74 ATaleofTwoMarkets
and inclination to conduct business analysis. While using an index
fund gives a reasonable assurance of obtaining the average market
return with very little effort, the investor should still have some rea-
sonable basis for believing that the basket of stocks that constitutes
the index—whether the S&P 500 or something else—is cheap rel-
ative to the value it contains. Making such a decision requires some
sense of the business analysis discussed in this boo keven if it does
not require precise or detailed application of it.
Monitoring of fundamentals is plain common sense. Buyers of a
market index need to know what value they are getting, just as buyers
of shares do. Both can fluctuate on the upside and the downside.
There is no assurance that the overall stoc kmar ket will go up any
more than there is any assurance that attendance at major league
baseball games will go up. Both can and do go down.
Patience while holding is not as valuable as research before buy-
ing, for many bear markets extend for long periods of time. Whether
a market is heading up or down is impossible to predict, even over
long periods, whereas there is at least some possibility of predicting,
over long periods, which way a particular stoc kis li kely to go.
Stoc kmutual funds are managed portfolios consisting of selected
stocks from the broader market. An investment committee regularly
buys and sells stocks for the fund. The fund’s shareholders pay the
costs of these trades, plus other fees, making mutual funds more
expensive than index funds. They are also more expensive from a tax
standpoint. Mutual fund portfolio changes often produce capital
gains, and shareholders pay the taxes.
The tax consequence of mutual fund ownership shows an ad-
vantage to holding individual stocks. When you make a mistake in
purchasing a stock—it declines in both price and value to the point
where it no longer meets your requirements for holding it—selling
it at least gives you the modest brea kof a tax deduction for the loss
on the sale.
For individual stocks, regular and periodic investing in dividend
reinvestment plans (DRIPs) using the concept of dollar-cost aver-
aging is a sensible alternative for many people. All this concept
means is that regular purchases of a particular stoc kin set dollar
amounts each month (or another interval) lower the average cost of
those shares compared to the average of the prices when the shares
were bought. It insulates an investor from the effects of Mr. Market’s
euphoria by taking advantage of his episodic gloom.
Suppose you invested $200 per month in Procter & Gamble dur-