I’m a happy follower of passive index (or Couch Potato) investing, but I have a confession. I can’t stop tinkering with my investment portfolio. Add a stock here, sell a stock there. I know I’m not supposed to, and that the magic of a Couch Potato portfolio is in just leaving it alone – but I can’t. The majority of my investments are appropriately allocated into either indexed mutual funds or exchange traded funds (ETFs). The other smaller portion I use to trade individual stocks. I call this my investing fun money, and it’s where I get out all of my bad investing behaviour.
I got the idea of investing fun money from Andrew Hallam’s Millionaire Teacher. He recommends that you use up to 10% of your portfolio for this but I stick to $1,000. By allowing myself to actively trade this small amount, I’m significantly more disciplined with the rest of my portfolio.
A Little Background on Couch Potato Investing
As a Canadian I use three ETFs to build my diversified portfolio. One tracks the Canadian market, one Canadian bond fund and one international fund excluding Canada. That’s it. Every month I do a quick check to ensure the percentage of each is within my target range and I rebalance when I put new money in.
A passive indexed portfolio aims to average the market, not beat it. Done correctly, the simplicity of passive investing provides appropriate diversification and peace of mind. When you get in there and tweak it you’re messing with ‘perfection’.
Why Do I Have Investing Fun Money?
I want to try and beat the market – plain and simple. I think a lot of investors (irrationally) dream about purchasing $100 of a stock that turns into $100,000 overnight. Insta-rich! I’m no different and this actually happens almost never.
Actively trading with $1,000 won’t make me rich but more importantly, it’ll NEVER make me poor.
My investing fun money keeps me from betting my life’s savings on a stock tip I heard from a neighbour or having a portfolio significantly over-weighted with my company’s stock.
Humans have trouble with keeping things simple and there’s a lot of temptation to stray off course. An uncomplicated, indexed portfolio should be the easier solution but leaving it alone is incredibly tough to actually do. Especially because a passive portfolio is not what I think of when I picture successful investors, and I want to be one.
Beating the Market
I have a mental image of how “real investors” invest. They sit at their real-time, market monitoring computers all day making trades on some pharmaceutical deal they heard about through their back channels, and ultimately, make millions. This isn’t reality. The real investors are the guys in charge of actively managed funds (hedge funds, mutual funds, etc.). They have impressive resumes filled with finance MBAs from Top 3 schools and difficult-to-attain CFA designations, first class market modeling software and access to the C-level executives of the companies they are looking to put in their funds. If anyone is beating the market, it’s these guys, right? Investors in their actively managed funds are paying for their experience and expertise. So why has only 12% of actively managed US funds beaten the market-tracking passive funds over the last 5 years?
Averaging the Market
The simple answer is that no one can predict the market. We can create forecast models today about what’s occurred historically – but the past doesn’t dictate the future. Watching more BNN, reading more MoneySense and building more complex strategies only gives the illusion that we know what we’re doing.
Achieving consistent above average returns is EXTREMELY difficult to do.
I’m not a professional and am happy to average the market. I try to limit all my poor investing behaviour and bias to $1,000. To be honest, while I monitor my whole portfolio monthly, the only numbers I really get excited about are for my investing fun money. I employ a self-devised strategy for choosing individual stocks because that’s what I find fun. It’s a kind of competition I have with myself to see if I can do it well. I’m stating up front that any market beating that goes on is largely due to luck.
So How do I Choose my Stocks?
To start, I only invest in companies I’m familiar with. I’ve either worked there or a family member/friends has or I like the brand, AND I like their corporate credo. Companies with capable, compassionate people at the top who treat their employees well. If you’ve ever worked for a company with someone toxic at the top you understand how that negativity pervasively filters down.
Once I have a list of companies I like, I monitor them until they’re trading much lower than usual, then I buy. This is categorized as value investing.
I then hold the stock until I wouldn’t buy it anymore. Even though I’m familiar with the companies, I don’t get too familiar with owning their stock. This is an attempt to limit any biases I might have, such as “they’re doing so well, I’m going to keep holding on to make even more money!”
I let myself keep any gains as more investing fun money.
A Major Caveat
Sometimes, if I’m on a roll, I catch myself thinking I should move more money into the fun money account. This is a terrible idea!
All good stock-picking streaks come to an end. Legendary portfolio manager Bill Miller beat the S&P 500 for 15 years in a row (1991-2005), growing his fund to over $20 billion in the process. The odds of this success are astronomically low, as only about 25% of funds beat the market in any given year. (To reiterate a little more about the downfalls of human behaviour – the average investor in Bill’s fund UNDERPERFORMED the S&P during this time). At the end of his hot streak in 2005 until 2011, the average investor in Bill’s fund lost 7.40% a year…
So seriously, if he can’t consistently beat the market, why on earth would I think I could?! I’m sticking to my passive Couch Potato portfolio – I just need a little investing fun money to keep myself in check.