![]() ![]() One investor explained this to me as "I'd rather lose money and know how and why I did, than to make money and have no idea how or why that happened or whether it might happen again." ![]() ![]() Fundamental - Although there's always plenty of uncertainty in investing, it's easier to model the expected total returns of a portfolio of 5-20 stocks by modeling each company's financials, growth, and valuation multiple expansion/contraction than trying to do the same for 500-2,000 companies at once.ESG / Ethical / Religious - Direct stock portfolios allow more control and visibility on what the companies you own are doing, and whether those business practices align with your environmental, social, governance, ethical, or religious principles.This alone can produce significant "tax alpha," even if you use all 500 stocks in the S&P 500. Tax - Direct stock portfolios allow the investor to " tax loss harvest" losing positions, while deferring gains on winning positions.Direct stock portfolios generally sidestep both of these issues. Regulatory - US persons living overseas in some jurisdictions find it difficult or impossible to access or trade SPY, and may find local index funds subject them to PFIC rules and other US tax traps.There are some very specific advantages/applications I see to using a direct stock portfolio (whether of 5 or 50 stock) over SPY, including: In this article, I will push to the challenge of trying to track (not necessarily beat) SPY as closely as possible with just five stocks, and testing in which cases that provides enough diversification for a human investor. For young investors, I took this a step further with a sample portfolio of the 10 first stocks to buy a 10-year-old, with the primary goal there being to have 10 stocks a 10-year old can understand and learn from. As a next step, I outlined a process I called " Make My Dow ," where the investor can replace Dow components with preferred alternatives while maintaining a balanced 30-stock portfolio. As a first step, I believe the super-simple, well-known and long-tested 30 stock index tracked by the SPDR Dow Jones Industrial Average ETF ( DIA ) can still offer modern investors a "gateway drug" away from index funds and toward a portfolio of stocks a human can know by name. Although many investors prefer the simplicity, low cost, and high liquidity of a widely-used index fund like the SPDR S&P 500 ETF ( NYSEARCA: SPY ), I find that most investors I ask don't know most of the stock "ingredients" in SPY, nor know how to model future expected returns of an ETF holding 500 stocks. Many "human" investors, by which I mean an individual who cares more about absolute returns than about metrics like tracking error, are likely to be more satisfied with a portfolio of a relatively small handful of known stocks than a fund holding hundreds or even thousands of unknown stocks. Photo by Andrii Yalanskyi/iStock via Getty Images Looking for a helping hand in the market? Members of Long Run Income get exclusive ideas and guidance to navigate any climate.There are tax, regulatory, and fundamental reasons why an investor might prefer the five-stock portfolio to SPY, and hopefully, this article provides some practical inspiration.This is one consequence/benefit of high correlations. Many investors may be surprised how closely these two test portfolios of five stocks each have tracked SPY.In this article, I test the "crazy-sounding" idea of trying to track SPY with just five stocks, using deliberately silly rules like choosing stocks starting with letters A-E.I find most "human" investors prefer owning a smaller number of stocks they can know and understand than a fund like SPY holding hundreds or thousands of unknown names.The SPDR S&P 500 ETF (SPY) is largely traded because it's standard and liquid, not because most of its users know or like all 500 names in it. ![]()
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