I’ve always wondered what a professional gambler’s portfolio would look like. Would it be a broadly diversified portfolio of penny stocks with a Kenny Rogers box set and a shot of whiskey to boot? Or perhaps, it would contain none of these worldly possessions. How would a gambler invest his or her winnings? I recently got the chance to find out.
A few weeks ago, I was contacted by a professional poker player from Los Angeles who asked me to examine and grade his investment portfolio. He was listening to my weekly radio program, the Index Investing Show, and heard me evaluating and grading another listener’s investment portfolio on the air.
He had $60,000 in his IRA from a 401k rollover and another $90,000 invested in a self-directed taxable brokerage account for a total value of $150,000. The money for both accounts was evenly divided across seven stocks — Google (GOOG), Bank of America (BAC), Celgene (CELG), EOG Resources (EOG), General Motors (GM), General Mills (GIS), and Whole Foods (WFM).
One of the investment philosophies I try to instill in my audience is to prioritize their investments.
In this regard, a person’s core portfolio (or investment foundation) always comes first and should always obtain the lowest-cost market exposure to all the major asset classes by using efficient vehicles, preferably ETFs. After you’ve completed Step 1, you can graduate to Step 2 and focus on building out your noncore investment portfolio, which is complementary to your core. (The noncore portfolio is typically strategic and can hold leveraged or inverse ETFs, individual stocks, options, futures, and other assets not held within the core portfolio.)
One of the problems with my gambler friend’s portfolio is that he’s tackled Step 2 before properly executing Step 1. It’s like trying to build the second floor of an architectural masterpiece without first completing the foundation. It’s a backward way to invest!
The other problem with this seven-stock portfolio deals with something all gamblers and investors should know: pure odds. What are the odds this gambler’s stock portfolio (built by an amateur) will outperform a simple index fund or ETF? The odds aren’t very good — look no further than the sub-par performance of the pros.
A five-year study examining the performance of professional stock pickers found that the yardstick outperformed their mutual funds 72.4% of the time across S&P indices linked to large companies (as tracked by the SPY), mid (MDY), and small (IJR). Put another way, people who put their money in index funds or ETFs tracking these three market segments had 3-to-1 odds in their favor! (To read more about the math, read “3-to1 Odds Favor Index Investors” by Rick Ferri.)
Winning the investing game is all about increasing your odds of success. And that’s why building a portfolio on a solid foundation of index ETFs helps you accomplish – the math doesn’t lie.
My final grade for this portfolio is incomplete because it lacks at least one-year of performance history. Anyway, it’s doubtful this seven-stock portfolio will outperform stock indices over the next year, let alone several years. For sure, it already flunks my test on risk and diversification.
What’s wrong with your investment portfolio? Ron DeLegge’s Portfolio Report Card will tell you. Is your portfolio well-built enough to score an “A”? If it is, Ron pays you $100.
Follow us on Twittter @ ETFguide