Lessons From My Grandfather: Stocks, Funds, and ETFs

As a young kid from Asheville, NC, my grandfather had a great influence on me and my investing knowledge development. He served for years in the US Army during WWII and later as a diplomat in the US Foreign Service, heading the US Embassy in Iran during the time of the Shah. Due to medical reasons he retired at a young age, granting him time to devote to our family. He used that time to plant seeds from his investment wisdom in my young, impressionable mind. Watching his thought process was fascinating to me, a blossoming money nerd. 

Nobody enjoyed digging into a company’s financial statements and press releases more than he did, and he’d relish owning a small slice of the best businesses in the world. He would track his stocks with the daily newspaper and wait for quarterly reports to arrive in the mail. Day trading did not exist, and commissions were high enough to make you think twice before committing to a trade. His moves were calculated, and his ideal holding period was forever (gee…where have I heard that before?). 

My grandfather prided himself on staying informed and had the foresight to identify trends on multiple instances. He was not gun shy about investing in an actively managed fund whose mandate aligned with keeping up with those economic trends. But, most importantly before investing in an actively managed fund, he researched the fund manager and went with those who had a stellar long-term track record. However, in the aftermath of the dot-com bubble burst, his opinions changed and he was less likely to invest in high-flying funds – especially those with high fees.

As my grandfather changed, so should you when it comes to your investing style. Index funds, actively managed funds, or individual stocks. Which is the way to go today? Each investing method has its raving fans, but which is best for you? As with all things personal finance, it all depends on…you. Let’s dive in and demystify some of the arguments made by each camp.

What do the pros say?

My grandfather isn’t the only person I’ve learned from. He taught me to follow wise people. While opinions may be a dime a dozen, it can be valuable to see where the “successes” weigh in, right?

Individual stocks:

Warren Buffett: “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”

Peter Lynch: “If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.” 

Jim Cramer: “Every once in a while, the market does something so stupid it takes your breath away.”

John Neff: “It’s not always easy to do what’s not popular, but that’s where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognized.”

Phillip Fisher: “The stock market is filled with individuals who know the price of everything, but the value of nothing.”

Sir John Templeton: “The four most dangerous words in investing are: ‘This time it’s different.'”

Warren Buffett: “Wide diversification is only required when investors do not understand what they are doing.”

The case for individual stocks:

• You maintain complete control of where you put your money
• Zero fees, assuming you invest with a commission-free broker
• Potential to have market-shattering returns
• You get to vote on company matters, and may attend the annual shareholder meeting
• You receive quarterly reports, annual financial statements, etc. in the mail (or online), which makes for some fun, light reading on the weekends

Actively Managed Funds:

Abigail Johnson: “Returns matter a lot. It’s our capital.” 

Dave Ramsey: “It really doesn’t take a rocket scientist to find a mutual fund that outperforms the S&P….You should be selecting funds that over time outperform the S&P….I find evidence contrary to this idea that you should be a passive investor and just buy index funds.”

Lou Simpson: “You can only know so many companies. If you’re managing 50 or 100 positions, the chances that you can add value are much, much lower.”

David Swensen: “I’m looking for somebody that’s got a screw loose and they define winning not by being as rich as they can be individually, but by producing great investment returns.”

Benjamin Graham: “I am convinced that an individual investor with sound principles, and soundly advised, can do distinctly better over the long pull than a large institution.”

The case for actively managed funds:

• Potential to pick a deft manager, who is able to see what others cannot
• You can find a fund that aligns with your investment objectives
• Managers who have done well historically in many economic cycles should have the experience to know what to do when the tides change
• You are likely to receive fun memorabilia from the fund company – mugs, t-shirts, pens…except Vanguard, cheap $#@&s!

Index funds:

Warren Buffett: “By periodically investing in an index fund, the know-nothing investors can actually outperform most investment professionals.”

Charlie Munger: “Our standard prescription for the know-nothing investor with a long-term time horizon is a no-load index fund. I think that works better than relying on your stock broker. The people who are telling you to do something else are all being paid by commissions or fees. The result is that while index fund investing is becoming more and more popular, by and large it’s not the individual investors that are doing it. It’s the institutions.”

Jim Cramer: “After a lifetime of picking stocks, I have to admit that Bogle’s arguments in favor of the index fund have me thinking of joining him rather than trying to beat him. Bogle’s wisdom and common sense are indispensable… for anyone trying to figure out how to invest in this crazy stock market.”

Paul Samuelson: “Still, I figure we shouldn’t discourage fans of actively managed funds. With all their buying and selling, active investors ensure the market is reasonably efficient. That makes it possible for the rest of us to do the sensible thing, which is to index. Want to join me in this parasitic behavior? To build a well-diversified portfolio, you might stash 70 percent of your stock portfolio into a Wilshire 5000-index fund and the remaining 30 percent in an international-index fund.”

Peter Lynch: “The S&P is up 343.8 percent for 10 years. That is a four-bagger. The general equity funds are up 283 percent. So it’s getting worse, the deterioration by professionals is getting worse. The public would be better off in an index fund.”

David F. Swensen: “Invest in low-turnover, passively managed index funds… and stay away from profit-driven investment management organizations… The mutual fund industry is a colossal failure… resulting from its systematic exploitation of individual investors… as funds extract enormous sums from investors in exchange for providing a shocking disservice… Excessive management fees take their toll, and manager profits dominate fiduciary responsibility.”

Burton Malkiel: “Experience conclusively shows that index-fund buyers are likely to obtain results exceeding those of the typical fund manager, whose large advisory fees and substantial portfolio turnover tend to reduce investment yields. Many people will find the guarantee of playing the stock-market game at par every round a very attractive one. The index fund is a sensible, serviceable method for obtaining the market’s rate of return with absolutely no effort and minimal expense.”

Roger G. Ibbotson: “We can extrapolate from the study that for the long term individual investor who maintains a consistent asset allocation and leans toward index funds, asset allocation determines about 100% of performance.”

William J. Bernstein: “While it is probably a poor idea to own actively managed funds in general, it is truly a terrible idea to own them in taxable accounts… taxes are a drag on performance of up to 4 percentage points each year… many index funds allow your capital gains to grow largely undisturbed until you sell… For the taxable investor, indexing means never having to say you’re sorry.”

John C. “Jack” Bogle: “Don’t look for the needle in the haystack. Just buy the haystack!”

The case for Index Funds

• Highly tax efficient when in a standard, taxable brokerage account
• Historically, you are likely to outperform the majority of other investors
• Very low cost
• Hands off investing – granting you time to worry about the El Camino’s rad paint job
• All the cool kids are doing it!

Putting it all together

So, Stacker, where does this leave you and me? 

My grandfather wasn’t afraid to admit mistakes, and neither am I. We learn from them all, and I, for one, have made many investing mistakes – buying penny stocks (hint: don’t!); day trading/swing trading/momentum trading (unless you’re a professional trader or live in your mom’s basement and devote all your time and energy to this, don’t); I bought a brand new tech stock fund from a high flying mutual fund company in the late 90s…and held it until mid-2001 (college kids…what you gonna do?); and I even gave my graduation gift money to a commissioned (I didn’t know it at the time) broker who promptly put me into A-shares of a very well known active fund, and subsequently was always with another customer when I tried to reach him (at least I got the tax write-offs).

Don’t do what I did.

Take a lesson from Grandpa Bailey

Now that I’m 40 with a family of my own, I look back and value even more the lessons that my grandpa tried to teach me. I’ve learned that a little in each bucket is not a bad thing. 

Individual stocks keep me engaged and intellectually stimulated, and I dig receiving calendars, pens, etc. from my companies. The individual stocks are chosen based on a set of criteria that applies to my situation. I buy them when the price looks right, and plan to hold them forever (unless something fundamental changes).

I invested in a total of three actively managed funds. The management teams have been doing a stellar job for decades, and the fund mandates align with my objectives. They are low-expense funds – even lower fee than some of the more expensive index funds on the market.

The bulk of my investment portfolio is in index funds. I enjoy knowing that my money is working for me without me ever having to touch it. This is the true “set it and forget it.” It frees up my time to play with my kids, cook with my wife, or yell at my cats.

Action steps 

Great, Kev, but what should I do? I have fat stacks sitting in cash and don’t want to screw up.

I’m glad you asked, imaginary Stacker!

Assuming you have all “bad” debts paid off and an emergency fund in place, sit down and think about you. 

Do you have the time, experience, and self-confidence to pick individual stocks? If yes, go for it!

If you love a given manager/management company, are pleased with their performance, and the fund mandate aligns with your needs….go for it!

Do you prefer the hands off, tried and true approach of indexing? Go for it!

Are you a nerd like yours truly who enjoys the heck out of digging into financial statements, annual reports, and the like; but still wants to maintain the bulk of your money in index funds with some in well vetted actively managed funds? Go for it!

You’re in the enviable position of having options with money. You can choose what your money future looks like.

Let’s do this! 

Grandpa-approved.

Check back with me at stackingbenjamins.com regularly to follow along with market discussions, stock talk, economic trends, and cat-related humor.

What about you?

Tell us what your investment strategy looks like…anything like I mentioned, or do you have a different approach? Let us know in the comments!