The Simply Investing Dividend Podcast

EP60: Stock vs Funds, Investing in the Dow

November 29, 2023 Kanwal Sarai Season 2 Episode 60
The Simply Investing Dividend Podcast
EP60: Stock vs Funds, Investing in the Dow
Show Notes Transcript Chapter Markers

In this episode, we'll compare the differences between investing in the 30 Dow companies versus investing in funds The following topics are covered in this episode:

- What is the Dow Jones Index?
- Index funds and ETFs investing in the Dow
- Individual investing vs funds
- Taking control of your investments

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Speaker 1:

In this episode we're going to compare buying individual stocks versus investing in an index fund or an ETF. Specifically, we're going to be looking at the 30 companies that make up the Dow Jones Index. Hi, my name is Kanwal Sarai and welcome to the Simply Investing Dividend Podcast. In this episode we're going to cover three topics. We're going to start off with topic number one what is the Dow Jones Index? Next we're going to look at index funds and ETFs that invest in the Dow, and then we're going to look at comparing the difference between investing in individual stocks versus investing in index funds or ETFs. So let's get started with our very first topic what is the Dow Jones Index? The Dow Jones Industrial Average, also referred to as Dow Jones or simply the Dow, is a stock market list of 30 prominent companies listed on stock exchanges in the US. The Dow is one of the oldest and most commonly followed equity indexes. So when we say index, basically what it means is a list. So here it's going to be a list of 30 US companies, and that's why they refer to it as the Dow Jones Index or the Dow Jones Industrial Average. Just a couple of facts here the Dow Jones Industrial Average was founded in 1885 and the market cap today, which means the total market value, as of this recording, for all 30 companies in that list, is $10.9 trillion. So let's take a look back at the last 25 years and we're going to look at the Dow Jones Index, we're going to look at the New York Stock Exchange Index, which is all of the stocks trading on the New York Stock Exchange, and then the SNMP 500, which is also another list, which is a list of 500 companies in the US. Now you can see up on the screen here there's three different lines. So the line at the very top represents the one in purple represents the Dow Jones Index, and the line below it, in orange, represents the New York Stock Exchange Index, and the line below that, in light blue, represents the SNMP 500. Now I'm not too concerned about the one line being higher than the other, for now, the biggest takeaway here, and what's important, is you'll see that all three lines behave in a similar fashion. So when the Dow Jones index is down, so is the New York Stock Exchange and so is the SNMP 500. And when the New York Stock Exchange is up, so is the Dow Jones and so is the SNMP 500. So you can see that all three lines behave in a similar fashion. They go up and down almost together, and I say this all the time in my episode. Stock prices go up and down all the time, and these lines are representing the accumulation of all of the stocks in each of those indexes or in each of those lists. So they go up and down over time and over the last 25 years and even more, but on the screen we're just going to show the 25 years. You can see that all of these indexes behave in tandem, and so what this tells us is that the Dow Jones Industrial Index is a good approximation for what's happening in the stock market. Now let's take a look specifically at some numbers. So here we're going to go back 10 years and you can see the rate of return. We have one for the Dow Jones Index and we have one for the SNMP 500. Now the SNMP 500 is made up of 500 companies US companies and the Dow, as we've already stated, composes of 30 US companies. But it's interesting here, same as what I just showed you in the previous graph, the markets go together and if we look at 2015, we can see there was a negative return for the Dow Jones, while the SNMP 500 also had a negative return. In 2018, the SNMP 500 had a negative return. So did the Dow Jones Index, so they kind of follow each other. Now the numbers don't match exactly, but they're fairly close. I'll give you an example In 2018, the Dow Jones was down 5.6%. The SNMP 500 was down 6.2%. So the numbers don't match, but they're fairly close. If we look in 2013, the SNMP 500 returned 29%. The Dow Jones returned 26%. So again, the numbers are not the same, but they're fairly close. Now, if we look here on the next slide, what I've done is I've taken the average, the average rate of return for the last 10 years, and so we can see the Dow Jones had an average rate of return of 10.42%, the SNMP 500, average rate of return of 11.56%. So again, the numbers are fairly close. So the Dow Jones Index is a good barometer of what is happening in the stock market and we don't need to track 500 or 6,000 stocks. We can just look at the 30, and we can see what's happening in the US stock market. Now the Dow Jones is made up of 30 companies, and I've said that before, but now you can see the list up on the screen. I'm not going to read all of the 30 companies on the list, but you'll recognize a lot of the names here. So Apple is on the list, coca-cola is on the list, microsoft, mcdonald's, verizon, ibm, walmart, disney. Those are just some of the examples of the 30 companies that make up the Dow Jones Index. Let's move on to our next topic. Now we're going to take a look at some index funds and ETFs that Only invest in the 30 Dow companies. So I just simply Googled that question and it came up with a whole bunch of index funds and ETFs. There's a lot of them out there. What I'm going to show you on the screen here are just five. I just randomly picked five of them and I've shown them right up on the screen here. So we have the RIDEX Dow Jones industrial average. You can see the. The symbol for that fund is up on the screen. We have the TD Dow Jones industrial average fund. We have the spider Dow Jones ETF, pro shares, ultra 30 and the nationwide Dow Jones ETF as well. So the names are up on the screen. The symbols are up on the screen. Now, what's important to know here? Because you might be thinking well, why don't I just invest in these funds Instead of investing in those 30 stocks myself? And you could certainly do that. The biggest difference is that these funds Charge a fee, an MER, which is a management expense ratio. That fee covers the cost of running the fund. So if there's any staff, any equipment, office space, marketing, advertising, all of those things that go into Running a fund and promoting a fund, those costs have to come out of the funds themselves. So you, as an investor, when you put money into an index fund or an ETF, you're gonna get charged a fee every single year and that fee is a percentage of the value of your investment. So you can see the fees here. The first one up on the list is 1.58 percent. That's an annual fee. The TD has a fee of 0.88, the spider Dow Jones is 0.16, pro shares is 0.95 and nationwide Dow Jones is 0.68. So the fees vary, right. So in this case we're looking at just a sampling of five companies. The fees vary anywhere from 0.16 to 1.58. Now, this is correct as of this recording, right, fees change all the time. So what we do now is we take an average of the five. Because I want to keep this simple, I want to give you one example. So we're gonna keep it simple and Instead of dealing with five different MERs, we're just gonna take the average. So the average here is 0.85. So remember that number because we're gonna use it in our next section. So that is the average MER fee of the five funds that we're looking at right now. So let's move on to our final section individual investing versus funds. So I've shown you this before a couple of slides before. This is the rate of return For the Dow Jones over the last 10 years. So last year, in 2022, the fund did negative 8.78 percent. The year before that it returned 18.73 percent, the year before that, 7.25 percent and the rest of the years they're up on the screen so you can see them for yourself. And we saw that the average was about ten point four, two percent over the last ten years. So if you were to invest directly, individually, into those 30 companies that I showed you before, you would get the same rate of return as an index fund or an ETF investing in those same 30 companies. So there's no difference there. The rate of return theoretically should be the same, because when you invest in one of these ETFs or index funds, what they do is they take your money and invest it on your behalf in those same 30 companies that are part of the Dow Jones Index. So you can invest that way, or you can invest directly into those 30 companies. So the rate of return is going to be the same for both. The biggest difference, as I mentioned before, is going to be the fee. So the index funds, etfs and mutual funds all carry a fee. So in this case we're going to let's go with the average 0.85%. That is the average MER across the five funds that I'm showing you up on the screen. So, to help us calculate the impact of the fee, we're going to go to our friends at nerdwalletcom you can see the link at the top of the screen here and on that site you're going to see that they have a mutual fund calculator. So I'm going to go through one example with you right now, but I'm going to encourage you to go to this mutual fund calculator with your own numbers and your own investments and to get an idea of what the fees will look like specifically for you. So for this example, we're going to keep the numbers simple, easy. We'll start with the initial investment amount of $250,000. I know for some people that is going to be a lot of money. For some people maybe not. What I'm doing here is I'm taking an approximation of somebody who's in their mid 40s, early 50s, has been working for 20 or 30 years working professional, has been saving consistently towards their retirement. So this would be a total of all of your investments in a 401k or an IRA. If you're in Canada, this would include your RSP or TFSA. So let's say the total amount available to you to invest at that stage in life and you've got $250,000 to invest. Again. I encourage you to go back to the mutual fund calculator and put in your own numbers Future planned contributions. I'm going to leave it at zero. Now. Most people invest regularly every month or every year. You start with $50 a month or $100 a month or $200 a month towards their future savings. In this case, I'm going to leave it at zero. Okay, we want to keep the example simple. So we're going to assume that this person in this example is going to start off with $250,000 to invest and they're not going to put a penny more in this investment for the next 25 years. So that's our time horizon and the rate of return I showed you at the beginning of this episode, the rate of return for the last 10 years in the Dow Jones has been 10.42%. In the SNMP 500, it was around 11%. I'm going to take a very conservative number here and put in eight as a long term rate of return. So let's stick with eight. And when it comes to the mutual fund expense ratio ETF fund or each index fund, we're going to go with the average that we showed you earlier. So I'm going to use 0.85%. So when we put all of these numbers into the mutual fund calculator, this is what you get. So $250,000 invested after 25 years in the Dow Jones index in those 30 companies will be worth approximately $1.7 million. So that sounds pretty good. But if you had invested in index funds or ETFs or mutual funds the fees you will have lost over $306,000 in fees. So that's really important. I'm going to say that again you will have lost over $306,000 in fees. I would rather you save that money for yourself and reinvest it elsewhere, because that is a lot of money. Even though the fee is less than 1% it's only 0.85. But it adds up over 25 years. The cost of fees adds up. So what you're left with after 25 years, instead of being left with a portfolio worth 1.7 million. It's going to be worth 1.4 million, so the fees are taking a very heavy toll on your investments. So when we compare investing in index funds and ETFs versus individual stocks, we can see that individual stocks are going to put you way ahead. So let me share with you a quick model portfolio based on the Dow 30 companies, and then we'll come back to our slides here. So what you can see here on the screen is a list of the 30 companies that make up the Dow Jones Index. So I've put the company names here. The stock symbols are here. This is the quantity of shares in this model portfolio. This is the share price as of this, recording the dividends, as of this, recording the dividend yield and the current expected annual dividend income, and then the market value of the shares that you own. So what I did is I took the same to you $250,000 divided by 30, because we have 30 companies, so it's approximately $8,300 in each of the companies. So I've taken the $250,000, divided it equally and spread it across the 30 companies, and so if we scroll down a little bit, you can see that the total model portfolio is approximately $250,000. And we can see here that this portfolio, if purchased today, would provide you in 12 months $6,767 in annual dividend income. Now, hopefully, this income will grow next year and the year after that and the year after that, because these companies have a list, have a history sorry, not a list have a history of growing their dividend every single year. So now let's take a look at what this investment $250,000, could be worth in the future. So here we are, using a spreadsheet to forecast. So it's not going to be 100% accurate, but we're forecasting, we're estimating what we think our portfolio will be worth. And again, I've taken the exact same numbers. So $250,000 to start with, and additional contributions zero. So we've kept it the same. The dividends earned annually is approximately $6,700. That's what we saw in the previous spreadsheet. So that's approximately the same. And what I did is I took the average dividend yield, which is 2.7% today for all 30 companies on the Dow Jones index. So that is their average 2.7%. Then we've added, of course, keeping it conservative stock price growth over time, dividend growth over time. So that's all going to get calculated in here and we can see that we end up with $1.7 million approximately, which is very close to the number that we saw when we used the mutual fund fee calculator. So this goes back to what I said before. If you invest individually in the stocks or you invest in the index fund or ETF, your rate of return is going to be the same. However, the big thing is going to be the fees, and you can see that the fee is not small. It's over $306,000 over 25 years. So the longer you invest, the higher the fees will be. The more money you invest, the higher the fees will be. The better the fund performs, the higher the fees will be, and the more you contribute regularly, monthly or annually, the higher the fees will be. So we want to avoid those fees if we can as much as possible. So here are some of the benefits of investing individually in those stocks. You have control over what and when to sell, so you can decide. For example, if Walmart is way higher than IBM, you may decide okay, well, I'm going to sell some of the Walmart shares. I need some of the money. I'm either in early retirement or getting close to it, or just you need money for children's education or anything you can. You have control over that with an index fund or an ETF, you cannot specifically pick and choose which stocks to sell, which also means you have no control over when you incur taxes when you're investing an index fund or an ETF or a mutual fund, whereas, again, here with individual stocks, you can control when you incur capital gains or any the dividends coming in right, so you can invest more or less in specific companies that might be paying more or less in dividends. Now, of course, if this isn't a 401k or IRA or RSP, for example in Canada, or a TfSA, the dividends and the capital gains will be tax free. But you do have control when you invest individually in the stocks and you also have control over the weighting of the stocks. So if you're investing individually and you really like I don't know Intel more than you do IBM then you could put an extra $100, $1000 in one company versus the other right. The model portfolio I showed you was just taking the 250,000, dividing it equally by 30. But in real life you don't need to divide it equally by 30. You can put more money in certain stocks that you like, or maybe they have a higher yield, so you could do that. But again, with mutual funds and index funds, you don't have that choice. Your money gets divided equally and put into those accounts. And one of the things I want to mention too, is because you have control over what and when to sell. When the market tanks, you could sort of just hang in there and say you know what? I'm going to hang on to the stocks, I'm not going to sell anything. I'm a long term investor when it comes to index funds, etfs or mutual funds, any type of fund. When the market tanks and investors call the company and they want to redeem their money, those companies have no choice but to sell the underlying investment to be able to pay the investors back. And the worst time to sell is when the market is down, when it tanks, because then you're going to solidify your losses. So when that happens, everybody loses, everybody who owns that fund. So even if you own the fund and you want to keep your money, well, the value of the fund has now come down because other investors wanted their money back and the company had no choice but to sell the underlying investments, which was the stocks, okay, and then the big one, of course. The last thing on the list I've already reset it, I'm going to repeat it again is you avoid paying the fees with individual stocks, and you can see that it is a big number. So does this mean that you should go out and buy all of the Dow 30 stocks today? And the answer is no. There's a couple of more things that we need to look at right. Our approach to investing is to invest safely and Reliably for the long term. How do we do that? We invest in quality dividend stocks when they're priced low, so not every company today in the Dow Jones index is priced low. Some of them are priced high, so we want to make sure we're buying them at the right price. Not all of the companies on that list today have debt, have low debt or have a low payout ratio, so we want to check those things. So how do we know, when you're looking at a company, if it's a quality company and how do you know if it's priced low? So for that, I've created what I call the 12 rules of simply investing. You can see them up on the screen here and for those of you listening, I'm gonna go through them right now. So this is your checklist. If a company fails even one rule, skip it. Move on, even if it's in the Dow Jones index. Skip it will have to be patient. Eventually, the company that are well, the companies that are well managed, will become financially healthy again, and they're they will become quality companies again. So this is your checklist. You have to make sure a company passes all of the 12 rules before you invest in it. Rule number one Do you understand how the company is making money? If not, skip it, move on to something else. Rule number two 20 years from now, will people still need its product and services? Rule number three does a company have a low-cost competitive advantage? Rule number four Is it recession proof? Rule number five Is it profitable? Rule number six Does it grow its dividend? Rule number seven Can it afford to pay the dividend? And rule number eight is the debt less than 70%? Rule number nine avoid companies with recent dividend cuts. Rule number ten does it buy back its own shares? Rule number eleven is the stock priced low? That's where we check the PE ratio, the PB ratio, and we compare the current yield to the average 20-year yield. And rule number 12 keep your emotions out of investing. So for those of you that are interested, I've created the simply investing course. It's an online, self-paced course. It's made up of 10 modules, and Module number one covers the investing basics. Module two covers the 12 rules in detail with real-life examples. Module three, I show you how to apply the 12 rules. Module four Show you how to use a simply investing platform. Module five, placing your first stock order. So we cover that in module five. Module six, building and tracking your portfolio. Module seven went to sell, which is just as important as to know when to buy. Module eight, reducing your fees and risk and we talked about some of the fees today. Module nine, your action plan to get started right away. And in the last module, I answer your frequently, most frequently asked questions. We also have the simply investing platform, which is a web app, and in that app we cover all six thousand companies in the US and in Canada and we apply the rules to all of those companies every single day. So when you log in, you can immediately see which companies you should avoid and which companies you should consider for Investing. So if you're interested, write down the coupon code save 10. Sa. Ve 1 0. This is going to save you 10% off of our course or the simply investing platform. If you enjoyed this video, be sure to hit the subscribe button. Hit the like button as well and, for more information, take a look at our website Simply investing comm. Thanks for watching.

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