Taking risk in an IRA

[manlymatt83]

Hi all,

So I know you're supposed to "buy an index fund, set it and forget it" in an IRA. And for the most part that's what I do. However, I'm also still young, and recently I've been thinking about something: what about keeping 70% in an index fund, and putting something like 30% into individual stocks that have historically beat the S&P for at least 20 years? Stocks like JNJ, for example. Wouldn't this likely give a small boost and "slightly" beat the S&P while still maintaining relatively low risk?

Just curious if anyone employs this strategy. There has to be a way to take a 'slightly larger risk' than a simple index fund, while still not being stupid.

Thoughts?

 

[s0me0nesmind1]

Hi all,

So I know you're supposed to "buy an index fund, set it and forget it" in an IRA. And for the most part that's what I do. However, I'm also still young, and recently I've been thinking about something: what about keeping 70% in an index fund, and putting something like 30% into individual stocks that have historically beat the S&P for at least 20 years? Stocks like JNJ, for example. Wouldn't this likely give a small boost and "slightly" beat the S&P while still maintaining relatively low risk?

Just curious if anyone employs this strategy. There has to be a way to take a 'slightly larger risk' than a simple index fund, while still not being stupid.

Thoughts?

Investing based on history is quite possibly the dumbest thing you can do when it comes to investing.

The concept of using an Index fund is simply diversification. It means when you're one stock falls it doesn't affect you much because it only makes up a tiny fraction of your portfolio. If you put 30% into one individual stock, you're doing the equivalent of putting all your eggs in 1 basket - and it's not a very good idea IMO. But hey, whatever works for you I suppose.

 

[KB]

Just because a stock historically beat the S&P, it doesn't mean it will in the future. JNJ could have a spell of bad products, lawsuits, a new competitor etc. Indexing means you get both the out-performers and under-performers and not having to guess which ones will be which.

Taking some additional risk isn't bad though if you do it for fun and in small amounts. Although I index mostly, I do pick some stocks. Its not because I plan to beat the market, I know I can't in the long run, but I enjoy reading about companies, products, profits and losses. I enjoy betting on an underdog and having something riding on it when they do.

 

[overst33r]

forget the needle buy the haystack

if you're gonna gamble, I would recommend not more than 5% of your investments.

 

[Exterous]

Contrary to what most will say I do something similar in a "play" Roth IRA and my taxable accounts but with a grounded understanding of the additional risks involved. I am a firm believer that the market is efficient over time but subject to short periods of irrationality that can be exploited. I'll set buy orders for a variety of companies well below their current value and then adjust them as conditions change. The companies involved are large market cap companies with strong market share, revenue and usually dividends. (Some examples: Apple, Walmart, JPM, Netflix, Lowes). Then its a bit of a waiting game for the market to over-react to something like Lowes buying Rona or Apple with its massive cash reserve dipping below $95/share. If its in my IRA I'm more tempted to sell it after it rebounds to get a quick 8-13% gain since it avoids taxes and the longer term risks of holding individual stock. My taxable accounts I'll consider the tax impacts vs the risk and gain to be realized.

There are a couple of challenges with this. The first being where to get the money to buy the stocks when the order fires. If the money is just sitting around doing nothing then you're missing out on gains from a stock index fund. I'll typically take the money from my more conservative allocation in money market or bonds to fund the purchase and then make up the reduction with my monthly contributions and\or dividends. This will briefly make my allocation percentage out of whack but for a variety of reasons I am comfortable with the short misalignment with the understanding of how the next risk plays into this. The next risk is the risk of all of these orders filling at once if the market tanks. For this reason my outstanding orders are in line with my existing money market allocation even though its rare for more than 1 to fire at a time. There is also the risk that in a period of massive market instability that the money market will become illiquid and I'll have to find the money elsewhere. That has really only happened on a wide scale in the US once (If we look at environments roughly similar to what we have now) and my overall account is much larger than my outstanding orders so that is a risk I am willing to accept. Another risk is lack of diversity. If you only have one or two stocks then you're really betting on those stocks. Not all your picks are going to do well.

All that said I'll add a caveat that my orders are firing less and less often despite using the same general method. Some of that is that I am placing slightly fewer orders as I have much more to lose now but it does make me more leery of the next year or two. Combine that with our current president and one of the longest runups in stocks in US history I'm not sure I would start doing this at this time if I were in your shoes

 

[dullard]

My comment is the same from the last time you posted this thread: do your individual gambling outside of an IRA.
https://forums.anandtech.com/thread...-long-term-10-20-years.2503097/#post-38828784

 

[dullard]

Also, your overall concept is just plain wrong. Buying something that has historically done well means you are buying something that is priced high. The easiest way to make money in the stock market is buy LOW sell high. Waiting decades until something has risen high means you are NOT buying low. It is possible to make money buying high and selling higher, but that is very difficult to do well.

Not only that but your underlying data is suspect:

• Vanguard S&P500 tracking fund VFIAX over the last 15 years: up 123.51%
• JNJ over the last 15 years: up just 94.25%.
• Meaning that the S&P500 has been doing BETTER than JNJ recently.

 

[manly]

Also, your overall concept is just plain wrong. Buying something that has historically done well means you are buying something that is priced high. The easiest way to make money in the stock market is buy LOW sell high. Waiting decades until something has risen high means you are NOT buying low. It is possible to make money buying high and selling higher, but that is very difficult to do well.

Not only that but your underlying data is suspect:

• Vanguard S&P500 tracking fund VFIAX over the last 15 years: up 123.51%
• JNJ over the last 15 years: up just 94.25%.
• Meaning that the S&P500 has been doing BETTER than JNJ recently.

Your first statement is incorrect. A stock that has done well historically doesn't mean it's priced high now. It could be fairly valued, overvalued or even undervalued.

To take one example, up until recently AAPL was historically "cheap" by P/E measures (with an occasional exception) compared to other large cap tech companies. With its big run-up this year, I think it's now fairly valued or even overvalued. But the point is that AAPL has done extremely well over a decade and a half and throughout most of that time was undervalued.

Investors now are banking on the 10th anniversary iPhone, and repatriation of overseas cash but I personally believe Apple's best days are behind it.

 

[sm625]

JNJ may have beat the S&P500 but it hasnt really outperformed XLP (Consumer Staples ETF) by any significant amount. So XLP could be a decent compromise for you.

 

[dullard]

Your first statement is incorrect. A stock that has done well historically doesn't mean it's priced high now. It could be fairly valued, overvalued or even undervalued.

To take one example, up until recently AAPL was historically "cheap" by P/E measures (with an occasional exception) compared to other large cap tech companies. With its big run-up this year, I think it's now fairly valued or even overvalued. But the point is that AAPL has done extremely well over a decade and a half and throughout most of that time was undervalued.

Investors now are banking on the 10th anniversary iPhone, and repatriation of overseas cash but I personally believe Apple's best days are behind it.

You just argued that Apple should have been purchased last year, not now. That doesn't make my statement incorrect. Heck, plot the 5-year graph of AAPL vs VFIAX and that will show you that AAPL was NOT doing better than the S&P500 in 2013 or 2016, both of which would have been great times to buy AAPL. That too invalidates the original poster's plan to only buy stocks that have historically beat the S&P.

You do have to look at P/E, growth potential, and many other factors. A stock that has been beating the market may be doing so for a very good reason and can be a great buy. Buy high and sell higher can work quite well profitably. But, the OP was considering solely the historical comparison to the S&P which I think is a bad move. And it is a very difficult move to pull off repeatedly. I would not advise doing it without using other information such as P/E.

 

[NesuD]

Rather than buy a few stocks like JnJ identify a well managed fund that targets that type of equity and invest in that. The diversification is well worth the doing. There are literally thousands of funds out there whose investment goals run the gamut. I have some in Index funds some in index combination funds and several that are more sector targeted. I actively self manage my portfolio and almost never buy individual stocks unless I see something happening that I'm very sure of and only as a short term position of 1 year or less. JnJ is a good stock and is likely to remain so but is more suitable as an income producer than an equity builder. Your young so unless you are unusually risk averse I would look for something more aggressive than the standard s&p 500 index fund and allocate a portion of my portfolio there.

 

[dullard]

I would look for something more aggressive than the standard s&p 500 index fund and allocate a portion of my portfolio there.

Exactly. You don't need to go to individual stocks in your IRA to get riskier (and thus hopefully larger returns) than the S&P500.

Vanguard lists the historical returns and relative risks of their funds. Unsurprisingly, they are correlated. Here are mostly randomly selected ones from each risk category in Vanguard's list:

• Vanguard's risk 1 (lowest risk category), returned 0.63% last year: https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0030
• Vanguard risk 2, returned 4.06% last year: https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0723
• Vanguard risk 3, returned 11.20% last year: https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0502
  
• Vanguard risk 4, the S&P500 fund, returned 17.87% last year: https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0540
  
• Vanguard risk 5 (the highest risk category), returned 19.53% last year: https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0081

By choosing some from risk #5, you can diversify, take on more risk, and most likely get better long term returns. You don't need individual stocks in your IRA to do that.

30% in individual stocks might not sound like much when you start out. What is a $3000 give or take at the beginning? But, as you age, that 30% strategy means that soon you risking $3,000,000 just when you need it to be stable. It just gets to be a bigger and bigger gamble as time goes on.

 

[DaveSimmons]

By choosing some from risk #5, you can diversify, take on more risk, and most likely get better long term returns. You don't need individual stocks in your IRA to do that.

This is good advice. Much safer than the risk #eleventy of picking individual stocks based on gut feelings or a "system."

 

[PowerEngineer]

I see that the response is being dominated by the supporters of index funds, and there are no shortage of financial experts (e.g. Warren Buffet) who tout the advantages of index funds (and ETFs) for the individual investors. And I myself have a large portion of my savings invested in them.

That said, I do have some reservations about index funds (and ETFs). It seems to me that investing in an index fund means that you are trusting that the market's pricing of all the stocks in that index is fair and reasonable. In essence, you are relying on the professional stock pickers who evaluate individual stocks to set a fair price through their decisions to buy and sell. This may have been a fair assumption to make when index funds were new and not a big part of the market. Index funds now account for about 20% of the market and the percentage is rising. It seems to me that at some point the fair pricing assumption for stocks will break down when "along for the ride" index funds overwhelm the stock pickers influence on market prices. That may be a long way off, but who really knows?

With that in mind, I see nothing wrong with the idea of building a diversified portfolio of individual stocks as part of your investment plan. It is certainly true that past performance is no guarantee of future performance, but it would be silly to ignore how a stock has performed over time. The so-called "dividend aristocrats" are certainly worth a look:

https://en.wikipedia.org/wiki/S&P_500_Dividend_Aristocrats

You might also be interested in the "Dogs of the Dow":

https://en.wikipedia.org/wiki/Dogs_of_the_Dow
https://en.wikipedia.org/wiki/Dogs_of_the_Dow
I assume Warren Buffet doesn't mind that I bought some Berkshire Hathaway.

My two cents...

 

[dullard]

With that in mind, I see nothing wrong with the idea of building a diversified portfolio of individual stocks as part of your investment plan. It is certainly true that past performance is no guarantee of future performance, but it would be silly to ignore how a stock has performed over time. The so-called "dividend aristocrats" are certainly worth a look:

https://en.wikipedia.org/wiki/S&P_500_Dividend_Aristocrats.

A diversified portfolio of individual stocks is, in essence, an index fund.

The difference is that instead of experts who can spend their entire lives thinking about individual stocks to include (and who probably have inside information that you don't have even though that isn't legal), you get to spend a few minutes guessing about stocks with limited information.

Heck, even if we look at your suggested dividend aristocrats, there are index funds that track them. As of right now, they are lagging the S&P500. Take NOBL for example, over its lifetime it is up 38.96% vs VFIAX (Vanguards S&P500 fund) which is up 42.34% in the same time frame. This is with experts selecting only from the stocks that you suggest that we should select from and they still can't beat just buying a bit of everything.

Yes, an index fund can do poorly. It could have high fees or it might not track what you want it to track. High fees are easy to spot. And there are comparisons readily available to see if the index is properly tracking. So, with the few minutes that most investors have, I think it is wiser to check to see if their index fund is cheap and functional than to attempt to self-build an index fund.

There is nothing wrong with a good individual stock. I own one at the moment. But they should be well-thought-out (which most of us can't do) and they just don't belong in an IRA which is supposed to be your stable lifeline later in life. Do your individual stock speculation in a taxable account.