It is time again to write down a few thoughts about investing. I started writing my thoughts on investing in my first blog post in 2017. Then I provided an update in another post in 2022. Also got a couple other posts that relate to the topic. In any case, I feel that now is a good time to provide some updates and look at how my capital allocation strategy has changed over the last few years.
Dividend Stocks
Originally my investments focused primarily on dividend paying stocks. But lately I have started to see the negative aspects of that strategy. My portfolio still consists mostly of dividend stocks and I have no intention of selling them. They still churn out steady dividends every quarter which is nice. But for adding new capital, I am focusing mostly on growth stocks and index funds.
In my opinion, investing in dividend stocks has three problems in particular:
- Tech stocks such as Apple, Amazon, Google, Microsoft and Tesla have greatly outperformed so called value stocks during the last two decades, which are the ones that tend to pay dividends. An investing strategy that has emphasized dividend stocks has missed all this upside from high-performing tech stocks.
- Dividends are not tax efficient because dividends are taxed when they are paid out. Capital appreciation is only taxed when you sell, which can be even twenty years later, so you can potentially postpone that taxation far into the future.
- Investing in dividend stocks often means buying "quality" companies and then holding them forever. These established companies will usually do well when the timeframe is a few years. But when considering extremely long periods, such as 20 or 30 years, then a significant fraction of them will disappear or become obsolete, replaced by newcomers and disruptors.
On the other hand, dividend stocks are excellent choice for an investor who actually needs the income right now. That is why many people in retirement prefer dividend stocks. But in my opinion they are not the best choice for younger people.
If I had to start over dividend investing today, I would probably choose an ETF instead of investing in individual stocks directly. If you hold a portfolio of 10 or 20 individual stocks, many of them will cut or eliminate their dividends over a very long time horizon. This negative effect is greatly reduced when holding a fund that contains 100 stocks for example.
On the other hand, a dividend ETF like SCHD is flat for the last 4 years (Nov 2021 to Nov 2025), while the Nasdaq index is up almost 50% over the same period. Sure, the situation could be reverse for the next 4 years, but given how fast technology is developing right now (and AI specifically), that does not seem likely. This underperformance of dividend stocks emphasizes that dividend focused strategy is more suited for older investors who actually need the income to live on.
Index Funds
I have began to prefer index funds, ETFs in particular, over individual stocks. It has been shown time and time again that most investors who try to pick stocks underperform indexes. Being a stock picker at a minimum requires spending lots of time analyzing individual companies. While I somewhat enjoy looking at companies, there are other things I enjoy even more for spending my limited free time. Therefore I think it's better to spend time working and earning money, the old fashion way, and then invest passively into index funds that don't require much research.
I like ETFs over mutual funds because they can be traded similar to individual stocks. I can open a chart and see the current price as well as the daily price ranges. That makes it more real for me. Mutual fund trades are executed once per day, at some price I don't see or understand. Also, I can set a limit order and only buy if the price hits a certain level. Limit orders can be very beneficial because ETFs can have a wide price range even during a single day, especially when there is a special situation like a market crash.
The S&P 500
Regarding index investing, the S&P 500 is the most popular index in the world, and it has delivered exceptionally good returns over the past few decades. I have been thinking about the reasons behind the success of the S&P 500 index. I believe there are two main reasons why the S&P 500 has been so successful, and why it will likely continue to perform well in the future.
First, it is a market-cap weighted index instead of equal weighted index. This means that companies have weight in the index in proportion to their size. Why is this a good thing? Well, turns out that often there are only a handful of companies, maybe 10 or 20, which are really driving the economy forward at any one time. These market leaders are companies that deliver really exceptional returns over a given (short) time period. For example, NVIDIA that has been the biggest benefactor of the AI boom during the last few years. As a result, it has grown to be the largest company by market capitalization, and also the largest constituent of the S&P 500 with almost 8% share of the index currently. In an equal-weighted index the share of NVIDIA would be 0.2%. So an equal weighted index would have missed all the upside of the hot AI stocks, while the market-cap weighted index has captured a good chunk of that. Similarly, if the AI boom cools and another group of stocks takes leadership of the market, the S&P 500 should keep performing well, as their proportional share of the index grows accordingly.
Secondly, the S&P 500 is not just a passive index, but it is actively managed in the sense that poorly performing companies are kicked out and new companies are added. And the selection of companies is not strictly rule-based but consists of an actual committee of humans that make the selections. The brutal truth of capitalism is that poorly performing companies often tend to continue to perform poorly for many years, if they ever recover. By keeping them in the S&P 500 would be a constant drag on the index. So it is very important to clean out the trash so to speak, and replace them with upcoming and fast growing companies. I believe this has been another key factor in the good performance of the index.
For these reasons I will continue to prefer the S&P 500 over other indexes in the future as well. I also have some money invested on the STOXX Europe 50 index, but sadly the European economy is very far behind America in innovation. The EU tends to be good at ever increasing regulation, not for creating best conditions for businesses to succeed. We don't have any big tech companies in EU (except maybe SAP, if you count it), and feels like we are a lightyear behind in AI.
Individual Stocks
Despite mostly allocating new capital towards index funds, I still like to dabble in individual stocks now and then. That is mostly just for fun and represents a smaller share of my portfolio. It is more to spice things up a little so investing doesn't get too boring. Although I have heard it said that boring is good when it comes to investing! And of course it is more interesting to focus on those growth stocks that have realistic potential to double or triple instead of the steady dividend stocks.
Dangers of Real Estate
I have not invested in real estate except for one apartment building in Turku. I have also used it as my home, so of course it is not a pure investment. But part of the time it has also been rented out. In any case, this apartment has been a financial calamity, and actually the worst financial investment I have ever made. The value was roughly 80k when I bought it, which was maybe 10 - 15 years ago (I don't remember exactly). Today the value is the same, about 80k. Having no appreciation over a decade is horrible already, but the real kicker is that the apartment has accumulated about 40k of debt meanwhile due to extensive repairs. Not repairs that I have chosen to do, but repairs that have been collectively decided by the apartment management which every shareholder had to accept. Of course those repairs were necessary because it is an old building. But it still shocking that the apartment has practically lost half of its value! It's shocking that 40k worth of repairs do not show up anywhere in the current value of the apartment!
Take this as a cautionary tale about investing in real estate. Thinking realistically, it is to be expected to lose money when investing in a new asset class for the first time. If I had invested in 10 apartments and gained more experience in the process, I might have performed better in the later ones. Of course there is a same learning curve in stocks and you should not be shocked to lose money when buying your first stock. The difference is that you can get into stocks with much smaller amounts than real estate. With such a negative experience, right now it feels unlikely that I will invest in real estate again. Unless it's some great deal that is a no-brainer. But you just can't beat liquidity and efficient price discovery of public stocks!
Estonia
I have also invested small amounts in some Estonian stocks through my personal company Laiho Consulting OÜ that is based in Tallinn. The performance of the Estonian economy has been horrible in recent years so it is no surprise that those stocks have not performed particularly well. But the Estonian companies will reap the benefits when the economy picks up and gets going again. Hopefully that happens sooner rather than later. And I say that more for the sake of the Estonian people than investors.
Bitcoin
Bitcoin has had rough two months as I am writing this post, hitting over 120k in October and now hovering around 85k. I opened a small position through an ETF. Yes, we now have Bitcoin ETFs and it is awesome! The price will fluctuate but I don't see Bitcoin going away soon. It has now established itself as a very mature technology. These days Bitcoin is part of portfolio allocations for even many institutional investors. Therefore I think it is a good idea to keep at least a small allocation in it.
Gold
Then there is gold, our shiny friend that has captivated humans for millennia. And sadly I have to admit that I do not own any! It is only sad because gold is up over 50% year-to-date. This is on top of an already stellar year 2024. If you bought gold in January of 2024, you are now sitting on a 100% gain in less than two years. But at this point I have to admit that I missed the train. I am not going to buy gold now at the current levels. And it is unlikely that I will buy gold even if the price goes down a bit. I do not particularly understand where the value comes from, other than simple supply and demand, so I do not find it particularly interesting as an investment. If it doubles again in the next two years, please use that opportunity to tell me what a fool I was! But we investors have to pick our battles. Experience shows that chasing every asset, especially when it is trading at historically elevated levels, is a sure recipe for financial ruin!
Summary
Therefore a summary of my current investment strategy goes something like this:
- Keep my old dividend portfolio as is
- New money goes mostly to index fund ETFs
- Dabble in individual stocks and Bitcoin to keep things interesting
I have really enjoyed writing a blog post again. I cannot believe I have only written one this year until now! I really hope I have the chance and free time to pick up the pace in the future.