Index fund vs different stocks from different sectors

bowlhead99

Pincher wrote: »

If you can buy and hold for years, and don't have to pay any custodian charges, and just keep getting dividends by sitting pretty, I suspect you will do better buying shares. Funds have ongoing annual management charges.

That's more true for UK shares than international ones which can be prohibitively expensive to access. So some people would build their own UK portfolio with 20 self-selected shares in it and do their own rebalancing as and when, and use funds or investment trusts for their overseas exposure and other asset classes like bonds and property.

Shares are more risky, sure, but if you have ten shares, and one of them goes bankrupt, is that actually that much different from a fund having a hundred different companies, and ten of them go belly up?

The thing is, you typically don't get 10% of companies going bankrupt in a year. Maybe it's more like only 2% going bust or having a monster loss (as distinct from a usual Very Big loss).

So if that were the case (and of course these are just example numbers not researched):

In your fund of 100 shares you kiss goodbye to 2 of them and lose 2% of your capital, however the rest of the investments are numerous and broad enough to pick up the whole range of market returns, including some that double or more and lots that achieve the average 5-10% or whatever the "average" return is that year, and you will still make money overall despite the bankruptcies.

So, in a broad portfolio that covers most of the market, the chance of someone going bust is quite high but not very costly ; it's expected, but totally affordable.

However in your portfolio of 10 companies the returns are much more 'binary'. 2% of the companies are having a catastrophic year. You have ten companies, and each of them will wipe out, costing you 10% of your portfolio, or it won't, costing you nothing.

When 2 companies on the 100-company market go bust, your company A has a 1 in 50 chance of being one of them, and so does your company B, and company C and so on, so with your 10 companies you end up with a little under one in five chance that you'll get a bust, and when it does it will wipe out 10% of the portfolio which is more than an average year's returns. The wipeout only happens once every five years but when it does, it hurts, and could be 20% if you were unlucky enough to hit both bad companies at once.

Contrast that with a broad portfolio which only has the known wipeout every year which doesn't ever hurt. That's why 10 companies is inadequate for diversification. Aside from the obvious point that there are more than 10 industries and multiple sizes of company and return profiles ( e.g. dividend vs growth) and multiple levels of exposure to demographics or geography, that your risks can be very skewed with just a "favourite ten'" portfolio.

birminghamuniv

Apart from useful comments from other members, many people feel they are a "real" investor/trader if they invest in a portfolio of individual companies of their choice rather than in collective funds. But it requires a lot of time.

BananaRepublic

birminghamuniv wrote: »

Apart from useful comments from other members, many people feel they are a "real" investor/trader if they invest in a portfolio of individual companies of their choice rather than in collective funds. But it requires a lot of time.

I have owned shares in companies I worked for. I sold them all. In one case I sold them just before they skyrocketed from ~£2K to ~£40K due to the tech stocks boom. So yes I am a real investor. :rotfl:Individual shares are best avoided.

birminghamuniv

Are you serious? Not a real investor in your case

Chickereeeee

Adding to Bowlhead's comment:

It is possible that if a company in a sector goes bust, their competitors can pick up the business they have lost. So if you have selected just one company in a sector for your portfolio, then not only do you lose on that one, but you do not pick up the benefit the others see due to reduced competition.

C

EdGasket

If you can identify good value stocks then go that route though your dealing costs will be higher; if not stick to funds. A few low-cost ETF's should suffice e.g. Vanguard's range or iShares Core series.

BananaRepublic

birminghamuniv wrote: »

Are you serious? Not a real investor in your case

If you mean me, then yes I am serious. I doubt anyone saw the tech boom coming, with absurd valuations on many companies. But it does illustrate why buying shares directly is not a good idea. You simply cannot foresee what might happen to one company.

birminghamuniv

Yes, I agree. And that is also why I meant some people like the feeling of being a real investor in the sense that they have to do everything from valuation to market timing.