Is it market acumen or just luck?
While rereading an investment book, I was reminded of something individual investors tend to lose sight of. When someone does well in the equities market, it’s probably due to luck, nothing more.
I realize for some these is fightin’ words. But think about it carefully for a minute. By definition, half of the investors in the market (this also applies to actively managed mutual funds, but I’ll use ‘individuals’ for simplicity) will beat the market average over any given time period. That means before fees, you have a 50% shot of beating the S&P 500 (or whatever index you want to use) this year, maybe by a lot. Sounds great, doesn’t it? Except so does any randomly selected stock.
Let’s look at it another way using the old flipping a coin analogy. If you have 100 people bet on whether a coin toss will come up heads or tails, 50 of them will get it right (unless you’re in an MIT lab). After the second flip, 25 get two in a row right. Continuing on, at toss five, three people have guessed all five tosses correctly. They’re coin toss geniuses! They must ‘know’ something the others don’t. Or maybe they’re just lucky.
Psychologically, people want to believe there’s a reason for success. In my opinion, the equity markets are just random. Bill Miller, manager of the Legg Mason Value Trust mutual fund, was ‘right’ for 15 straight years, beating the S&P 500 average each year. Is he a supergenius or just that last guy standing in the coin toss experiment? I’m saying it’s the latter. (Incidentally, in 2006, Miller’s streak ended when his fund earned 5.85% versus 15.75% for the S&P.)
The whole point of this post is that picking stocks, either as an individual investor or via an actively managed mutual fund, is a loser’s game for all but the luckiest individuals. As a long-term investor, I prefer to focus on things I can control (fees, taxes, allocation) rather than those I can’t (luck). That said, if you truly enjoy trying to find the next Google then go ahead and try. But if that’s your retirement plan and you’re not Bill Miller, you’ll be in for a rough ride.
individual investors, investment, legg mason, luck, mit, mutual funds s&p 500
May 14th, 2007 at 8:46 am
There are a lot of people who invest in value and growth stocks who do match or exceed the S&P. With the ability to trade even for free online now, fees aren’t a concern, with only capital gain taxes the main issue.
Investing in solid stocks who show good future potential is a viable, riskier, and fun way to make money. You either need to be good at this yourself (which admittedly can be difficult) or subscribe to one of the investment newsletters that has been around for awhile and has a proven track record.
Index funds aren’t the only way to invest, they’re just the easiest and safest for a decent return, and all the rage thanks to people like Malkiel and Bogle. If anything they’re much better then a lot of the mutual funds people are invested in, they’re just not the only option like they’re often made out to be.
May 14th, 2007 at 1:37 pm
It is very very hard to beat the market. I have actually done it this past year. There is no guarantee that I’ll be able to continue to do it; hence the question - will I be able to beat the market over the long term? Don’t know, I’m going to have to find out the hard way!
I surprised myself with my stock picking this year. I’m actually getting good at it. But if I am unable to consistently beat the market, then there is the possibility that over the long haul, I’d be better off in index funds. I don’t think that will be the case, but we’ll see.
May 14th, 2007 at 2:37 pm
Early on in my “investing” career, I made a lot of money on a few stock picks. Notably, I doubled my money in a short while on MOT. I made a bundle on IBM. I felt invincible.
Then I bought some RFMD. Turns out I wasn’t so invincible after all. Since then my picks have been hit and miss.
And yet we hear about lots of people who seem to pick winner after winner. The problem is that people are all too eager to talk about their double- or triple-bagger, but a bit more reluctant to talk about the stocks they’re losing money on.
May 14th, 2007 at 3:55 pm
May 14th, 2007 at 7:40 pm
May 15th, 2007 at 8:07 am
And the fees in the 50 win - 50 lose stock picking game are equivalent to the juice that bookies charge in sports betting. They are the oil that greases the “investment advisor” industry. In fact, is stock picking any different than gambling? Well, in the sense that the outcome is not entirely statistically random, yes. But Ibbotson and crew have done a fairly thorough job demonstrating that in fact, the cycles of the economy create the same unpredictable but 50/50 outcome of games.
That being said, many many intelligent individuals can see the particular signs of change and benefit from it. One example of that phenomenon would be people that simply sold and walked away from perfectly good homes in 2005/early 06 because they could smell a crash coming. Or those that thought the internet boom was just as fraudulent as it turned out to be. Some people realize that when the dumb jerk in your office finally starts talking about something, it’s time to run from whatever that is.
May 15th, 2007 at 9:07 am
Micah,
You’re correct about macroeconomic trends. I find it reasonable to suggest that a person can adjust investment allocation based on their opinion of where the economy is headed. But timing those moves is akin to timing the buying and selling of an individual stock - you’re very unlikely to hit the top or bottom exactly.