how an individual company fits in the greater scheme of things *and* make it fit within the diversification plan I use.
Once in a while I see a stock that begs to be bought. One of those was Dreamworks Animation (DWA). I was reading the business page of my local newspaper and they were going on and on about what a disappointment the stock was since it had failed to hit estimated earnings. This was a year after the IPO, and the stock was trading for about half of the IPO value, at $23. On the basis of ‘sheer cussedness’ (or if everybody is talking it down, it might be undervalued), I gave it a hard look. Compared to Pixar (DWA’s main competitor), the fundamentals looked very good, and they seemed to have popular (even ‘blockbuster’) films. I bought 100 shares, and we’ll see how it pans out in time.
As I outlined in the section on IRAs and diversification, I’m primarily looking for the cheapest way to adequately cover the four corners of the style box, both domestically and internationally. Rebalancing these diverse investments as they ebb and flow differently is how I try to build wealth.
Mutual funds are a huge marketplace, and if you’re willing to shop around, there is truly something for everyone. For a few years, I felt like I had found funds that were no-load, and appropriately cost-efficient (low management fees, though the fees run a little higher as the need for research grows as with small-cap value funds or diversified emerging market funds). What began to gnaw at me were the transactional costs. Even ‘no-load’ mutual funds sometimes carry punitive costs to buy and sell, which makes rebalancing a drag.
I had heard dribs and drabs about Exchange Traded Funds (ETF’s) here and there during 2005; I think the final push came when my cousin Richard (whom I see once a year, tops) mentioned them at the family reunion picnic.
Setting off to properly research ETF’s, I happened upon the Radical Guide to Investing. This website really gelled my thinking on diversification, rebalancing, cost avoidance, and wealth building/management without benefit of a paid advisor.
One of my favorite quotes from Radical Guide comes from the chapter titled -
“Look at it this way. I guess that even if you're extremely wealthy you don't buy specially hand-tailored underpants. After all, the commodity underwear business produces superb products at low prices. So why buy specially tailored investment products in an equally efficient and commoditized market?”
Accordingly, I have embarked on a quest to make ETF’s the core of my IRA accounts. For the most part, they offer very efficient exposure to the four corners of the style box, at least for domestic funds. What they offer currently (early 2006) for international exposure is a little uneven (compared to the huge universe of mutual funds), but I’ve found I can cover the basic indices well.
The best part for me about ETF’s is the rebalancing question. As the Radical Guide put it in the chapter titled –
“. . . the correct question may not be ‘How often should I rebalance?’, but rather ‘How far should I allow my asset classes to stray from their target allocations before I rebalance?’.”
This was an epiphany to me, as I always struggled with mutual funds to avoid ‘180 day redemption rules’ and other friction that stopped me from trading them when I thought perhaps I should. My old ‘rules’ about rebalancing had me looking at doing it when I added funds to the IRA accounts (once a year), and maybe checking in one other time six months later. The simple construct of ‘how far out of bed is my asset allocation?’ has me trading at times that make the most sense to me for wealth building (buy low, sell high).
Of course, the opposite problem could set in: I could become so fixated on watching these allocations that I adopt the ‘soul of a day-trader’, constantly checking the market. That’s not where I want to be, so as I write this, I’m trying to figure out ‘how often’ is the right frequency to run the numbers on asset allocation. Probably monthly, unless I hear extraordinary market news.
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