3 ms·

One of my big brain investing ideas is to pick the stocks at the top of the index instead of buying the whole index. If index funds continue to rise in populari

One of my big brain investing ideas is to pick the stocks at the top of the index instead of buying the whole index. If index funds continue to rise in popularity, the stocks that are at the top will benefit most from passive investment volume. Plus, index funds follow a kind of Pareto principle where the top stocks contribute disproportionately to the total return anyway. As I’ve gotten older though, one of my realizations is that the tax-free rebalancing of index ETFs is their most valuable property, rather than their actual choice of equities.

jackcosgrove 2y ago
I had an active manager reach out to me with exactly this strategy. I didn't look at the fees or rebalancing schedule super closely, because I didn't want to invest with the guy, but IMO his market-beating claims were due to increased concentration during a bull market (risk) which could go sideways fast if he didn't rebalance at opportune times.
- ghaff 2y ago
  Which, without looking, probably means NASDAQ today--and certainly the top 50 or whatever tech stocks by whatever metric. That didn't look so great in late 2001. Certainly my T Rowe Price tech fund cratered. Tech has been very good, even relatively speaking through the great recession, since then.
  - jacobsimon 2y ago
    The best approximation I’ve found is S&P has this Top 10 index[1]. Over the last 10 years it has performed 18% annually vs 11% for the overall S&P 500, but that’s obviously been a historic bull run in large cap growth stocks. I can’t find data going back to 2000 to see how that strategy would have played out, but curious if someone else finds it or crunches the numbers. 1. https://www.spglobal.com/spdji/en/indices/equity/sp-500-top-10-index/#overview https://www.spglobal.com/spdji/en/indices/equity/sp-500-top-...
    - ghaff 2y ago
      Yeah, for what it's worth, my financial advisor is pushing me towards more value stocks and some more bonds. (I am somewhat older as well in addition to be in a position where being conservative makes sense.) Was just doing some research.
      - throwaway2037 2y ago
        What do you pay for that advice?
Mistletoe 2y ago
https://www.aqr.com/Insights/Perspectives/Value-Spreads-Back-to-Tech-Bubble-Highs-Are-You-People-Crazy https://www.aqr.com/Insights/Perspectives/Value-Spreads-Back... I’d be cautious that you are about to get a wicked mean reversion.
- jacobsimon 2y ago
  Yeah to clarify, I don’t necessarily recommend (or even follow) this strategy, I still mostly invest in passive index funds.
  - Mistletoe 2y ago
    Ah I see, carry on then!
WillPostForFood 2y ago
There is an old strategy that is kind of the inverse of this this called Dogs of the Dow where. You buy with stocks with the highest dividend-to-price ratio (implicitly underperforming), looking for the rebound. https://en.wikipedia.org/wiki/Dogs_of_the_Dow https://en.wikipedia.org/wiki/Dogs_of_the_Dow
- jacobsimon 2y ago
  I don’t know for sure, but I have a hunch this strategy has done below-average for the past 10-20 years, because most of the above-average returns have been driven by growth stocks with low dividends. Stock buybacks have also become a really popular way of returning value to shareholders instead of dividends.
Etheryte 2y ago
Hint: this idea has been around for as long as index funds have been around, if it actually worked well, everyone would be doing it. Alas, a big part of why index funds work well in the long term is diversification, and when you cherry pick a subset you also lose out on diversification. It's one of those strategies that looks clever if you don't delve into it, but actually the returns are worse. As an example, if you take the SP100 it might outperform the SP500 on single year performance every now and then, but in the long term, SP500 has consistently outperformed it.
- jacobsimon 2y ago
  Do you have data to back that up?
  - Etheryte 2y ago
    You can pull up SP100 and SP500 and look at their historical returns. SP100 is an actual index, not something I made up for illustration. If you look at the last 40ish years, SP100 is up roughly 45 times, SP500 is up roughly 50 times. What might help understand this concept intuitively is if you take it to the extreme: what if you always held only the very first company of the SP500. Sure, you would have a lot of the upside, but you would also be completely naked to the downturns. Similarly, you would lose a lot of money on commissions whenever the leader changes. Taking any other smaller subsection has the same problems, it's simply a matter of what tradeoff works best for you.
    - jacobsimon 2y ago
      Sorry I know what you mean - I’m just having trouble finding any data source / website that shows useful comparisons going back that far - what website are you looking at? These are the 10 year returns I’m seeing according to S&P: S&P 500: 11.1% S&P 500 Top 50: 13.2% S&P 500 Top 10: 18.1% The trend is pretty clear, at least in the last decade. My other point was that the historical data may not be as relevant because the index is much more top-heavy today, perhaps in part due to the popularity of index funds and part because the top companies are actually outperforming. Here’s an article to that effect - the top 20 stocks in the S&P accounted for ~90% of the index’s gains last year: https://www.visualcapitalist.com/cp/top-20-stocks-sp-500-returns/ https://www.visualcapitalist.com/cp/top-20-stocks-sp-500-ret... To your question about picking the extreme Top 1 stock - again I’m having trouble finding good data on that, but I’d be curious what the hypothetical outcome would have been over the last 20 years.
humansareok1 2y ago
100% you're just adding additional volatility for higher returns. Backdate the strategy, doubtful you're beating the overall index on decade timescales.

jackcosgrove 2y ago

I had an active manager reach out to me with exactly this strategy. I didn't look at the fees or rebalancing schedule super closely, because I didn't want to invest with the guy, but IMO his market-beating claims were due to increased concentration during a bull market (risk) which could go sideways fast if he didn't rebalance at opportune times.

ghaff 2y ago
Which, without looking, probably means NASDAQ today--and certainly the top 50 or whatever tech stocks by whatever metric. That didn't look so great in late 2001. Certainly my T Rowe Price tech fund cratered. Tech has been very good, even relatively speaking through the great recession, since then.
- jacobsimon 2y ago
  The best approximation I’ve found is S&P has this Top 10 index[1]. Over the last 10 years it has performed 18% annually vs 11% for the overall S&P 500, but that’s obviously been a historic bull run in large cap growth stocks. I can’t find data going back to 2000 to see how that strategy would have played out, but curious if someone else finds it or crunches the numbers. 1. https://www.spglobal.com/spdji/en/indices/equity/sp-500-top-10-index/#overview https://www.spglobal.com/spdji/en/indices/equity/sp-500-top-...
  - ghaff 2y ago
    Yeah, for what it's worth, my financial advisor is pushing me towards more value stocks and some more bonds. (I am somewhat older as well in addition to be in a position where being conservative makes sense.) Was just doing some research.
    - throwaway2037 2y ago
      What do you pay for that advice?

Mistletoe 2y ago

https://www.aqr.com/Insights/Perspectives/Value-Spreads-Back-to-Tech-Bubble-Highs-Are-You-People-Crazy https://www.aqr.com/Insights/Perspectives/Value-Spreads-Back... I’d be cautious that you are about to get a wicked mean reversion.

jacobsimon 2y ago
Yeah to clarify, I don’t necessarily recommend (or even follow) this strategy, I still mostly invest in passive index funds.
- Mistletoe 2y ago
  Ah I see, carry on then!

WillPostForFood 2y ago

There is an old strategy that is kind of the inverse of this this called Dogs of the Dow where. You buy with stocks with the highest dividend-to-price ratio (implicitly underperforming), looking for the rebound. https://en.wikipedia.org/wiki/Dogs_of_the_Dow https://en.wikipedia.org/wiki/Dogs_of_the_Dow

jacobsimon 2y ago
I don’t know for sure, but I have a hunch this strategy has done below-average for the past 10-20 years, because most of the above-average returns have been driven by growth stocks with low dividends. Stock buybacks have also become a really popular way of returning value to shareholders instead of dividends.

Etheryte 2y ago

Hint: this idea has been around for as long as index funds have been around, if it actually worked well, everyone would be doing it. Alas, a big part of why index funds work well in the long term is diversification, and when you cherry pick a subset you also lose out on diversification. It's one of those strategies that looks clever if you don't delve into it, but actually the returns are worse. As an example, if you take the SP100 it might outperform the SP500 on single year performance every now and then, but in the long term, SP500 has consistently outperformed it.

jacobsimon 2y ago
Do you have data to back that up?
- Etheryte 2y ago
  You can pull up SP100 and SP500 and look at their historical returns. SP100 is an actual index, not something I made up for illustration. If you look at the last 40ish years, SP100 is up roughly 45 times, SP500 is up roughly 50 times. What might help understand this concept intuitively is if you take it to the extreme: what if you always held only the very first company of the SP500. Sure, you would have a lot of the upside, but you would also be completely naked to the downturns. Similarly, you would lose a lot of money on commissions whenever the leader changes. Taking any other smaller subsection has the same problems, it's simply a matter of what tradeoff works best for you.
  - jacobsimon 2y ago
    Sorry I know what you mean - I’m just having trouble finding any data source / website that shows useful comparisons going back that far - what website are you looking at? These are the 10 year returns I’m seeing according to S&P: S&P 500: 11.1% S&P 500 Top 50: 13.2% S&P 500 Top 10: 18.1% The trend is pretty clear, at least in the last decade. My other point was that the historical data may not be as relevant because the index is much more top-heavy today, perhaps in part due to the popularity of index funds and part because the top companies are actually outperforming. Here’s an article to that effect - the top 20 stocks in the S&P accounted for ~90% of the index’s gains last year: https://www.visualcapitalist.com/cp/top-20-stocks-sp-500-returns/ https://www.visualcapitalist.com/cp/top-20-stocks-sp-500-ret... To your question about picking the extreme Top 1 stock - again I’m having trouble finding good data on that, but I’d be curious what the hypothetical outcome would have been over the last 20 years.

humansareok1 2y ago

100% you're just adding additional volatility for higher returns. Backdate the strategy, doubtful you're beating the overall index on decade timescales.