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“Coffee Can” Approach to Investing – But is that a Blackberry or Apple iPhone inside that Can?
Portfolio rebalancing is hard, especially during volatile times
Warren Buffet has always favored low-cost index funds for investors. Back in 2008, he even placed a million-dollar bet against a hedge fund manager that the S&P 500 would outperform a portfolio of hedge funds over 10 years. Buffet won that bet by a landslide in 2018.
One key benefit to investing regularly in an index fund is that it automatically weeds out weaker companies over time. A case in point is Peloton ($PTON), which was dropped from Nasdaq-100 in January 2022, just a year after it was added in December 2020. Nasdaq rebalances its constituents annually, based on a list of clear-cut factors, including share price performance. Peloton lost so much market value over the course of 2021, it was no longer eligible for index inclusion.
In this example, the benefit to investors of index funds mirroring Nasdaq-100 would have been minimal exposure to Peloton. Not only was it just one of 100 stocks, but a regular investment plan would limit Peloton exposure to just a year. And Nasdaq-100 does not consider if the company will make a comeback due to Barry McCarthy of Spotify fame, or John Foley learning his lessons from overexpansion. It is a dispassionate exclusion from the index – until Peloton does indeed make a comeback and share price recovers.
Compare that with a “Coffee Can” approach to assembling a customized portfolio. The onus is on the investor to decide if the coffee can is holding Blackberry equivalent companies, or the next Apple Inc. When red flags start to show for an investment – and they always do, even Apple Inc. has shown more than a few over the course of its corporate life – does one continue to hold, double down, or drop it like it is hot? Such contemplation would not be necessary investing in index funds.
Therein lies a major issue with a “Coffee Can” approach to investing. It is not a buy-and-forget strategy. Investors need to be on the constant lookout for stinkers wrapped in perfume to discard them, but keep the gems covered in dirt. Sometimes, the two can be indistinguishable from one another. Back in 2018, when Tesla ($TSLA) was having major issues ramping up Model 3, Elon Musk described the company to be edging close to bankruptcy. If it had not succeeded in overcoming “production hell”, Tesla would likely be worth only a fraction of what it is today. Looking back, it could have gone either way.
As markets continue to drop, punters (or investors) are dropping a multitude of high-growth companies over the slightest earnings miss and lowered guidance, for fear of holding onto Blackberry equivalent stocks. On the other hand, some continue to hope that their investee companies will reclaim AND exceed their previous all-time highs.
No one really knows – everything will only become clear in hindsight.
Since 2013, when Tesla was first included in Nasdaq-100, it had missed all sorts of guidance and street estimates. If investors had dropped Tesla from their portfolios anywhere between 2013 and 2018 – because it was looking like a real stinker at times – their coffee cans might look deficient today. Note that Tesla has never been excluded from Nasdaq-100 since 2013. On the other hand, holding onto Peloton, even after it had been dropped by Nasdaq-100, would have been regrettable today, though one may argue that its eventual fate is still indeterminable.
Perhaps Warren Buffett is right about investing in index funds. It is hard for investors to make rebalancing choices. Try as we may to avoid stinkers, we could still end up throwing out gems, and be left holding a coffee can full of Blackberries.
The Nasdaq 100 might do a better job at rebalancing after all, because it has no false hopes or fear.
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