The Peloton

A peloton is a thing of beauty with hundreds of cyclists riding as one.  It moves like an enormous, colorful snake as it serpentines across valleys and over mountain ranges.

According to Merriam-Webster’s dictionary “peloton” first appeared in 1951; coined by the French to mean “ball.”  A giant ball of cyclists hurtling through the country, shifting gears in unison, and rising from their saddles in perfect harmony is an amazing site.

A peloton is extremely efficient as riders use each other to propel themselves faster.  It can travel at speeds of more than 30 miles-per-hour for a long time.  The lead rider does most of the work while the others in the middle the pack use about 40% of their energy.  When the lead rider gets tired he’ll move to the side to let the peloton pass and then he’ll hitch a ride to the back of the pack and conserve his energy as he works his way back to the front of the group.

The Tour de France is a three-week race with 21 stages covering 2,200 miles. It starts at sea level, traverses through the French Alps and finishes in Paris near the Arc de Triomphe. It’s a long race and the peloton is a useful resource for the riders to utilize so they can finish the race.

When I watch the Tour de France I’m intrigued when two or three riders break away from the pack.  They’ll mount an attack to separate themselves from the peloton by pedaling at a furious pace; hopefully catching the group by surprise.  The goal is to win a stage and finish several minutes ahead of the other riders.

A breakaway is exciting.  On-lookers, announcers and teammates cheer the small pack of riders on and wish them the best. It’s a game of cat and mouse that can last for hours. However, in the end, the riders usually get swallowed by the peloton and finish the stage well behind the winners.

In investing terms, the peloton is like an index fund and the breakaway group, an individual stock.  An index fund is efficient because it benefits from the collective wisdom of millions of investors owning thousands of stocks.  A few of the more popular index funds are the Vanguard S&P 500 Index Fund (VOO), the iShares S&P 600 Small Cap Index Fund (IJR), and the Dimensional Fund Advisors Emerging Market Fund (DFCEX).  These funds returned 21.77%, 13.15%, and 36.55% in 2017, respectively.

When you own an index fund you don’t have to worry about picking the best stock or owning the right sector.  With a diversified basked of low-cost mutual funds, you’ll own thousands of companies, across several sectors domiciled in various countries.  It would be financially impossible for most investors to replicate a portfolio of index funds by picking individual stocks.

Stock picking is fun, and it may produce a few winners over time.  Like a breakaway rider, you may win on occasion.  However, it’s not possible to consistently beat the stock market and your stock portfolio will eventually be passed by the market.  Morningstar tracks over 110,000 stocks so how’s it possible to pick the best two or three companies each year that will outperform the market?

Dimensional Fund Advisors did a study on stock performance from 1994 to 2016 and they found that if you owned a portfolio of stocks from around the world your returns would’ve averaged 7.3% per year.  However, if you excluded the top 25% of performers each year you would’ve lost 5.2% annually.[1]

If you have a strong desire to pick individual stocks, keep your allocation to 10% of your portfolio and invest the remaining 90% in a diversified portfolio of low-cost mutual funds.

A bike has many moving parts all designed to help the rider; a peloton will use these features to move closer to the winner’s podium.  As you build your portfolio, don’t go it alone, harness the power of index funds along with the guidance of a Certified Financial Planner®!

Happy Cycling!

Life is like riding a bicycle. In order to keep your balance, you must keep moving.” ~ Albert Einstein.

A person standing alone can be attacked and defeated, but two can stand back-to-back and conquer. Three are even better, for a triple-braided cord is not easily broken. ~ Ecclesiastes 4:12.

 

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

January 18, 2018

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.

 

 

 

 

 

 

 

 

[1] DFA Funds, Investment Principles, Diversification My Prevent You from Missing Opportunity, 1994 – 2016

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