[maire]

I actually investigated this strategy (only buy index funds) because it was highly recommended in a book my daughter read. I thought it was bogus and it turns out that it is.

I haven't been an active investor for 15 years so it took a little time to fire up my investing analysis tools. This is what I found out.

Index funds are highly incestuous. There is a high correlation across the top index funds because they largely have the same stocks. The exceptions seem to be reits, oil, foreign, and financial index funds.

The rest of the index funds all seem to be heavily weighted in big tech stock.

So - if that is true, why not buy the heavily weighted stocks directly and do your own financial analysis on them? For instance, I look at past 5 year sales growth. Then I look at yoy sales growth. Then I look at P/S over the last 5 years (to see if it is out of whack). Then I look at PEG over the last 5 years (to see if it is out of whack). Then I look at gross margins. Then I look at dividend yield. All of this data is available for free.

[atombender]

It's a little tone deaf to claim that index funds are "bogus". Your average American worker is not going to be better off doing what you do, as opposed to throwing it all in VT/VTWAX or a Vanguard target date fund.

Index funds accomplish three things, as I see it:

* By investing in a broad basket of stocks, you can eliminate unsystematic risk. This was shown by Harry Markowitz in his landmark paper that established modern portfolio theory.

* By using an index that weights by market cap, you get, at any point in time, what the market thinks the value of the stocks are.

* By letting a management company track the index for you, you take all the work and emotion out of it.

"Building your own index" like you suggest is feasible, but a lot of work. Turnover can also be a real problem in a taxable account. My suggestion to anyone who wants to do this sort of thing is to use M1 Finance, which automates the trading for you. You just set the percentages and go. I think it could be an enlightening way to manage a small amount of "fun money", but I wouldn't do this for everything.

Lastly, there are absolutely mutual funds and ETFs that screen by financial criteria the way you're doing. Look at the Russell RAFI indexes, for example.

[maire]

My favorite book on investing is The Intelligent Asset Allocator by William Bernstein. This is what made me aware of issues in correlations.

I still believe in diversification. If an ETF is sufficiently diverse I will buy the ETF. Some ETFs are not - XLE is nearly 50% Chevron and Exxon!

You should also read Taleb if you want to understand the fallacy of unsystematic risk. He is difficult to read because of his overinflated ego but he has some persuasive ideas.

[atombender]

There are plenty of bad ETFs out there, sure.

[maire]

Here is my correlation between QQQ and major sector ETFs going back to 2005 when Bond ETFs were introduced.

QQQ 1 XLK 0.9952440282 VCR 0.9813656495 SPY 0.9774334512 VHT 0.9749607257 DIA 0.9738966572 XLI 0.944646275 MDY 0.9418372572 XLP 0.9340495871 XLU 0.9322048846 VBK 0.9749569179 TLT 0.8238447288 IEF 0.7459539935 LQD 0.7698459752 VNQ 0.7211819234 SHY 0.5117276512 GLD 0.4880148474 XLF 0.4715141612 EFA 0.2721585482 XLE 0.04648142997

[atombender]

What is your formula? This doesn't match what I'm used to. For example, TLT has an inverse correlation with the US stock market (-0.32 according to PortfolioVisualizer.com), so I would expect it to be inversely correlated with QQQ.

[maire]

Yes - some periods TLT does have negative correlation to QQQ. I was pretty surprised when I saw this since Bernstein did not see this in his analysis.

As I said it had been 15 years since I have been actively managed my investments. When the stock market dropped I was surprised that our investments hadn't actually dropped so I wanted to find out why. So I put together a google sheet and tried to replicate the Intelligent Asset Allocator with just ETFs. This only goes back to 2005.

First I put in all of the ETFs with weekly data going back to 2005 from GoogleFinance. I then added in the dividend yields - which most online analysis does not do. Then I just used the google sheets correlation function. I set up the sheet so I could slice and dice across different time periods. And then I chose my own asset allocation based on what I saw.

I also looked at the optimal rebalancing period. It looks like it is 2 years for this set of data.

[loco5niner]

> So - if that is true, why not buy the heavily weighted stocks directly and do your own financial analysis on them? For instance, I look at past 5 year sales growth. Then I look at yoy sales growth. Then I look at P/S over the last 5 years (to see if it is out of whack). Then I look at PEG over the last 5 years (to see if it is out of whack). Then I look at gross margins. Then I look at dividend yield. All of this data is available for free.

I'm not really sure how to do all those things, and I'd rather spend that learning how to make database things work.

Also, it sounds like all you're doing is looking at (very recent)past performance (not a predictor of future performance), and putting all your eggs in one basket (big tech).