I think there must be investors who have made the switch from indexing to stock picking. I think it makes all the sense in the world to proceed that way. Indexing is best for those who don’t have the knowledge base to pick stocks effectively (which is most of us). But stock picking delivers better return for the small number who really know what they are doing. The smart thing is to start out indexing and then over time shift to stock picking.

I agree that it is probably a greater number that starts out stock picking and moves to indexing.

Rob

I asked because I’m curious how other people feel about the question. Many index investors seem to be mostly, but not entirely, indexed–they still use a portion of their portfolio to try other strategies. I always find it interesting to hear the motivations behind that.

I think part of being a successful oblivious investor is knowing what’s worth listening to and what’s not. That means realizing that trying to reduce risk by hedging with options as insurance for long-term investors is nothing but noise.

There is no need to insure your investments against a decline in value as long as you are not planning on selling them. Mark Wolfinger is essentially advocating buying trip insurance for a trip you’re not even going to take. Insurance only lowers risk when there is a real risk, not an imagined one. Otherwise it just costs you with no real benefit, and limiting your gains is definitely a cost.

Also, Mike asked, “do you ever feel that you’re missing out because your funds are guaranteed to never outperform the market?”

The market is comprised of investments and investors. You are guaranteed to never outperform the aggregate of investments (because of costs), but your are guaranteed to out perform the aggregate of investors (because of costs).

But does performance relative to anything other than the ability to most efficiently fund one’s own goals really even matter?

After seeing these huge losses, I began doing research and have decided to invest heavily in index funds from this point forward.

I have only recently realized the incredible importance of investing and would like to thank Mike, JD, & many others for their excellent advice, and sometimes painful trial & error that have saved me (and many others) from having to reinvent the investing wheel.

Purchasing a put (the first part of a collar) certainly reduces risk. But it comes at a cost. I think that much is obvious.

Selling a call (the second part of a collar) raises cash, but limits your upside.

Even if the cash from selling the call covers the cost of the put, you still have to account for the fact that a limit to your upside is a real cost–that is, a decrease in expected return.

(If it were not a real cost, selling covered calls–whether as a part of a collar, or simply on their own–would always increase return. And I suspect that is not really the case.)

In short, yes, a collar will reduce your risk. But that reduction in risk comes at a cost. Is that any better than simply reducing your stock allocation (which would also reduce risk, but at a cost of decreasing expected return)?

Can we take this discussion to email if you’d like to continue it? This isn’t what the post is about at all.

The cash from the call sale is usually sufficient to pay for the puts. Sometimes you collect a little extra, sometimes you collect a little less.

Those call options act as a cap on potential earnings, but in return – you get insurance. If preservation of capital is the goal – and I admit it’s not for everyone – then this is an ideal way to achieve that goal. And this strategy can be used on a portion of one’s portfolio. This is not an all or nothing approach.

Not everyone wants that insurance, but for the conservative investor who does, collars truly protect assets.

I apologize for not replying to other requests for more information.

How can you also say that that is “at no dollar cost”?

I’ve asked you that question (in various forms) on several occasions, and you have yet to answer.

I’m not trying to be snide here–I’m genuinely curious.