This year is the 50^th anniversary of one of Wall Street’s most influential books, A Random Walk Down Wall Street. Author Burton Malkiel argued that news and expectations are factored into stock prices so investors can’t consistently outperform the market with good stock selection. Although index funds didn’t exist at the time, Malkiel argued that investors would be best served by buying and holding a diversified basket of securities.

With that in mind, John Bogle founded The Vanguard Group and in 1975 launched their first low-cost index fund. He, too, believed that index funds would outperform most active portfolio managers because of the fund’s very low fees. He was right. Today, five of the 10 largest ETFs are from Vanguard and all of the top 10 are index funds.

The dominance of index funds over actively managed funds wouldn’t have happened unless the market was efficient, or nearly so. If analyzing a stock’s bullish fundamental or technical picture automatically would lead to outperformance, then actively managed funds would do better. But if the analysis doesn’t lead to better decisions, then it’s best to keep costs minimal.  

Most people choose to hold an S&P 500 fund. While that works well over the long-term I believe there are better funds.  The problem with the S&P 500 is that it overweights the most expensive stocks. A year ago technology stocks had the largest weighting in the index (about 33%) because those stocks had done so well. But in 2022 technology was the worst performing sector and it crushed the S&P 500.

Instead, I like to hold dividend paying ETFs like Vanguard Dividend Growth (VIG), Schwab Dividend Equity (SCHD), and ProShares S&P 500 Dividend Aristocrats (NOBL). Those were down between 4-10% last year so they avoided the bear market, and the fees for VIG and SCHD are an extremely low 0.06%.

All this doesn’t mean that individual stocks shouldn’t be part of your portfolio. In my managed accounts, I hold both index ETFs and individual stocks. As readers of this column know I overweighted the healthcare sector so dividend-paying stocks like Merck (MRK), Pfizer (PFE), Amgen (AMGN), and Becton Dickinson (BDX) helped the portfolios.

By holding a combination of individual stocks (no cost of ownership) along with some low-cost index funds, an investor can build an attractive portfolio that overweights specific sectors while avoiding areas that are less attractive. And all that can be done while paying very little in fees. That is to our advantage.  

David Vomund is an Incline Village-based Independent Investment Advisor. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.