Indexes and Minotaurs

Why can't investors buy and hold?

The Ship of Theseus is a famous thought experiment.

Theseus was a legendary Greek hero, most famous for killing the Minotaur - a monstrous creature with the body of a human and the head of a bull. After killing the Minotaur, Theseus had to escaping from the labyrinth - a complex maze nobody had ever solved. He then escaped from the island of Crete, where the Minotaur and Labyrinth were on a ship.

The Athenians preserved this ship as a relic, but over time, as its wooden parts decayed, they were replaced one by one. The paradox arises when we consider whether the ship, with all its original parts replaced, is still the same ship as the one Theseus originally sailed.

Essentially, it poses the question: If something is gradually changed, piece by piece, until none of its original components remain, is it still the same thing?

I know what you’re thinking - great lesson in mythology and philosophy, TJ. Real interesting 🙄 What’s that have to do with investing?

For me, nothing.

For index investors, a lot.

What’s your index look like in a decade?

That’s the question index investors probably aren’t asking themselves, but should be.

The index you buy today isn’t the one you’ll own in a decade. Here’s the number of companies added and dropped from the S&P 500 between 1995 and 2022.

Every year, on average you’re buying and selling 26 companies. Sound passive? Even worse, you’re usually selling cheap companies and buying expensive ones.

Let me make this even more clear. If you buy the S&P 500 today, you’re investing most of the money in:

1. Apple

2. Microsoft

3. Alphabet

4. Amazon

5. Nvidia

If you bought in 2014, most of your money went to:

1. Apple

2. Exxon

3. Berkshire Hathaway

4. General Electric

5. Johnson & Johnson

To drive the point home even further, here’s the changes in the S&P through the 2010’s by sector:

Pick an icon and follow it. You’ll see it gets bought heavily, sold off a few years later, then bought again.

Does all this activity matter?

Truthfully, it’s hard to say.

Most investors underperform the index.

There’s a “study” from 2014 by Fidelity that shows that the investors who performed the best were either dead or forgot they had accounts. This study has a few flaws though:

1. We don’t know what the investors owned - indexes, individual stocks, bonds, bitcoin?

2. Nobody can find the original study, so it might not have ever existed.

I couldn’t find any data on what the performance would be if you bought the S&P, then ignored all the changes. I even asked Google’s Gemini - since AI is going to take over the world. It told me:

In conclusion, while it's an interesting thought experiment, creating a static S&P 500 is not feasible or realistic. The index's dynamic nature is essential for reflecting the evolving economy and providing investors with a relevant benchmark.

What does matter?

Most data points to investor behavior as the most important factor, especially when we talk about “passive” strategies.

I put passive in quotes, because from the data, most investors are not truly passive. Most investors get optimistic and pessimistic with the market, buying and selling at the wrong times.

We’ve all seen the “cost of missing the best days” graphics:

There’s also data that investors tend to be worse at selling than buying.

The bottom line is this: the best performance comes when you buy, and rarely, if ever sell.

Holding the index

One of my personal issues with index investing is that I don’t really know what I own.

That makes it really hard for me to hold it.

I suspect that’s true for a lot of other investors as well. You can’t know 500 businesses well, so how do you choose when to buy and sell?

The only rational choice for indexers is to buy regularly and not sell.

The problem is, most people can’t handle that from an emotional and behavioral standpoint.

Most investors are the middle guy in the famous IQ bell curve meme:

The Alternatives

The best performance will come from going to one of the tails. You have to be really uninformed about your investments, or know them really well.

Here are a few ideas on how to make those shifts:

1️⃣ Know what you own and why.

This is the route I’ve gone. I know the businesses I own. I know why. I know what it would take for me to sell them. I have some price alerts set, and as long as the company isn’t way overvalued or way undervalued, I ignore the market.

2️⃣ True coffee can investing

You’ve probably heard of the coffee can strategy. It’s where you buy companies and refuse to sell them for a long time, if ever.

Similar to #1, but in the best version, there’s no “I’ll sell if…” rules. You just hold.

10 Stocks To Own Forever

3️⃣ Outsource it

Not to a financial advisor, but to someone you trust. Here’s the plan:

1. Set up automatic investments

2. Give account access to someone you trust - the last part is important

3. Have that person change the password to the account

Now you can’t easily sell. You have to convince your trusted partner that you need access and have a good reason to sell. This extra step might help you hold.

That’s it for today!

These thoughts aren’t fully formed, but I hoped writing about them would help clarify them.

Let me know if you liked this type of article, and if you have any input on anything here.

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